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| Post/ Thomas McKAy, Aldo Svaldi |
Posted on 08/03/2003 1:26:14 AM PDT by sarcasm
Sunday, August 03, 2003 -
Tim McDonald and his staff at Wells Fargo Home Mortgage in Denver have harvested a whirlwind the past few months.
Post/ Thomas McKAy, Aldo Svaldi
"Picture every homeowner wanting to refinance," said McDonald, a regional manager. "It was like drinking out of a fire hydrant."
A sharp rise in long-term interest rates over the last few weeks could give McDonald and his crew a chance to catch up with their backlog and take a needed rest.
But if they rest for too long, some analysts worry, the country's fragile economic recovery could falter.
"Consumers are in a very sensitive position and aren't overly excited by the outlook," said Robert Bush, founder of ERIC Forecasting Publications in Englewood. "The more interest rates rise, the more pressure it puts on the economic system."
Long-term rates are rising, in part, on expectations the U.S. economy will gather steam as the year goes on. Stronger growth increases the demand for money, causing its cost, represented by interest rates, to rise.
The market's expectations contrast with the policy of the Federal Reserve, which has locked the short-term rate it controls, the federal funds rate, at 1 percent. The government has less control over long-term rates.
"We can't have a recovery without higher interest rates. It is that simple," notes Craig Thomas, an economist with Economy.com
Although more costly credit will cut into home and auto sales, a stronger recovery that creates jobs is worth the trade-off, he contends.
Yet, other analysts are concerned that consumers, who account for 70 percent of economic activity, will cut back under the weight of higher rates, stalling the very recovery higher rates are supposed to reflect.
"The cost of credit would be going up at the wrong time," said Andrew Clark, a senior research analyst specializing in fixed income issues at Lipper Inc. in Denver. "There would be a growing chance of the economy getting strangled."
The economy's growth, as measured by gross domestic product, surged an unexpectedly robust 2.4 percent in the second quarter. Consumer spending rose at an annualized rate of 3.3 percent in the second quarter, driven by a 33.3 percent jump in vehicle sales and a 15.7 percent jump in purchases of appliances and furniture.
The strength in consumer spending can be linked more to lower rates than rising incomes. Homeowners raised about $75 billion in cash through refinancing during the first half of the year, estimates Gerald Cohen, a senior economist with Merrill Lynch. The benefits of that extra money should stretch into the rest of the year.
Across 2001, 2002 and the first quarter of 2003, homeowners are estimated to have pulled out $250 billion in cash from their refinancing, said Jay Brinkmann, an economist with the Mortgage Bankers Association of America.
Rising rates threaten to choke off that source of cash and the other benefits that low rates provide.
Clark said sustained yields on 10-year Treasuries above 4.5 percent and closer to 5 percent could strangle the whole economy. Yields on 10-year Treasuries, which influence many other interest rates, including mortgages, closed at a low of 3.1 percent on June 13.
On Thursday, they broke through 4.5 percent, a 45 percent rise.
The massive swing in interest rates on 10-year notes is one of the most volatile the country has experienced in 25 years, and has made purchasing homes, cars and anything on credit more expensive.
"It is a signal that investors really can't ignore because it is so substantial," said Paul Dickey, a financial consultant with A.G. Edwards in Denver.
Mortgage rates for 30-year loans bottomed at 5.2 percent in mid-June, according to Freddie Mac. For the week that ended Friday they averaged 6.14 percent, the highest levels of the year.
Rates at those levels are already making a dent on mortgage refinancing, a key financial pillar for consumers struggling with stagnant incomes and a weak job market.
From a high in late May through July 25, applications for mortgage refinancing plunged 58 percent. They fell 33 percent in the week ended July 25 alone, according to the Mortgage Bankers Association of America's Refinance Index.
"The big jump in rates we have seen over the last few weeks has come faster than what anyone predicted," said Brinkmann.
How fast? On July 14, Mortgage Bankers Association economists forecast the 30-year fixed-rate mortgage would reach 6.1 percent by the end of 2004. Rates got there in two weeks.
All the volatility has also raised concerns about whether interest rates are artificially high.
The federal government expects to sell $60 billion of new debt this week. To attract enough buyers to match the extra supply coming to the market, rates are rising.
Mortgage lenders have also had to dump their Treasury notes to protect themselves against rising rates, which in itself causes rates to rise.
Cohen said that holders of 10-year Treasuries normally demand a 2.75 percent "real" rate of return. They also need a premium for inflation, which ran at 1 percent in the second quarter and at about 1.5 percent the past year.
That would put a fair yield for 10-year Treasuries somewhere between 3.75 and 4.25 percent.
The latest GDP numbers show price increases are moderating, not accelerating. Inflation often falls during the early stages of a recovery as manufacturers gear up production, Bush said.
Inflation doesn't become a threat until production capacity and labor markets get strained, Bush said, and both those are a long way off.
Cohen said it is important to keep things in perspective. Rates are at levels seen a year ago and from a historical perspective are still low.
An argument can be made that rates became artificially low because of the Iraq war and deflation fears.
Also, the dip in rates was too short for consumers to become dependent on them, Cohen said. At the end of the day, consumers care more about jobs than what credit costs them.
Interest rates also carry a self-correcting mechanism. If the economy falters, then interest rates will fall, making capital cheaper and priming the economy again.
But another downward cycle of interest rates would reveal a U.S. economy addicted to cheap capital and prove that deflation is a real threat, some analysts said.
Clark shrugs his shoulders when asked what would break the cycle of an economy addicted to easy credit. The economic models that have worked since World War II don't have answers.
There is also a risk the volatility could create a crisis that damages credit markets and the larger economy, Cohen said.
A hedge fund, bank or other big investor could have bet the wrong way on rates and be at risk of collapse. So far, there are no signs that other shoe has dropped.
For his part, McDonald doesn't plan to kick back. The backlog of applications will keep Wells Fargo busy through August and beyond.
The state's largest mortgage lender made plans for the day when refinancing would dry up and new mortgages would dominate.
New mortgages have only fallen 8 percent from their peak in late May, according to the MBA index, and aren't as sensitive to rising rates as refinancings.
But even McDonald worries about an upward rate spiral that gets out of control.
"The economy can afford a bump in rates; the question is how much and how long," McDonald said.REVERSAL HITS BONDS
Bond markets have experienced one of the sharpest reversals in a quarter century, driving up long-term interest rates on home, auto, corporate and other loans. When bonds fall in price, the yield or return they offer rises to compensate. Below are some drivers behind the higher long-term interest rates.
Investors snapped up fixed-income investments in March after Federal Reserve officials warned about the risk of deflation, or falling prices. When the Fed cut the federal funds rates by only half the expected amount in June and dropped the deflation talk, interest rates began their current rise.
Some investors anticipate more robust economic growth in the second half of the year, which could boost inflation.
Federal deficits are ballooning, requiring Uncle Sam to issue more debt, including $60 million this week. The glut of supply has lowered the value of existing treasuries and required a higher yield to attract new investors.
Mortgage issuers, opportunistic investors and foreign central banks are dumping their holdings of U.S. government Treasuries, adding to the upward pressure on yields.WHO SETS THE RATES?
Although long-rates have risen sharply in the past month, short-term rates under the control of the Federal Reserve have stayed firm. Below is a brief description of which rates the Federal Reserve controls and doesn't control:
Federal funds and discount rate
The Federal Reserve sets short-term interest rates through the loans it or other banks make to each other. The discount rate, currently 2 percent, represents what the Fed charges banks for loans. The Fed also has set a 1 percent target for the federal funds rate - the rate banks pay each other for overnight loans. That rate is at 1.05 percent.
Prime rate
Banks set their prime rate, given to their best borrowers, based on the federal funds rate. The prime rate at most banks is at 4 percent.
10-Year Treasury note
This debt security became a key benchmark for interest rates after the government stopped issuing 30-year bonds. Investors set its price on the open market, with limited government influence.
30-year fixed mortgage rate
Mortgage issuers link the rates on this popular home loan to rates on the 10-year Treasury, in part because most 30-year mortgages don't last for more than 10 years.
Long-term rates are rising, in part, on expectations the U.S. economy will gather steam as the year goes on. Stronger growth increases the demand for money, causing its cost, represented by interest rates, to rise.
... I know who ever is speaking is only putting out spin crap !
Let's hear some opinion on how long and how deep the bond blow off is going to be and what are the ramifications.
A prolonged period of stagflation ahead?
"We can't have a recovery without higher interest rates. It is that simple," notes Craig Thomas, an economist with Economy.com
What kind of Barbra Streisand is that? The "we" this guy refers to must mean his banker buddies and the grey Nazis of the AARP who live off their CDs.
The risk to both the homeowner and the lending institution is in the devaluation of the asset (home) upon which the loan was made. As long as the homeowner isn't forced into selling, then things gererally work out (S&L crisis excepted). If a home does go on the market for whatever reason (job loss, transfer, divorce) and the sellers market has turned soft due to higher mortgage rates, then either the owner has to eat a loss or he walks away (bankruptcy for example) and the lender takes the loss.
Richard W.
A lot. Congratulations, you have just won the "Nightmare on Wall Street" award.
Regards,
What happens to some neighborhoods when too many homes in it start going to foreclosure auction ---won't the price of all of them be in danger of falling? Some people bought bigger homes than they could afford because of low interest rates ---wait until the property taxes come due. They'll be stuck with taking a pretty good-size loss either way. Houses aren't good investments anymore because of outrageously high property taxes.
It would help the citizens. Be a major blow to big government proponets on both sides of the isle tho. That's why I think it will collapse before it's reformed.
The moneychangers have no intention of giving up the control fiat gives them. I think you'll have to pry fiat from their cold,dead hands.
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