Thursday, July 08, 2004

Today the General has some juicy housing bubble data to relay. I'll do it in two postings.

Yesterday I returned to one of my favorite subjects, housing bubbles. The Great Thinkers of Our Age generally reject the existence of housing bubbles in the US today, mainly due to the existence of exceptionally low interest rates. Whereas at one point during the bad old 1980s you couldn't get a 30-year fixed rate mortgage for under 16%, today rates slipped once again under 6%. Even with the Fed hiking the federal funds rate 25 basis points last week, the housing market continues to surge.

Now its time to burst the Great Thinkers bubble.

Nominal interest rates are quite low. Of course, so is inflation. Put the two together and one finds that real mortgage rates aren't all that low. In May 2004 the real interest rate on a 30-year fixed mortgage (Fannie Mae's conventional fixed-rate 30-year mortgage minus core consumer price index) was 4.57%. The lowest it has been in this age of ultra-low interest rates was 3.73% in June 2003. These figures are on the low end of the average interest rate band which has existed in the US since Volcker squeezed inflation out of the US economy in the early 1980s. From 1986 to the present, real 30-year rates have fluctuated between a high of 7% and a low of of 3.7%. From 1990 to the present real 30-year rates have been virtually stable, declining on average just 0.0014% monthly. Granted the US has been at the low end of this band over the last three plus years, but the larger point is that current real rates are far from unprecedented. We had only slightly higher real rates from 1991 to 1993, and dramatically lower real rates (averaging around 2.2%) from 1976 to 1979.

The same story goes for the UK, which I discussed last month.

The bottom line: low interest rates, but not unusually so.


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