William H. Gross of PIMCO writes about the [cycle of real estate and our danger of slipping into a recession [PIMCO]](http://www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2005/IO+October+2005.htm):

* Housing prices will cool/stop going up very much/even go down in some cities, WHEN…

a. Interest rates rise to a high enough level to make the purchase of a new home a burden instead of a boon for first time buyers.
b. Mild regulatory pressure begins to reduce the amount of funny-money lending.
c. Speculators sniff the beginning of the end.

* Home equitization should retreat shortly thereafter.
* Consumption/the U.S. economy will then weaken when the house ATM starts running out of fresh new $25,000/$50,000/$100,000 home equity loan dollar bills.
* The Fed will cut interest rates in order to start the game all over again.

The factors affecting the US Economy’s fate are:

* [oil/natural gas prices [Slate]](http://www.slate.com/id/2127384/)
* China’s economic growth
* foreign willingness to buy our Treasury bonds

He concludes that the froth in the housing market is leaving and higher mortgage rates will make a recession nearly inevitable, possibly requiring the Fed to lower short term rates in mid-2006.

The result? Housing appreciation slows to single digits next year, thereby having a soft landing.

One Comment

  1. John Philip Mason October 5, 2005 at 8:35 pm

    What an interesting article this was (I read the complete version). As I read it I couldn’t help but wonder if the acceleration of home prices might not exacerbate the effect of increasing interest rates. Taken to an extreme, it might even supplement this factor (of increasing rates) in the formula he cited. That is, even if mortgage rates remained low, at some point the ever increasing sale prices have to exceed the reach of more and more buyers. And all this even after the system has stretched itself in an effort to postpone the inevitable impact on the financial limitations of buyers. These tactics now include no money down, negative amortization, sellers paying closing costs, inflated appraisals and more. But let’s not forget that this could this could happen financially, psychologically, or worse yet, both simultaneously. If it’s financial, we simply wait for the numbers to balance out with lower prices, increased income, lower mortgage rates, or some combination. If it’s psychological, we wait for the wounds to heal, which could be a lot longer. With the potential for the entry level buyers to be psychologically wounded, the real estate markets could be chilly at best and for quite some time.

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