by Adam Wolf, Director of US Operations
I ran across a great question the other day in an email that was asked somewhat rhetorically: If housing demand is all about low rates, why don’t 30-year fixed rates under 4% set loose the animal instincts?
The answer has multiple parts to it and it goes something like this:
- Because those rates are completely manipulated, and everyone knows it;
- The only people who win in a manipulated market are the manipulators themselves;
- Even if someone is ready and willing to buy a house, they’re usually still not able because the banks aren’t lending money to people who don’t have a spotless credit history and, most importantly;
- Housing prices are still too high.
Deep down in the marrow of our bones, we all know this to be true: housing prices are still too high.
Sage maxims like, “If it sounds too good to be true, it probably is,” come to mind as we wrestle with trying to decide whether or not to make large buying decisions, and generally speaking, for most of us, a house is still a large buying decision.
But let’s step back and examine what “demand” really means, and we won’t confuse the matter with talk of long-term financing just yet.
If you have a widget that I want, and I have the amount of money that you are asking for your widget, then demand exists, and I have to decide if it’s worth parting with my money to acquire your widget. To make that decision, I apply a personal judgment about the perceived value of your widget and the perceived value of my money. Only when I think your widget is of equitable or greater value than my money, do I purchase it from you. While you control the price you’re asking for your widget, I decide whether or not to buy it, so I am in control of the transaction. If I decide my money has more perceived value than your widget, there is no sale at your price. You cannot force me to buy your widget.
If there are only a few of these widgets out there and a lot of ready, willing, and able buyers, then demand is high, and sellers can raise prices. If there are lots of widgets out there and only a handful of ready, willing, and able buyers, then demand is low, and sellers have to lower prices if they want to attract a buyer.
In today’s housing market, there are lots and lots of widgets out there, only a handful of ready, willing, and able buyers, and while sellers have lowered prices, buyers still think prices are too high, so demand remains low. The perceived value of the buyers’ money is greater than the perceived value of the sellers’ widgets. Also, by not entering the housing market at this time, ready, willing, and able buyers are speculating that the prices of houses will be lower in the future. (Yes, those “evil” speculators strike again.)
It gets a little more complicated when you add long-term financing to the mix, but not by much. Consumers understand that they still have to repay debt, at least most consumers know that, so in effect, even though there’s a middle-man involved, it’s still the consumers’ money that has to be given to the seller in order to purchase the widget.
(I know, I know…there are lots of consumers who don’t think they have to repay their debts, and that’s partially why the housing market is so screwed up, but I honestly believe those parasites make up a pretty small slice of the home-buying public, so I don’t give them as much attention as other analysts do. They clearly have created some market distortions, but at the end of the day, it doesn’t really matter what caused the market distortions; the only things that matter are supply and demand in the current housing market.)
Knowing that, let’s revisit the initial question that sent us down this rabbit hole in the first place: If housing demand is all about low rates, why don’t 30-year fixed rates under 4% set loose the animal instincts?
We can infer the answer to the question from the question itself: Housing demand is low because ready, willing, and able buyers perceive the value of their money to be greater than than the perceived value of the houses, so low rates have little direct effect on demand.
Certainly other factors start entering the buyer’s mind when they start making the all-important value judgment, and when we add long-term financing in the mix, we start thinking about perceived value further down the road. But, hypothetically, if rates were zero, buyers still have to make the decision whether or not they want to part with their money for that widget. They still have to decide if the perceived value of their money is less than or equal to the perceived value of the house if they are going to buy. And, if banks are still worshiping at the altar of the almighty FICO score and have lending standards so tight that only the most perfect among us can qualify for a loan, it doesn’t matter what the interest rate is.
The fact that the housing market is in the crapper tells us all we need to know about the buyers’ value judgment. The bottom line, regardless of interest rates, is that buyers are not willing to part with their money to acquire a widget they think is still overpriced.
For the housing market to pick up, prices need to fall even more. Then and only then will the ready, willing, and able buyers enter the housing market on the increasing demand and start buying up the inventory.
One final thought about the interest rates, though. We know that the interest rates are completely manipulated, so just because rates are below 4% does not mean they cannot go lower. Don’t let normalcy bias cloud your judgment here. Just because 30-year fixed interest rate mortgages have never been below 3%, doesn’t mean they can’t go there. No one thought interest rates would ever be over 15%, but it wasn’t that long ago in our nation’s history when that was precisely where they were.