In his previous post, Duncan said, "The housing increase is not really a bubble, since a bubble would reflect speculative excess, whereas we have so far seen refinancings with some $ taken off the table as opposed to borrowing to speculate (e.g., 'no down payment' types of purchases). Bubble or not, history says it will correct & this will sap what little staying power still exists in the economy."
I think this point is worthy of a bit more exploration. The 'wealth effect' is a well-known artifact of rising asset values, primarily financial assets but also associated with real estate and other real asset inflation. Simply put, when people feel like they have more wealth, the spend more money. If we define speculation as the active attempt to make money through risk-taking, then clearly much of the increase in housing prices is not speculation. Nonetheless, this sort of increase in asset value can have the same deleterious effect as temporarily-successful speculation -- excess consumption on non-essentials, poor financial choices, and vastly increased personal exposure to pending financial downturns. It seems to me that the distinction between speculation- and asset-inflation- driven wealth-effect spending is moot.
Having claimed the distinction moot, I'll go back and poke at the distinction itself a bit more; can we really claim that buying a house in today's market isn't speculation because of an absence of "borrowing to speculate"? In California, it is not only possible to purchase with as little as 5% down in some cases, but complex financial instruments masquerading as mortgages, such as a 7-year balloon, further separate real estate transactions from the concept of "housing purchase" and push them increasingly into highly leveraged financial risks -- mostly partaken, as the highly-leveraged rubric implies, with other people's money.
It is commonly agreed that people buy homes on the basis of total monthly housing payment; and as mortgage rates decrease, the ability to afford high list prices, and thus housing prices themselves, expand.
This comes-out-in-the-wash thinking hides a dangerous rachet, however; If I purchase a house in a time of high interest rates, then the low list price of my asset has large potential to grow while at the same time, my ability to refinance my mortgage in a potential lower-rate future means that my monthly payment has high potential to fall. In the opposite situation -- such as today's market -- buying in a time of high nominal list prices and low interest rates, my asset is poised to decrease in list price, and my ability to reduce my monthly payment, even if I have locked in low fixed interest rates, is nonexistent. If I have *not* locked in low rates, choosing to go with a variable-rate instrument, my monthly payment is quite likely to rise.
The resultant 'negative equity' trap can be terrifying -- such a rebound nearly destroyed the Southeast UK (i.e. London) housing market in the early 1990s, with dramatic social effect on the ability of the middle class to buy housing throughout much of the next decade. I see no reason why we are not poised for a similar blowout, and can only term the willingness of some home-buyers to commit to the largest single asset-purchase and risk-assumption transaction of their lives in the face of such negative potential, as uninformed speculation at its worst.
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