Actually, I believe you are both wrong. Think about the basic laws of economics: supply and demand. When the interest rates are low, money is cheap so demand increases. Lowering rates effectively puts
more money into circulation. Rates are raised, demand lowers and the money supply contracts. And this is the main reason we are in this financial mess: basic economic laws.
Home values are still the 800 pound gorilla in the elevator.
First, you look at the Fed and Greenspan. After the dot-com bust, 9/11 and during the recession that followed, the Fed cut rates. As they should in times of weak demand for money. On 1/1/01 the target rate was 6.5%. By 9/1/01, the rate was down to 3.5% to deal with the after-effects of the dot-com bust. That's exactly what the Fed should have done. Then 9/11 sent an already-weakened economy into a shell. By 1/1/02 the rate was down to 1.75%. 4-3/4 points in 12 months. Indeed, the GDP reacted well to the rate cuts. After the initial round of cuts in early 2001, the economy grew at a modest 2.6% in Q2. 9/11, and the economy retracted again, with 2001 finishing with an anemic 1.1% GDP growth.
2002 started off with a bang: 3.5% growth in Q1. Q's 2&3 also showed decent growt - 2.1 and 2% respectively. Q4, war plans accelerate, Wall St. took a bad turn, and the growth slowed to .1%. Rates are cut even more. It works. The economy shows robust growth from 2Q 2003 through Q1 of 2006. BUT - even in the face of that robust growth throughout 2003 and 2004, the Fed rate stayed very low, below 2%, and not starting to creep up until Jan. 2005. That's a very important point, because it was during this time of cheap money and robust growth that the housing bubble grew. The growth of the economy far outstripped any meager Fed rate increases for about 3 years.
It was during this period (2002-2005) that the 5/1 ARMs were all the rage in the mortgage industry. With rates that low, they weren't too difficult a sell. Surely you'll be able to re-fi before that 5 years was up? RIGHT? Not so fast, my friends. Starting in mid-2005, the Fed rate climbed steadily. In 2007, the first wave of ARMs adjusted. Foreclosures increased. In 2008, it really hit. 2003 was a big year for ARM sales in the mortgage industry. Most of these were targeted in the subprime market, which grew to historical heights in 2004-2006. In 2006, home values started dropping for the first time in nearly a generation. Most ARMs in the subprime market were no-cost closings. Home values declined, and people couldn't re-fi their ARMs. When they re-set, they couldn't make the payments.
What most people with 5/1's didn't count on was losing their job. 2.5 million of them did from Q2 of 2007 to Q3 of 2008. By the end of 2008, that number had swelled to 3.87 million. Kind of hard to re-fi without a job. It was in Q2 of 2007 that foreclosure rates hit historic highs, and then took off like a rocket from there.
Bubble becomes bust. Subprime paper takes down Wall St. TARP has to step in and avert financial calamity.
But here is the salient point: by keeping the Fed rate
artificially low for too long, Greenspan and the Fed actually laid the groundwork for the housing bust that lies at the root of the economic downturn. Had those rates risen at a historical rate with the growth of the economy, many, if not most, of those ARMs wouldn't have been sold because the rates would not have been affordable by so many subprime borrowers. If the rates had risen in 2003 in concert with the economic growth over the same period, the meltdown would have been FAR less severe. It would still have happened, but the effects (and cure) wouldn't have been as drastic.
As it stands now, home values are still somewhat higher than the historical pre-bubble trend would indicate.
But as I've said for a long time now: the economy is not going to rebound as long as home prices remain stagnant or drop more. We're in a catch-22. We need home prices to rebound. They aren't going to. They're right at or just above where they should, historically, be. Taxes will not effect home values. Income will not effect home values. Stimulus will not effect home values. Tightened spending will not effect home values.
There's only one real answer for those of us that are making mortgage payments: hold on to your job and pray that you don't have to try to sell your house for any reason unless you have at least 10 years' equity to cover your loss.
Now, what was it you guys were saying about consumer confidence and how tax rates and government spending do or don't cause recessions? [/sarc]
Fed rates
Foreclosure chart
Quarterly GDP figures
bls.gov Labor Statistics
Home prices and trends
