Thursday, March 26, 2009

Housing Market, Interest and Exchange Rates

I originally wrote this entry on August 26, 2004, and published it on

Shreedhar has written regarding his surprise at the unfathomable Bay Area housing market. He has noted wages and population moving in a direction that will lead to lower prices. Things are a bit more complicated, as research has shown.

Housing prices are determined by a number of factors, including wages, population growth (as Shreedhar has noted implicitly), interest rates, inventory, "production" (new houses), etc. When interest rates are low, housing market will move faster; when production or inventory is high, prices will be lower.

Historic prices, however, need to rise somewhat to provide an incentive for buying the house and also to help avoid defaults. If prices fall too sharply and too much, borrowers will go into default. This is not good for the borrowers. It's also not good for the banks or other creditors. At the moment, loans on houses form the largest volume of "fixed-income" debt paper (i.e. bonds) out there. So, on its own, any illiquidity in housing debt (bond) markets may have more influence on interest rates in the U.S. than government treasuries.

If bonds on loans become cheap, i.e. once default rises, interest rates will rise, too. However, high interest rates are not good for a sputtering economy because they make money too "slow" to come by. The only saving grace, I've read, is for the U.S. dollar to devalue even further against other currencies.

This could be good for companies such as Sun because of its large revenue footprint abroad, but it also may mean inflation if the U.S. becomes increasing more dependent on imports of basic goods. Any devaluation steps need to be taken very gradually.

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