The other factor that people ought to be weighing is peak oil.

If the doomsayers turn out to be right & 10 years from now a fillup is $100, the prices of outlying or “bedroom communities” will be severely depressed, and all downtown cores with decent public transportation will skyrocket in price.

All the new developments that’re being advertised these days as “just 30 minutes from the downtown on xxxx highway ” will be ghost towns, “just 30 minutes from the downtown …”

Although I agree that there would be MANY unemployed people if there were hyperinflation in the US, I do think that one of the aggregate net effects would be a mass transfer of wealth from lenders to borrowers. If inflation is 1000000% and my salary only goes up by a tenth that, I can still pay my mortgage off in a week. If 25% of homeowners lose their jobs and can’t easily pay their mortgages, the other 75% can pay off their mortgages easily with the newly deflated currency.

Of course, this is a highly unlikely scenario. The only thing that can cause that sort of hyperinflation is printing currency on a massive scale, and the government is unlikely to go that far. I think we’re much more likely to see a repeat of 1970’s style stagflation, with higher interest rates, lower housing prices, increasing prices for food, housing, and imports, salaries increasing more slowly than inflation, and the average homeowner somewhat worse off.

I’m not sure I agree that Cambridge real estate is in a bubble. In particular, buying and renting do NOT seem very out of whack to me costwise. I bought a condo in Central Square last year. Factoring in the mortage interest deduction (and including property taxes), my total costs are quite similar to what I’d paid to rent the year before (actually, the cost is somewhat higher, but the place I own is much nicer). I think that if you’re planning to stay in a home for quite a few years (to amortize the transaction costs and short-term price risks), buying in Cambridge can make reasonable financial sense. Not that it’s a screaming steal.

It’s very different in Silicon Valley, where it seems like rental prices are more-or-less the same as in Cambridge, but housing prices are 25-35% higher.

As a realtor, I track of this issue. My husband says he has to read Roach in his line of work, and that Steve Roach is a “Morgan toady and sell side blow hard,” whatever that means. It does not sound good. Nonetheless, a few points. First, the real estate market is not national like a stock market. Locations mean much more, as some regions have “enjoyed” explosive growth for the last few years (read, NYC, LA, San Fran, Boston, Ft. Lauderdale, FL), while others have not(read, Chicago, IL or Rochester, NY). Appreciation has been limited in many markets, while on the coasts… well, you know. 1.25 million is no so far fetched. So maybe you want to buy Rochester and rent Boston, which you might feel is overvalued. My husband says he also agrees with your view of Central Square.

The other point: as of this year, there are broker dealers who offer options to retail investors on local markets for the first time. Not complicated puts on the 10 year treasury bond yields, but simple to understand products. So, maybe it makes sense to insure your bet if you buy in Boston. I don’t know, but it may be worth a look.
CNN/Money reported about them this past summer, see, http://money.cnn.com/2004/08/06/real_estate/investment_prop/hedging/index.htm

The author wrote: “At least two firms, Macro Securities Research and HedgeStreet, are in the process of introducing securities that will allow investors to hedge against falling prices in their own market…”

responding to Sanjeev: Regulation is a factor, but in Massachusetts (and probably everywhere else in the country) another factor is the power of local residents who oppose homebuilding because of fears that families will move in and absorb more resources (schooling) than they contribute (taxes). As someone who believes in “smart growth,” I support regulation that prevents interminable and unlivable sprawl a la the states you cite and therefore clustering denser housing around trasportation hubs. Unfortunately, local populations usually oppose just about any develop. (True, it’s often state and local laws that empower groups to stop development).

Cambridge is clearly in a bubble. I live <1 mi south of Central Square (which, btw, has significantly gentrified — I live across from public housing and we are part of the process, for better or for worse) and our rental fee is significantly less than the mortgage / tax / maintenance would be for a comparable condo. Someone in my situation would of course prefer that the bubble burst than that rental prices jack up…

(interesting topic, this’ll be my last post, probably).

Interest rates could go down. A CONTRARIAN VIEW.

People mix up mortgage rates with the Fed’s discount rate. Mortgate rates are not at historical lows.

http://www.investmentuonline.com/IUEL/2004/20040806.html

This guy hasa point but my view is that long term rates will go up. The bond carry traders have bought boatloads of long-dated paper(driving down the yield and driving down mortgage rates) using short term (FED) financing. So when the FED increases the short rate some of the carry trade must unwind, driving long yields up, driving mortgage rates up.

>>
What would the government do, if anything, to try to recover nearly valueless debts on property with obvious real value?
<<<<

Some ideas might be

the FED monetizes bad debt from banks to keep banks afloat

fannie/Ginnie/Freddie get re-purposed into “keep prices up” entities instead of “help more people get into houses”

Regarding “inflation will let you pay off your mortgate with a week’s salary”,

first, lots of people will be unemployed when this happens,
Second we’re seeing that wages in fact are not currently keeping pace with (perhaps under-reported CPI) inflation because of outsourcing & offshoring.

So if there is a hyperinflation some people MAY benefit, but the majority would suffer.

Philip, I read a John Mauldin article recently about the “housing bubble” (I’m just reporting, not judging the merits of the argument)

It seems that all the areas where there is a bubble share one important distinction – HEAVY, HEAVY regulation.

In places like Florida & Texas where demand is high the demand is not pushing up prices because developers build as much as they want, while places like parts of MA, NY & CA with heavy regulation preventing lots of new housing going up quickly do indeed look like they’re in bubble territory.

(please don’t send anything to the email, it’s a spam trap)

Thanks to Craig on the correction. I have never dealt with an ARM because I want a little more certainty in a large loan and the rate I have on my fixed rate mortgage is more than fair.

So then, what would happen if the USA experienced some sort of extreme inflation? Or is this question just academic (i.e. it “can’t” happen)? Now we know that there is no method built into any loan contract for the lender to radically modify the interest rate or principal amount. What would the government do, if anything, to try to recover nearly valueless debts on property with obvious real value? If this type of inflation occurred obviously savings would be wiped out for the rich as well as a middle class. But in addition to that there would be a defacto transfer of wealth of trillions of dollars from the wealthy and the government to the middle class.

To correct Gun Nut on ARM loans, most (if not all) of these have caps built in so that the interest rate can only adjust up some fixed amount (like 1%) per year and there is also cap on the total that it can adjust over the life of the loan (typically 5%-7%).

This should be a better URL for article:
http://www.morganstanley.com/GEFdata/digests/20041203-fri.html