Another fall in the Case Shiller Price Index, and another round of commentaries that housing prices are rock bottom, and headed for an upswing.
Actually since 2008, houses are becoming more expensive, in a sense, due to the reduction of nominal interest rates which affects negatively the Mortgage Interest Tax Deduction.
Cutting interest from 6%, the 2008 rate, to 3%, just for the sake of argument, reduces the tax incentive by 50%, making houses more expensive, not cheaper.
So the correct analysis is to factor these two variables:
1. Lower prices due lower demand, and
2. Higher costs due to the reduction of the tax incentive afforded by the Mortgage Interest Deduction.
Unfortunately many are just looking at the Case Shiller Price Index, without factoring in the cost of lower tax incentive.
Granted, there are 4 or 5 assumptions and averaging that are necessary. Interest rates, tax rate, second mortgage trend, average down payment , etc.
I have refrained of presenting my own calculations here, because I know I will be bogged down justifying my assumptions, when my only point here is to show a key variable being left out.
An extreme case, a 48% Tax bracket mortgage, were the incentive reaches 80% of loan, in the first few years, at a 6% interest rate, shows that lowering interest rates, can effectively increase housing costs by 20% or more, due to reductions in the Mortgage Interest Deduction.
Since in the US, the Mortgage Interest Deduction is based on Nominal Interest Rates, and not Real Interest Rates, a big economic mistake, high inflation rates increase home demand, rather than reduce it.
Low inflation rates, as a corollary, reduce home ownership.
So, many savvy home buyers are actually waiting for Nominal interest rates to increase, before committing to a 30 year mortgage.
What is amazing is that those that, like Paul Krugman, favor more government incentives don't realize that Nominal Interest Rate Deductions, usually 3 times the Real Interest Rate, is already an enormous fiscal incentive, all set up in place.
And what is more amazing, are those that favor monetarist approaches to stimulate the economy, such as reducing real interest rates, do not factor in the damage that that does to the home industry.
So my guess, is that the home industry will only really rebound, with inflation raising nominal interest rates again, and that seems to be nowhere in sight.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
