In the midst of my daily research today, out of curiosity I attempted to search the following phrase, "relationship between real estate prices and real inflation". I ran into an article by Taylor Cottam, "How Increasing Inflation Could Affect Housing Prices" and wanted to thank him for pointing me in the right direction. In 2010, he showed a relationship between the 30 year fixed mortgage rate and real home appreciation from 1970 to 2006. A very interesting pattern shot out at me and I felt compelled to extrapolate a similar chart to the end of 2013. What I saw was extraordinary.
Comparing the percentage of change in the home price index with the 30 year fixed mortgage interest rate, revealed an amazing recession indicators graph. We can clearly see the infamous "Greed Cross" or "Greed Squeeze", as home owners felt over-confident in their ability to maximize returns, consistently produced a bad result. Appropriate increases in interest rates manage and normalize the spread; however, the shrinking spread consistently reveals over-valuation of home prices. The psychological pattern of seller confidence and market affect seem to show through this graph quite well.
In 1976, the good feelings that resulted from leaving an earlier recession caused an unwise bounce in home prices; which caused another "Greed Cross". This boost in prices met an increase in interest rates but at a much slower pace. The result, a 3 year period were the spread was either inverted and/or out of norm. We can see from the recession indicators graph, that the return to norm pushed GDP down below potential output for about 4 years.
In 1987, we see a "Greed Squeeze". A time in history where interest rates appear to manage prices much better but not enough to maintain the normal spread. The positive focal point, a much smaller and less damaging recession. Another interesting pattern also shows up here. From the tightest point of the squeeze, right where the cross was avoided, we see three years until a damaging down-turn in GDP. You can also see this from the 1976 "Greed Cross".
In 1998, things really get interesting, and we start to see the evidence of governmental manipulations, in a free market system that just wants to normalize itself. Look closely at 1999 and notice how a more aggressive interest rate policy should have been adopted to force a correction. Instead, partly due to 9/11/2001, interest rate policies were softened and home prices soared. In hind sight, this was a major mistake. We should have taken our medicine, dealt with a little pain and allowed things to normalize.
The remainder of the chart may look like a statistical anomaly and not statistically valid but that could not be further from the truth. Numbers do not lie, unless the numbers are lies; in which case, the reporting agencies would be liars. While that chance does exist, I do tend to believe these data and their sources. With that being said, what the graph is telling us is compelling and somewhat overwhelming. The result of an ultra soft interest rate policy, produced a massive build up and subsequent collapse of perceived asset value. Unfortunately, this was followed by a recession that only lasted one year. Do you see the problem? The break in the pattern?
It took over 9 years from the time of the "Greed Cross" in 1998, until we hit a brick wall in 2008. After a one year, heavily manipulated recession, we have not normalized anything! Thus, you see a chart that appears to be statistically invalid. However, it is telling us exactly what is going on... OUR SYSTEM IS BROKEN!! Our country is broke, completely over-leveraged and our economy is on life support (code named "Quantitative Easing"). The steepness of the drop and rebound in home prices is just screaming... "HOUSTON, WE HAVE A PROBLEM!"
I need to interject a quick note here. We know that GDP has not been completely adjusted for the period extending back to 2010. Lakshman Achuthan of ECRI, has gone on record with a call of an official recession beginning in 2011 or 2012. From our chart we would agree and expect that GDP will be adjusted, at a later date, to show the actual, small recession.
THE BOTTOM LINE: the most recent "Greed Cross" in 2012, occurred so quickly, that we have no choice but to consider the next recession will eclipse anything else we have ever seen. Moreover, due to the steepness of the curve, it will also happen much quicker than the normal 3 year period, as previously mentioned.