I'd like to talk about a topic that has many people left scratching their heads.
Suppose I run a business manufacturing tiny cubes of gold. (Never mind why, just tag along for now.) Suppose also there's another guy across the street manufacturing the exact same thing, and let's say the market value of each piece is $1000. (just to make calculations easy.)
Now, imagine someone comes in to my shop, and since it goes "oh so well with the decor in her home", she wants to buy it but doesn't have $1000 in cash. Suppose I offer it to her at 20% simple interest to be paid back in 12 installments ($1200/12 = $100 a month for a year.)
There are three concepts here:
Intrinsic Value : $1000.
Interest Rate: 12%
Payment Schedule: $100 per month.
Now, suppose my competitor really really wants this lady to buy it from his store (he wants to bang her on the side so there's your "economic incentive") so he offers it to her at 10% simple interest to be paid back in 12 installments ($1100/12 = $91.67 per month.)
Did the intrinsic value of the object change?
Well, of course not, because he (or I) would be happy to sell it to anyone who walked in with $1000 in cash.
So what changed? (because she would clearly prefer the second "deal".)
Well, clearly the interest rate changed so her payment schedule changed!
Now, I'm a crafty guy, and go tell this broad, "Look you don't have to pay it off right away. I'll charge you 20% simple interest over two years." (equivalently $1400/24 = $58.33 per month.)
Oooh! that must be a better deal, right, right, right?
Bzzzz. Wrong.
The intrinsic value is still $1000. Nothing has changed.
You can get a lower monthly payment by either lowering the rate, or increasing the payment schedule, or both.
But the fuckin' crucial point is that the intrinsic value of the goddamn' object has not changed!
(On a side note, you can quickly see the "best deal" by seeing how much you are paying net over the intrinsic value -- $200, $100, and $400 respectively.)
And that, ladies and gentlemen, is the lesson about the housing market of the last seven years. Interest rates were artificially lowered, and payment schedules stretched out to infinity (I/O-loans.) Nothing has fuckin' changed. Wages are exactly where they were in inflation-adjusted terms seven years ago.
So if salaries are exactly where they were, on what basis did California prices triple, and New York prices double?
Answer: the payment schedule changed (in very complicated ways); the intrinsic value never did.
Now you all know why Joe-Monthly-Payment and How-much-a-month-Sally are truly and royally fucked!
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