Don’t obsess over interest rates

After doing an extensive quantitative study, Glaeser, Gottlieb, and Gyourko report (ungated here):

Interest rates do influence house prices, but they cannot provide anything close to a complete explanation of the great housing market gyrations between 1996 and 2010.  Over the long 1996-2006 boom, they cannot account for more than one-fifth of the rise in house prices.  Their biggest predictive influence is during the 2000-2005 period, when long rates fell by almost 200 basis points.  That can account for about 45 of the run-up in home values nationally during that half-decade span.


Yet another paper rendered useless by its assumptions. Indirect/feedback effects are just way too strong to generalise beyond the seemingly unrealistic constraints of the paper.

Why did people have irrational views of future increases in home values? Because low interest rates lowered monthly payments and increased demand. The increased demand pushed housing prices to levels that were out of whack with incomes. But that meant outsized profits for many early movers.

Also the type of mortgages, tied to interest rates, such as ARM's (which were at record levels) and interest only mortgages made housing much more sensitive to interest rates then this study argues I think

Didn't low interest rates cause major problems elsewhere? I thought that the low interest rates were the impetus for financial organizations to take on greater leverage to increase returns. The quest for higher returns led to risky investment practices which caused much of the trouble.

Before I start a fire, that would be $50k of interest deductions a year.


The exclusion is $500,000 for a married couple. The rules are more complicated if it is an income producing property, but until tax rates goes up, you pay 15% on capital gains. Assuming that you held the house for 2 years, the exclusion is worth $75,000. Nice, but not overwhelming.

Rich, That's a 15% capital gains rate beginning after the $500,000 exclusion on gain. The change occured in the late 90's and many never reach the excluded gain point.

Let me be more specific though on my former neighbor who was also successful on converting her husbands labor into a 15% rate: When we moved here, the house next door was income property for the owner: renting it to students. The owner kicked out the students, and moved in. The husband, an artist and carpenter/very skilled artisan, completely gutted the house, raised the foundation and poured a new basement. Two years is about right in terms of how long they were here. I don't know what they paid for the property (I think it wasn't much because they owned it for a long time as rental property--I'm guessing $80k for a purchase in the early 80's--and resold it for $720k). If they had hired someone (and they did hire people) the laborer would pay ordinary income rates on the income; but since the husband did most of the work on the house, his imputed income is taxed at a 15% rate. The wife--a very aggressive real estate agent, made and still makes a very high income (specializing in neighborhoods that are unique--old and upper middle class neighborhoods).

They literally move from property to property. They have moved two times since, doing the same thing.

Now, I certainly do not think that is normal. But, I would not be dismissive of tax policy--both on the capital gains exclusion and on the capital gains rate--on the change in the public attitude towards house values and the house as a storer and creater of value. I could also write about a friend of mine--a former general counsel and his real estate wife--who were into flipping houses in Arizona and Florida when the crash came, but that is a different, and somewhat sadder, story.

I can't do anymore writing now because I have to go outside and work on a bricklaying/landscaping project to improve my backyard.

Something most people don't realize is that, while the Fed funds rate was low/accommodative in the early-to-mid 2000s, it nevertheless had little effect on mortgage rates. That's because mortgage rates are long-term rates which are largely based on expectations about future growth & inflation, and aren't strongly correlated with the Fed funds rate (see graph linked to below). Thus, even if you think that interest rates are a primary cause of the housing bubble, it's very hard to blame that bubble on monetary policy.

A graph of mortgage rates and the Fed funds rate can be found here (the Federal Reserve website has the raw data):

@Rich and Gabe, Before we throw out the AMT as somehow a limit on all this, I think the readers should know a little more, because, as in life, it is more complicated than saying "Oh, AMT solves it or it doesn't happen":

This is from a piece on interest deductions and the AMT (You can find it here: )

From the article on AMT and the amount of interest deduction you can take:

"Dollar Limitations for the Mortgage Interest Deduction
The amount of mortgage interest you can deduct each year is limited. There is one limit for loans used to buy or build a residence -- called "home acquisition debt." And there is another limit for loans not used to buy or to build a residence -- called home equity debt. All loans, whether secured by your main home or your second home, are subject to the same overall limitations.
Home Acquisition Debt
You may not deduct interest on more than $1,000,000 of home acquisition debt for your main home and secondary residence. Home acquisition debt means any loan whose purpose is to acquire, to construct, or substantially to improve a qualified home. The limit is reduced to $500,000 if you are married filing separately.

For example, you borrowed $800,000 against your primary residence and $400,000 against your secondary residence. Both loans were used solely to acquire your residences. The loan amounts add up to $1,200,000. Since your loan amount exceeds the $1 million limit for home acquisition debt, your mortgage deduction is limited. Let's say both loans have a fixed interest rate of 6% and your total interest paid for the year was $72,000. You would only be able to deduct $60,000, which is the interest on the first $1 million of home acquisition debt. Use the worksheet on page 9 of Publication 936 to calculate your allowable mortgage deduction.

Home Equity Debt
You may not deduct interest on more than $100,000 of home equity debt for your main home and secondary residence. Home equity debt means any loan whose purpose is not to acquire, to construct, or substantially to improve a qualified home, or any loan whose purposes was to substantially improve a qualified home but exceeds the home acquisition debt limit. The home equity debt limit is reduced to $50,000 if you are married filing separately. Your deduction for home equity interest may be reduced even below the $100,000 limit if your indebtedness exceeds the fair market value of your home. See the "home equity debt" section of IRS Publication 936. "

@Rich and Gabe, So, to recap, what we have is: 0% marginal rate for the first $500k of gain; 15% marginal rate on gains beginning after the $500k exclusion, leverage on existing property to borrow, interest deduction for residential borrowing subject to the AMT cap above (not much of a limit)

Pair this against choice of participating in the stock market or investing in a business. If you had personal wealth, which would you chose firsts.

Which would you chose if your wife watched the Home and Garden Channel.

When it comes to personal finance, we can all be economic anthropoligical observers. Think about your own experience or those of persons you know.


Wake me up when you make a comment that contains claims that can actually be evaluated.

I didn't think this study was very well done. Only the brave or the foolhardy try to do macro time series analysis like this.

Rich, The NYT article also noted that less than 5% of house owners per Moody's reach the $500k exclusion, so their effective marginal rate on housing appreciation is 0%. Tax certainly can be a motivator for the 95% who will pay no taxes on appreciation, and get a deduction on their interest.

Characteristics of bubble cascades involve you looking at your neighbor or someone else thinking, I can play this game and get out before it crashes. Unfortunately, everyone in the room thinks they are smarter than everyone else in the room.

If you want to see an illustration of this, google Charles Plott of Caltech and bubble and look at some of the demonstrations and videos from some of his in classroom experiments with economists as the participants. Bubbles and crashes everytime by persons who should know better.

Rich, I guess I must be living in a different neighborhood than you. An untaxed gain of $500k is pretty good, considering that before the tax law change the exclusion was $125k. Furthermore, we have not accounted for interest deductions from housing debt, and the effect of leverage on debt to create the greater potential for gain, after the $500k exclusion, at a capital gains rate of 15%. As to the AMT point, interest is deductable on debt up to $1million, which again is a mighty incentive to build mansions.

Your rudeness does not deter me, but rather spurs me on. You may chose to ignore the articles, Vernon Smith, or anything else you wish. I don't care, but, for other readers of this blog, I'm laying out the information I know for them to draw their own conclusions.

Bill is the intellectual equivalent of a Cleveland steamer.

To be honest, I'm not sure I even understand the statement. No, inflation was not the cause of the housing boom, but I'm not sure what you are saying was the failure.

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