Rising rates: Black Monday for home prices?

Bond yields have jumped 1.10 percentage points in the last six weeks. In relative terms, the rise is equal in severity to the rise that led to the stock market crash of October 1987.

Unfortunately, the NYTimes article I’m citing doesn’t mention Japanese arbitrage sellers or the rocketting the projected Federal deficit. Both mean lots more bonds for sale, but myopic economists ignore these factors because they prefer to think “interest rates” are driven by “economic variables” and not raw supply and demand for debt instruments.

Since June 13, the US Treasure ten year note has risen from 3.11% to 4.21%. That 35% rise in yield is nearly as severe in relative terms as the rise in ten year note yields (from 6.98% to 10.23%) that occured in the nine months before October 19, 1987… known to many as Black Monday. Go read this Black Monday chronology. Here’s the entry for January 1, 1987: “The year opens with bond yields near their lowest levels in nine years.”

Stocks may well get hit this time around too as the rate at which investors discount future earnings rises, but the dividend tax abatement may counterbalance this effect.

Another asset is more likely to get gored now: homes. Falling federal borrowing and rising tax revenues meant rates could tumble in the 1990s, and falling rates boosted everyone’s house price as buyers could afford more house for their money.

Now that the government will be issuing $1.4 trillion more securities in the coming two years than the prior two years, borrowing costs will rise and housing prices must fall. Here’s the math: if the rate on a 30 year mortgage rise from 4.5% to 5.5%, a family that can afford a $1013 monthly payment will pay only $179,000 for a house rather than $200,000.

If I were a Democratic Presidential candidate, I’d jump all over the escalating deficit (“driven by reckless Republican fat-cat tax cuts and defense industry sweetheart deals”), since it is going to crush housing prices.