Thursday, December 04, 2008

Global Insight: Pushing the String Uphill?

Readers will recall that Global Insight is the firm used by the State of Wisconsin for economic forecasts. Those forecasts form the basis for revenue-side projections in the State's budgeting process.

Keep that in mind as you read the following.

The first story came out this morning, and quoted a report from Global Insight suggesting "the housing market is now slightly undervalued".

Here's GI's rationale:

...a conventional 30-year mortgage of $200,000 carries a monthly cost of $1,468 with mortgage interest rates of 8 percent. At 6 percent, however, a homebuyer could service a far higher $245,000 mortgage with the same monthly expense...

That's true; cashflow is a major element of home-purchase decisions, which has an impact on home prices. The same principle holds for variations in property tax--higher taxes tend to reduce the values of homes, if one bases the decision on cashflow alone.

Calculated Risk raises some objections, however.

But why would this push up prices as suggested by the Global Insight analysis? Prices would increase because of higher demand - not directly because of lower interest rates. A rational buyer wouldn't pay more just because the interest rate is lower - although they might have to pay more because the demand is greater. But the current buyer wouldn't pay much more, because the rational buyer would realize interest rates will probably not be artificially low when they try to sell, and their future buyer would have a higher interest rate and a lower price.

This suggests the Global Insight analysis is flawed, as is the "affordability index" from the NAR, or any other measure of house prices based on interest rates. In fact house prices are still too high as suggested by the price-to-income ratio and real prices.

Of the two objections from CR, I favor the red-highlighted one (one could add the price-to-rent index to bolster the argument.)

Housing purchases are not necessarily "rational" because there are a number of intangibles which are at play--e.g., location, school systems, conveniences, and family-size. Thus, the 'resale' value is not necessarily a factor.

This comes down to a fundamental: is housing an 'investment,' or is it 'housing'?

In any case, attempting to push housing values up by decreasing interest rates is questionable, because INCOME is key. And in an environment where income is stagnant, or decreasing, housing prices are necessarily going to decrease.

We concur with Calculated Risk: GI's analysis may be correct if one considers only the cashflow results of interest rates.

But the analysis is incomplete unless it includes price-to-rent, income-prospect considerations, and real-price realities.


Shoebox said...

It's basic supply and demand economics. If rates go down it takes less $ to make the payment. That allows more folks to enter the housing market. More buyers generally yield a higher price for the product, all other things being equal. Will it solve all the ills, nope. Are there other issues, yep. However, lowering the interest rate will have some positive effect on sales just like we've seen some increases taking place as some of the prices have seen big drops.

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