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Saturday, June 4, 2011

Bond Crash Could Send Mortgage Rates Soaring, Home Prices Tumbling

In prior articles I have warned that residential real estate prices could crash again when mortgage rates start moving up much higher than the lifetime-historic-low-rates (at 50 year lows, according to one report) we have seen in the last few years.

Mortgage rates may be just about to skyrocket.  This report states that China has gotten rid of almost all of its U.S. Treasury bills (maturities of less than one year). (See this Treasury Department chart, go to column 9 and then compare the May 2009 figure with the March 2011 figure.)  Declining demand for Treasury bills indicates that our federal government may need to boost yields (the interest rate paid on the security, and which move inversely to prices) to attract buyers.  As the era of essentially free money ends, conventional mortgage rates (pegged somewhat to Treasuries) will also move up as banks pass on the higher cost of accessing capital to borrowers.
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Another interesting chart shows that two countries have sharply reduced their holdings of all Treasury securities (bonds, etc.) in the last six months:  Russia and Australia.  I think many countries are doing a "flight to quality" but there may be some savvy sovereign nations out there who are less concerned about return and more concerned about preservation of capital and not taking a loss on securities which, quite frankly, have little room left in which to appreciate in value but plenty of room -- loads of it -- in which to depreciate in value.

Since monthly affordability, the measure upon which banks rely to determine the size of the loan to offer, is viewed as a constant factor, increasing interest obligations will result in a corresponding drop in principal payments from each monthly payment, and hence a drop in offered loan principal.  This acts as a reduction in credit -- a smaller loan.  This outcome, combined with a proposed requirement for buyers to put down a minimum of 20% of the purchase price for a home, can send buyer demand plummeting and home values down sharply as a result.

One item to remember:  the housing crash (with average home prices down one-third since 2006) has occurred despite mortgage rates remaining at all-time lows.  As the housing bubble was fed in part by sharply dropping interest rates (from the nine-percent level in 2000), one can and should expect the reverse effect (plunging values with skyrocketing interest rates).

Housing may be back to 2002 levels and much less expensive than five years ago.  And some measures of home prices to income suggest homes are now undervalued and make an attractive long-term investment.  But there are undeniably strong economic forces that indicate that housing is susceptible to a renewed price crash. 

Eric Dixon is a New York lawyer, strategist and business consultant.  For inquiries, please contact Mr. Dixon at edixon@NYBusinessCounsel.com.

 

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