The Fake Boom and Real Bust: US Housing from 1979 - 1982

A friend of mine recently asked me about my medium term outlook on housing.  I said that it is due for another drop if inflation raises its ugly head.  Why?  Really, it is simple.   Housing is a financial asset, meaning, people finance it, many for 30 years.  That means that their income can only support a certain payment.  The payment is a function of principal and interest.  With a given payment, as the interest rate goes up, the principal must go down, and vice versal. 

He said to me, "Well what happened in 1979.  There was a housing boom, at the same time there was an increase in the interest rate."

That's not entirely true.  The first mistake was not looking at real prices.  There was high inflation, during which time, you would expect to see a large increase in nominal prices.  There was a more modest 5% per annum increase in housing which is no what I would call a boom.  Second, the real decline was partially masked by inflation.  Furthermore, what was expected - a real decline in housing prices - was exactly what was expected with an increase in interest rates.

The reason why that is relevant today is because, if nominal mortgage rates rise of their current historical lows, housing should take another 5-15% real decline.    That is why I would not be a buyer of real estate and financial assets in general.


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