Take this sentence for example "The banks pre-figure what principal and interest cash stream they want to realize from a mortgage, and then set the price of the house." Since when does the bank set the price of the house? It doesn't, the market does. This is too tin-foily for me to accept.
I agree housing prices are rediculous. What am I to do, though? Sell my house, move to a rental, and wait for prices to go down? I suppose a small minority of people will do that, or retirees or people who's kids have grown and moved out might consider it (in fact that would be smart to downsize)... but the vast majority of us will stay put and ride out the devaluation of homes, which will surely occur once interest rates begin rising again.
All we have to do is lock in these rates, and hope we can keep our jobs and cash flow positive to pay the mortgage during the housing price decline.
There is one thing fueling this increase in housing prices. Working couples are devoting huge percentages of their income to feeding the home. Why do this? Because a mortgage has been called a form of enforced savings. People are foregoing investments because housing keep rising.
However if housing prices are flat or simply don't increase as much as alternative investments, then enforced savings becomes a money pit.
People won't simply hang on to an expensive house and hope to make the payments as you suggest, if they are falling behind and their retirement is threatened as a result.
The housing market is on a knife edge. It looks like a sure thing. But all that has to happen is for for the economy to pick up to any degree, and suddenly housing will look like a very bad deal.