Although we currently have an administration in Washington that is determined to micro-manage the economy the data is already proving that it’s just not possible.  Markets are stronger than governments and going against the market is like building cities below sea level in the path of hurricanes. The water always gets in. (In fact, the Dutch have recently decided to relinquish many of their low lying areas to the sea.) For instance, there are numerous examples of governments attempting to manipulate their currencies but in the end George Soros and the markets always win.

So it is with mortgage rates. The government attempted to drive down mortgage rates and other interest rates by buying all manner of bonds, and for a while it worked. However, recently the levies are starting to leak. Check out what has happened to 30 year mortgage rates in the last couple of weeks:

You can see the same pattern in the interest rate on the 10 year government bond:

For a while the interest rate on these government bonds was driven down as investors sought safety, but not any more.

There are a few things going on here and not many of them are good for the housing market. First, the US just has too much debt – too much personal debt, too much government debt, and too much financial leverage – and our creditors have taken note. There is even talk of a downgrade of the credit rating of the US government. All this translates into a higher risk premium for US debt and that means higher interest rates.

The second issue is that in creating huge amounts of money in order to manipulate the market the US government has created inflation fears. Consequently, the dollar has taken a nose dive and with it the price of oil and other commodities have taken off. To get an idea of what is going on with the dollar just look at this chart of the dollar priced in Euros:

Inflationary fears and a weaker dollar (two sides of the same coin) mean that investors need higher interest rates to hold US dollar denominated investments.

So I think higher mortgage rates are going to be the reality – and they’re currently no higher than they’ve been on average over the last 5 years and they are significantly lower than they have been in the past 20 years. So there is still plenty of upside (or downside depending upon your perspective) in mortgage rates. And if inflation really materializes watch out.

There is one potential silver lining in all this – and one can’t help but wonder if this isn’t actually the government’s secret intention. If inflation takes off then we can all pay back our debt with cheaper dollars down the road. The debt stays constant but we all eventually start making more money, even though the money is worth less. It’s one way to work ourselves out of debt.

Of course, for those of us that don’t have a lot of debt and in fact have lent money, it’s not so good. But eventually, in an inflationary environment, housing prices take off and that will bail out a lot of people who are upside down on their mortgages – unless of course interest rates are so high that no one can afford to buy these higher priced homes, in which case maybe home prices don’t go quite that high. I guess we’ll just have to wait and see how all these forces net out. I’m betting that the force of the government will prove to be nil in this equation.

I think Mick Jagger might actually know a bit more about the housing market than our politicians. In case you can’t already see where this is going let me spell it out for you: “You can’t always get what you want but if you try sometimes you just might find you get what you need.” In this case what we need is for the housing market to clear and, unfortunately, that is not consistent with stabilized home prices, which is what everyone wants. And in this highly charged political season politicians want to give people what they want, not what they need. So we hear endless lamentation about how we are not going to solve our economic problems until we stop the decline of home prices and everyone is floating ideas about how to prop up the housing market.

No surprise that the NAR is also getting in on the action with their 4 point plan for government handouts to the real estate industry. More on that another day.

Unfortunately, all this is a bit like trying to build a city below sea level in the path of numerous hurricanes. Wait a second…don’t we do that also? The fact of the matter is that sooner or later nature has to take its course. Home prices have to seek their natural level. They expanded at above-trend rates and now they need to return to the trend line, which is a bit below where they are now. Driving this was an unnatural growth in home ownership levels above the norm of the last 40 years as demonstrated in the chart below from the Federal Reserve Bank of St. Louis.

It should be no surprise that during this period the affordability of homes declined.

Now, as the real estate market attempts to cope with these imbalances, we find buyers and sellers at a stalemate and transaction volume has dried up. Politicians can pull all the rabbits out of the hat that they want: tax credits for homebuyers, Fannie and Freddie support for the mortgage market, government purchases of mortgages, etc… However, they can’t stop the ocean from seeking the lowest level. Nothing will return to normal until prices return to normal. And normal prices will be a good thing. For instance, homes can once again be affordable for people with good paying jobs.

During the last 10 years or so the country made poor financial decisions to put too many people in their own homes and to build bigger homes than people really needed. Instead of investing in our infrastructure we invested in granite countertops and marble showers. So today we find ourselves with vacant homes, collapsing bridges, and roads full of potholes. If the government wants to stimulate our economy they would be better off investing in our infrastructure than in more homes.

Speaking Of Potholes

While perusing David Dalka’s Internet Marketing Blog the other day I noticed several links to sites for reporting potholes and even filing a claim for vehicle damage from potholes. Sounds like a great idea. However, I attempted to file a claim about 6 months ago using the process outlined on one of those sites after my car was nearly swallowed by a giant sinkhole. OK, maybe I’m exaggerating a little bit but I did blow a tire. After dutifully taking my pictures, attaching a receipt, filling out the form, and sending it in I’m still waiting. However, I wouldn’t let that discourage you. Maybe if they get enough forms in the mail they’ll have to do something about it.