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Understanding why low mortgage rates will not stop the decline of housing prices is centrally important to fully comprehending The Affordable Mortgage Depression.  
 
Ignorance as Public Policy

The specific catalyst which prompted my public writings on the Depression was a credible proposal by the Dean of Columbia's Business School featured in the Wall Street Journal during October 2008.  The editorial advocated solving the economy's problem, defined as falling housing prices, through Government manipulation of mortgage rates. 

"First, Let's Stabilize Housing Prices" advised politicians to refinance all existing home loans into 30-year fixed mortgages with an interest rate of 5.25%.  The authors concluded that reducing the national mortgage rate to the lowest level seen in 30 years would halt housing price declines.

The premises that falling prices were the cause of the economy's problem, and that lower mortgage rates would halt declines were based on a deeply flawed understanding of economic reality. 

My response explained that the country's real problem was overvalued and overleveraged housing prices and articulated why lower mortgage rates would have no beneficial impact on resolving the housing crisis.  The analysis further described that any initiative undertaken by the Government which had the effect, intended or otherwise, of preventing the housing market from clearing would make the Depression worse, by lengthening and deepening the downturn.

I believe the response is worth reviewing and remains as relevant today as when it was authored.  Link to Response

Mortgage Rates Do Not Matter

Almost every fundamental determinant for the market value of houses today is less favorable than that which existed in the late 1990s, with the exception of population. 

• The supply is higher as there are “more vacant houses than at any time since the Census Bureau started keeping such data in 1960”
• The increase in housing stock has far outstripped the rate of population growth, more than offsetting any potential benefit from a larger pool of potential buyers
• Demand is lower as a result of the decline in the availability of sub-prime mortgages
• Credit is much tighter
• The availability of highly leveraged and 100% loan-to-value mortgages, which had the effect of decoupling housing values from underlying fundamentals, are less available
• Houses are no longer perceived to be safe investments
• Potential buyers no longer expect houses to appreciate rapidly and are increasingly worried that prices may continue to fall
• Changing expectations have eliminated the home’s value as a leveraged investment opportunity.  Cultural and social values attached to homeownership are being eroded
• And most importantly, with respect to the Hubbard/Mayer argument, marginal effective interest rates are MUCH higher

Teaser rates associated with ARMs and Option ARM payment choices lowered the marginal effective interest rate of many mortgages to as low as 1%.  People with bad credit, could put nothing down and service a mortgage at a 1% rate for years.  It was these extraordinarily low effective interest rates and the absence of capital requirements that caused the housing bubble and sustained such lofty valuations.

Economic Illiteracy

According to Hubbard and Mayer:

"Housing starts are at their lowest level since the early 1980s, while there are more vacant houses than at any time since the Census Bureau started keeping such data in 1960.  Millions of homeowners owe more on their mortgage than their house is worth.  Foreclosures are accelerating.  House prices continue to fall, weakening household balance sheets and the balance sheets of financial institutions.

But this can stop.  The price of a home is partially dependent on the mortgage rate -- a lower mortgage rate raises house prices.

We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25%"

"Rising mortgage spreads and down-payment requirements are what's still driving down housing prices.  We need to stop this decline."

Hubbard and Mayer articulated a perspective shared and subsequently implemented by our policy makers.  Over the past 21 months mortgage rates have been directly and indirectly manipulated to record lows based on the hope that housing prices would stop falling. 

The Empirical Data

• At the time of Hubbard and Mayer's policy suggestion (9/25/08) mortgage rates were 6.09%

• Federal Reserve subsidization reduced this rate below the proposed 5.25% 3 months later (12/18/08)

• Since 12/18/08 mortgage rates nationally have been below the Mayer/Hubbard Mendoza Line, with the exception of 6 weeks during the Summer of 2009.  (75 out of 81 weeks)

• The national mortgage rate has now been less than 5.25% for 11 straight months

• Mortgage rates have been below 5.0% during 38 individual weeks since the Hubbard/Mayer proposal

• Today any qualified buyer can access a loan at 4.58%.  Any qualified homeowner can refinance at a level 73 basis points below that purportedly consistent with halting national housing price declines.

National mortgage rates have been below 5.25% consistently for 21 months but neither housing prices or sales volumes have benefitted from the subsidization in any material way.  Each displays little correlation with borrowing rates.  Transaction volumes and prices were temporarily distorted by other coordinated market manipulations, but the efficacy of these programs is waning.





Dismal Reality

Today mortgage rates are at all-time lows, yet housing transaction volumes are establishing bleak new records for inactivity.  Housing prices have fallen consistently since December 2008, with the exception of a Government-directed, mini-bubble in 2009.  All current economic fundamentals which determine housing prices indicate that price depreciation will continue. 

The misguided mortgage rate experiment has further demonstrated the efficacy of The Affordable Mortgage Depression framework of economic understanding.

Excerpt from 10/2/08 response to "First, Let's Stabilize Housing Prices":

"Government manipulation of interest rates with the intentional or unintentional effect of materially influencing asset prices is a bad idea.

It was government intervention designed to realize a social agenda that principally contributed to the current problem of overvalued houses.  Proposing further government intervention with the goal of supporting prices at an arbitrary level cannot and will not work.  The only solution to our present predicament is to allow the markets to clear.  We must let housing prices reach an equilibrium relative to the supply, demand, credit availability and more conservative mortgage characteristics of the post-bubble economy, as well as the new risk premium perceptions and performance expectations of potential buyers.  Much of the housing gains seen since the late 1990s, when sub-prime and affordability mortgages began to distort the market, will be reversed.

There are steps that the government can take to facilitate the stabilization of the housing market and limit collateral damage to both the credit markets and the broader economy.  Any action which would attempt or have the effect to prop up housing prices at an artificial value, though, is counterproductive.  Such initiatives will only lengthen, deepen and increase the damage caused by the inevitable march to a sustainable equilibrium.  The Japanese have provided us with a useful case study on this subject.  Don’t stand in the way of the markets clearing.  Any government action should be undertaken with a design to facilitate this clearing process and an understanding that substantial economic pain is unavoidable."