Monday, June 13

An impending Housing market bubble "bust" or a "controlled deflation"?

The link at the bottom of this message, goes to an article that discusses Interest Only (IO) loans and gives a list of a major metro cities with percentages of IO loans. It's an interesting study and maybe we can learn something about the housing market "bubble" from it. Naturally, IO financing is not the smartest or wisest form of financing. In a housing market bubbling as fast as this, and in the face of warnings and cautions of a bubble bursting, it is in fact unbeleivable. Leaving people's financing choices and prudence aside, if we look behind the numbers, there may be a different story to tell.

According to the Joint Center for Housing Studies of Harvard University's study on The State of the Nation's Housing 2005, the housing price increases do not appear to be speculative in nature. Under 6 % of houses in the most aggresively rising markets were purchased as second homes. According to the study, most households make a house purchase decision despite the fact that renting a similar house can be 30% cheaper in the hottest markets. This indicates, according to the study, that the average home buyer is not being speculative in the classic sense but simply optimistic based on current increases. Also, a very small percentage of homeowners are actually turning over the homes for a quick profit (although that number did rise by 1 % in 2005). This again indicates that it is not speculative. They attribute the housing price increases to restrictive land use and building policies by city councils in townships and counties surrounding burgeoning metro areas. This artificially creates a scarcity of land and thus raises existing home prices in the face of increasing true demand.

To distill something of importance from these two reports, it seems to me that one thing is striking. If housing demand is true, and short term interest rates are rising (thanks to the Fed), then the impending bust that everyone is talking about, will disproportionately affect those markets where there is a large number of unwise borrowers who are not taking into account the possibilty of defaulting when the interest rates rise on their Short Term Interest Only loans (ARMs and such). Thus, if there is a bust, it will most likely affect markets at the top of this list of IO mortgages. If you are looking to buy a home in one of these areas, it would serve to wait for a year or 2 or even 3 to let those homes come back on the market for lesser than they were bought, unwisely. As a corollary, if this were a correct hypothesis, then then so-called housing market "bust" will really be a controlled "deflation" largely localized in such IO islands across the nation and may as well serve to be a "boon" to the economy.

MSN Money - BusinessWeek Business News: The Home Loans Vexing Greenspan

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