October 3, 2022

Mortgage Rates At 10% a Real Possibility If Inflation Can’t Be Reduced

Mortgage Rates Explode to 12 Year High

This year has seen one of the most explosive mortgage rates increases in history.  In a matter of a few short months the 30-year fixed rate mortgage has almost doubled from the high 2’s to over 5%. There have been previous periods of time during which rates rose substantially but 2022 has been a vertical move up that is rarely seen.

30-year fixed mortgage

Why rates have risen so quickly is no mystery.  After months of Federal Reserve talk of “transitory inflation” it has become clear that inflation is here to stay and likely to get worse before it gets better. The Fed must increase rates significantly to have any chance of reducing the inflation rate since current rates are far below the rate of inflation.

This from the WSJ:

During the 1980s, when Paul Volcker’s Fed was desperate to avoid a repeat of the inflation of the 1970s, interest rates were on average more than 4 percentage points higher than inflation. Leave aside the fact that at the moment the Fed Funds target rate is an extraordinary 7 percentage points below inflation; markets aren’t bracing for the Fed to be truly hawkish in the long run. Investors still think there’s no need, since in the long run inflation pressures will abate.

This is probably a mistake. The inflationary pressures from Covid and war will surely go away eventually. But self-fulfilling consumer and business expectations of inflation are rising, and a bunch of longer-term inflationary pressures are on the way. These include the retreat of globalization, massive spending to shift away from fossil fuels, more military spending, governments willing to run loose fiscal policy, and a starting point of an overheated economy and supercheap money.

If interest rates continue to rise, we may be looking at another housing bust similar to what we saw in 2018.

The Zero Sum Game Of Lower Interest Rates And Why Mortgage Rates Will Rise

The Federal Reserve has forced long term interest rates to historic lows in a desperate attempt to “stimulate” both the housing market and the economy in general.  The results have been mixed but the benefits of lower rates to borrowers are undeniable.  Lower rates reduce the cost of large debt burdens carried by many Americans and increases the spending power of those able to refinance.

Exactly how much lower the Fed intends to repress mortgage rates is anyone’s guess but as interest continue to decline, the overall benefits diminish.  Here’s three reasons why the Fed may wind up discovering that the economic benefits of further rate cuts will be muted at best, self defeating at worst.

1.  Lower rates are becoming a zero sum game for the economy as lower rates for borrowers translates into lower income for savers.  Every loan is also an asset of someone else and lower interest rates have merely been a mechanism for transferring wealth from savers to debtors.  Every retiree who prudently saved with the expectation of receiving interest income on their savings have been brutalized by the Fed’s financial repression. Even more infuriating to some savers is the fact that many debtors who took on irresponsible amounts of debt are now actually profiting from various government programs (see Foreclosure Settlement Q&A – A Victory For The Irresponsible).

A significant number of retirees that I know have been forced to drastically curtail their spending in order to make ends meet while others have been forced to draw down their savings.  The increased spending power of borrowers has been negated by the reduced spending power of savers.  This fact seems to elude Professor Bernanke who hasn’t been able to figure out why lower rates have not ignited the economy.

2.  Many consumer who would like to incur more debt are often turned down by the banks since their debt levels are already too high.  Those who can borrow often times chose to deleverage instead, considering the fragile state of the economy.  Anyone saving for a future financial goal (college tuition, home down payment, retirement, etc) is forced to reduce consumption and increase savings due to  near zero interest rates.  The Federal Reserve has destroyed Americans most powerful wealth building technique – the power of compound interest.  A 5% yield on savings will double your money in about 14.4 years while a 1% yield will double your money in 72 years – and that’s before taxes and inflation.

3.  As mortgage rates decline into uncharted territory, the mathematical benefit of lower rates diminishes.  As can be seen in the chart below the absolute dollar amount of monthly savings as well as the percentage decrease in the monthly payment diminish as rates race to zero.

Benefits of a refinance on a $200,000 mortgage diminish as rates decline

% Rate Mo Payment Mo Savings % Reduction Yearly Savings
6.00% $1,199.00
3.00%    $843.00 $356.00 29.70% $4,272.00
1.50%    $690.00 $153.00 18.10% $1,836.00
0.75%    $621.00  $69.00 10.00%    $828.00

Closing costs at lower rates also become problematic, making it impossible to recapture fees within a reasonable period of time.  With closing costs of $8,000 on a $200,000 mortgage refinance, it would take a decade to recoup closing costs.

Many astute analysts have made elaborate and compelling arguments that interest rates can only go lower.  From a contrary point of view, I believe that a future rise in interest rates is a high probability event.  This is the opposite of my prediction in March 2009 when I surmised that mortgage rates would decline to 3.5% – see 30 Year Fixed Rate of 3.5% Likely.

The Chart of the Day has a long term chart of the 10 year treasury and notes that the recent sharp decline in interest rates “has brought the 10-year Treasury bond yield right up against resistance of its 26-year downtrend channel.”

 

Optimists On Housing Recovery May Have To Wait Another Decade – Humpty Dumpty Vs The Fed

It wasn’t supposed to be like this.

Housing prices were never supposed to decline year over year.

Economic depressions were supposed to be a relic of the past.

If the economy weakened, the Fed would fix everything with lower interest rates and Congress would pass some new laws to create new jobs.

If things got really tough, the government would temporarily increase the debt and the magic of Keynesian economics was supposed to quickly “re-stimulate” the economy.

Our children were expected to lead more prosperous lives.  They were not supposed to move back in with Mom and Dad after four expensive years of college – arriving on the doorstep with a diploma in one hand, student loan notes in the other, telling us that they couldn’t find a job.

Day by day, we are discovering that a lot of things that were never supposed to happen are happening and no one seems able to turn things around.

The Federal Reserve and the White House promised to re-inflate the collapsed humpty dumpty real estate bubble with printed money and bailout programs for banks and defaulted homeowners.

An ex Princeton professor, now Chairman of the Federal Reserve, spent his life studying the Great Depression of the 1930’s.  He was supposed to know how to prevent another one, or so he assured us.

Fast forward to 2022 – housing prices that were supposed to have recovered a decade ago are still at levels seen more than 20 years ago.

Not possible you say?  Optimists and shills for the housing industry might want to consider some inconvenient truths.

Will the U.S. have 20 years of stagnant home prices?

What if real estate prices remain the same for another decade?  As I look at economic trends in our nation including the jobs we are adding, it is becoming more apparent that we may be entering a time when low wage jobs dominate and home prices remain sluggish for a decade moving forward.  Why would this occur?  No one has a crystal ball but looking at the Federal Reserve’s quantitative easing program, growth of lower paying jobs, baby boomers retiring, and the massive amount of excess housing inventory we start to see why Japan’s post-bubble real estate market is very likely to occur in the United States.  It is probably useful to mention that the Case-Shiller 20 City Index has already hit the rewind button to 2003 and many metro areas have already surpassed the lost decade mark in prices.  This is the aftermath of a bubble.  Prices cannot go back to previous peaks because those summits never reflected an economic reality that was sustainable.

Courtesy: doctorhousingbubble.com

The days of “no doc” loans are long gone and not likely to return anytime soon.  Lenders have reactivated a quaint old mainstay of mortgage underwriting and now require borrowers to verify the capacity to service debt payments.  Higher home prices require rising incomes but real incomes for many Americans have been declining for decades.

The income of the typical American family—long the envy of much of the world—has dropped for the third year in a row and is now roughly where it was in 1996 when adjusted for inflation.

The income of a household considered to be at the statistical middle fell 2.3% to an inflation-adjusted $49,445 in 2010, which is 7.1% below its 1999 peak, the Census Bureau said.

The Census Bureau’s annual snapshot of living standards offered a new set of statistics to show how devastating the recession was and how disappointing the recovery has been. For a huge swath of American families, the gains of the boom of the 2000s have been wiped out.

Earnings of the typical man who works full-time year round fell, and are lower—adjusted for inflation—than in 1978.

Gary Shilling, who correctly called the housing bubble collapse, tells the Wall Street Journal that housing prices could decline another  20% or more.

It will take a 22% drop to return median single-family house prices to the trend identified by Robert Shiller of Yale University that stretches back to the 1890s and prevailed until the housing bubble began. (It adjusts for inflation and the tendency of houses to get bigger over time.) And corrections usually overshoot on the downside just as bubbles do on the upside.

The problem is excess inventories. They are the mortal enemy of prices, and we’ve calculated an excess of two million housing units, over and above normal working levels of inventories of new and existing homes. That is huge, considering that before the housing market collapsed, about 1.5 million new homes were being built annually, a figure that shrank to 568,000 in February. At current rates of housing starts and household formation, it will take four years to work off the excess inventory, plenty of time for those surplus houses to drag down prices.

Additionally, our inventory estimate doesn’t even include future foreclosures, some five million of which are waiting in the wings. The 49% drop in new foreclosures since the second quarter of 2009 is a mirage, and was partly due to the Obama administration pressuring mortgage lenders to try to modify troubled mortgages to keep people in their homes. (They were largely unsuccessful.)

We can say that “We are not Japan” but every passing day proves otherwise.  And for those misguided souls who still believe that the government and Fed can put humpty dumpty back together again, don’t you think that if they could have they would have?

$700 Billion Debated – $5 Trillion Ignored

When the original $700 billion TARP bailout program was proposed by Treasury Secretary Paulson and Federal Reserve Chairman Bernanke, the American public was shocked.  The size of the bailout request was colossal, representing almost 10% of the country’s entire yearly economic output.  The country’s financial meltdown hit the front pages and caused public outrage.  Realization set in that the Government had been blindsided by the crisis and that interest rate cuts alone would not solve this problem.

Opposition to the bill’s passage was intense and the initial bill was defeated.   The Treasury and Federal Reserve insisted that the money was needed to prevent a collapse of the banking system.  Scare tactics were employed to sway voters minds.   President Bush informed us that the bill was necessary to protect America’s retirement plans and financial future.

TARP was passed and $350 billion quickly dissipated with little to show for it.  Secretary Paulson is now requesting the remaining $350 which will quickly disappear as well, with little assurance of ending the financial crisis.

Meanwhile, with virtually no public debate, the Federal Reserve has put the US taxpayers at risk for over $5 trillion dollars and counting.   This $5 trillion includes direct loans (such as to AIG),  debt guarantees and asset purchases from troubled institutions.

Bernanke, the non elected head of a central bank gone wild is committing vast sums of taxpayer money with no assurance of a positive outcome.  Are we to put our trust in a man who did not see this crisis coming, predicted that it would be contained and is now in charge of solving the problem?    Is Bernanke the savior or the guide on the road to financial Armageddon?

Mr. Bernanke’s predecessor at the Federal Reserve allowed the explosive credit growth and easy lending that fueled financial bubbles.  These bubbles are now bursting and collapsing the world economy.  We now have the lunacy of the Federal Reserve trying to convince us that easy money, which caused the problem, is now also the solution.  Easy money and low interest rates are the only answer the Fed has and so far all it has caused is financial insolvency on a worldwide scale..

The fact of the matter is, the Federal Reserve is not bigger than the US economy.   The power of the Fed is derived from the US free enterprise system.   The Fed cannot change the primary trend of market forces nor can it bailout an entire nation.  All they can do is slow it down and drag it out, as happened in Japan.  The end result of the Fed’s “rescue” is likely  to be an impoverished future caused by unmanageable debt burdens.