Smart Borrower Blog

Housing, Rent, and the Consumer Price Index

Sep 22nd, 2007 @ 10:10 AM by Alden Smith reports today that the sales of homes over $1 million has fallen. I have to ask myself how many people averaging over the country buy $1 million homes? Regardless, this indicator is not good. One of the things most people do not understand is that the Consumer Price Index is not an indicator of what homes sell for, but owner’s equivalent rent. What this means is this – if rent is stable as it has been in the last decade, and home prices ran up 93%, then the CPI is rather meaningless.

Time To Rent

Look at this from the point of view in the mortgage market at present, with sub-prime loans causing people to just walk away from their overly expensive homes. Surely, these people are not going to live in a cardboard box down by the river! Their alternative? Rent. It is their only option. At present, the rental availability in the US is quite tight, and that means rent prices are only going to increase. With rent prices increasing, you can see the effect that this will have on the CPI. Check out the Labor of Statistics and look at housing rent data. It is not hard to figure out that the housing component of the CPI could easily raise by more than 4%. Now, figuring that the housing component of the CPI is about 30% of the total, a 4% increase becomes very significant. The end results? Inflation looms on the horizon. Other indicators are the price of oil, at over $80 a barrel, the devaluation of the American dollar, and have any of you noticed how the price of food just keeps going up?

Watching The Fed

The Fed has a great way of sitting on their hands and watching data and what the market is indicating before making a rate hike, or especially a rate decrease. Now, the Fed has to be very careful. It appears they have been more watchful of data than looking forward to what lies ahead.

What Fed Governor Fred Mishkin Thinks

Mishkin is a bit of an unknown, but is responsible for some very exciting work in the economics sector. He joined the Fed Board of Governors last September, 2006. At Jackson Hole Symposium, he said that policymakers should not wait until output falls, but should ‘react immediately to the house price decline when they see it.’ He feels that policymakers should be more proactive, and not just wait until their datas show that a move is in order. His way of thinking impresses me. Quoting Financial Times, Mishkin had this to say: “He said simulations show that this approach ‘can be very successful at counteracting the real effects’ of even a large house price slump, because of the long lags from changes in housing wealth to changes in consumer spending.”

Good News or Bad?

Let’s look at a case scenario in the US economy. It affects not only us, but the entire world. We shall see many months go by before there is ever again a functioning sub-prime market. To my way of thinking, it should never happen again. If it does, however, this means that many shaky mortgages can then again be packages and sold on the open market, and investors once again take risk. I believe the first thing that should be seen is transparency in the different banks that put together these packages. If this is the case, investors can then make a more sound decision as to what to purchase. Hedge funds should also become more transparent, because hedge funds typically gamble on the market.

Moving Forward

The housing market is valued at $20 trillion. Knock of $4 trillion, and you have a serious drop in the wealth of homeowners. This effectively wipes out equity built up over the years. Now that we will see tighter loan markets, it drops about 10-15% of home buyers out of the running for a mortgage. This is a serious drop, and calls for adjustment in housing prices. Add this to all the other woes in the present market, and you get what Gary Shilling, investment advisor and economic consultant, predicts as a drop of 25%. Others, such as Dr. Nouriel Roubini, feels 15-20% is likely. And we need to look to rental property, and the almost predictable raising price of rent. Only time will tell. It surely will get ugly before it is done.

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