View Full Version : Mortgage rate blowout - a new bubble in the making?

12-21-2008, 10:02 AM
Mortgage rate blowout - a new bubble in the making?
by cmartenson
December 18, 2008

Between 2002 aand 2005, Alan Greenspan dropped interest rates too low for too long. This created a property bubble which was really no surprise at all to anybody who follows such matters.

In fact, there are reams of papers written by PhD Fed staffers that explore the unusually tight correlation between real estate and mortgage interest rates. There's really not a lot of mystery as to why this is the case.

To make an extreme example of it (and leaving the principal payments out of it), if you can afford $12,000 per year towards mortgage payments, at 10% interest you'd be able to afford a $120,000 mortgage whereas at a 1% rate of interest you'd be able to afford a $1,200,000 mortgage.

As a rule of thumb, each 1% reduction in the rate of mortgage interest supports a 10% increase in the price of a house.

So if you're a government official in charge of cleaning up after the last bubble, what does one do? Well, if one of the goals is to stem the losses arising from plummeting house prices then driving interest rates down has to be one of the more obvious policy plays.

Recently the Fed has been buying both GSE Agency debt and MBS products. That is, both Fannie and Freddie debt (to supply them with more cash that they can lend) and their bundled mortgage products.

This, coupled with the Fed's extreme support for the US government treasury market has served to push mortgage rates to their lowest levels in the entire data series.

30-year fixed-rate mortgage at 37-year low
CHICAGO (MarketWatch) -- The benchmark 30-year fixed-rate mortgage tumbled to a national average 5.17% this week, the lowest level since Freddie Mac began its weekly rate survey in 1971.

Will these record-breaking low mortgage rates help? That depends on your position. Certainly anybody who has a mortgage and is in a position to refinance to these new lower levels will be helped. And all the ARMs due to reset that are tied to LIBOR and Prime rates will be helped (by lower adjustment resets).

But all the people who did not participate in the housing bubble and have been patiently waiting for better prices are now 'fighting the Fed' which is a lousy place to be.

But will house prices actually go up as a result? Of that I am less sure. House prices are a complicated affair relying on other factors besides mortgage interest rates such as jobs and consumer psychology. I think these last two factors will more than counterbalance the Fed's attempt to reinflate the housing bubble for some time, probably another 12-18 months.

After that? It seems extremely likely to me that the another bubble is in the offing because the Fed is determined to create one. It's almost as if it's all they know how to create.

But you and I know that the real reason is that our monetary systems demands continual expansion and so the Fed, as the guardian of that system, will do everything it can to keep the expansion going.

To some financial observers this is known as the "inflate or die" strategy.

At any rate, this is one example of how the Fed intends to get new credit money flowing back out to the people. Now if they could just get the banks to play along....

12-21-2008, 07:20 PM
Low Rates, Big Problems
December 7, 2008

Government and mainstream economists have erroneously concluded that the key to reversing the financial free fall can be found in stopping the plunge in home prices. (I would offer the corollary that the key to reducing injuries in auto accidents is to suspend the laws of inertia). But to accomplish the improbable task of re-inflating the housing bubble, the government appears ready to announce a coordinated plan to push down mortgage rates to just 4.5%. Of course, this is precisely the wrong solution to the housing crisis, but when it comes to bad ideas our government has been remarkably consistent.

The plan would require the newly created Federal agencies of Fannie Mae and Freddie Mac to lower rates to 4.5%, and then require the Fed to directly buy the loans after they were made. The idea is that by lowering mortgage rates, current homeowners will be able to afford to make their payments, and new buyers will be more likely to qualify for larger loans, provided of course they do not have to come up with a burdensome down payment. If 4.5% is not enough to convince reluctant borrowers then look for the mandated rate to drop further. Perhaps there may come a time where the interest flows to the borrower instead of the lender. Anything to get Americans borrowing again.

But artificially suppressing mortgage rates will encourage risk taking and debt assumption at a time when consumers and lenders should be acting prudently. By setting rates below market levels, and buying mortgages that no private funder would want to touch, the government is creating a mortgage entitlement. Given the size of the home mortgage market, the program could eventually become one of the largest entitlement program on the federal books.

The most obvious problem is that the Government has no money. All it has is a printing press. So the more money it provides for cheap mortgages, the higher the inflation tax will be for all Americans. Higher inflation will cause the difference between where rates should be and where the government sets them to grow wider, and the entitlement to become more costly to provide.

Assuming $5 trillion in mortgages are refinanced at 4.5% in an environment where the unsubsidized rate would have been 10%. The annual cost to the government in such a scenario would be $275 billion. But the subsidy will have to be provided in perpetuity, as the minute it is removed, mortgage rates would surge and housing prices would plummet. Of course, the mere existence of the subsidy will continue to create demand for mortgage credit, which the government will be forced to provide by printing even more money. This would set into place a self perpetuating spiral of rising inflation and mortgage demand, with practically 100% of mortgage money being provided by the government. Ultimately the whole scheme would collapse, as run-away inflation would completely destroy what would be left of our shattered economy.

Some argue that since the government can now borrow for 30 years at 3%, issuing mortgages at 4.5% is a winning trade. There are three problems with this analysis. First, just because money is cheap does not mean we should borrow it-you think we would have at least learned that by now! Second, this analysis does not factor in default related losses. Finally, there is no way the government would be able to borrow that much money at the long end of the rate curve without driving interest rates much higher. The only reason long-term rates are so low now is that the government is concentrating its borrowing on the short end of the curve. So to pull of the trade, the government will have to finance it with treasury bills. If we turn the government into a massively leveraged hedge fund that cycles a multi-trillion dollar carry trade of short-term debt used to finance long term mortgages, then I think we already know how that movie ends.

In the final analysis the market must be allowed to function. If real estate prices are too high they must be allowed to fall, regardless of the consequences. Lower prices are the market's solution to housing affordability. Government attempts to artificially prop up prices will have much more dire economic consequences then letting them fall. Until we figure this out, there will be no escape from the economic death spiral the government is setting in motion.

12-21-2008, 07:32 PM
good info.

unfortunately for us our politicians are not rocket scientists by any stretch of the imagination, in fact they are borderline retarded. We can count on them selecting the most inappropriate choice possible.

12-21-2008, 07:36 PM
They aren't retarded. They are doing what they are pressured or bribed into doing by those who will make the most off of their legislation.

12-21-2008, 07:39 PM
I don't know. From some of the things they do, I'd have to say they are either evil or retarded. I'm choosing to believe they are not smart enough to figure out they are being manipulated over them picking personal gain and screwing over the country.

12-21-2008, 08:33 PM
good info.

unfortunately for us our politicians are not rocket scientists by any stretch of the imagination, in fact they are borderline retarded. We can count on them selecting the most inappropriate choice possible.

OMG, my first thought was "I didn't know jason worked with politicians too".

On average i would say 70% are retarded, 20% are corrupt, and 10% are trying to do well for the people (usually the new ones). I would say 20% overlap the retarded/corrupt line. Honestly, it's kinda hard to tell the difference.