Mortgage Meltdown?

Safemoney Report ^ | 18 Oct 2003 | Martin Weiss

[sourcery]

It also correctly, in my view, points to a fundamental moral lassitude as the basis for economic decline.

Arete, Starwind, TauZero and I are always being accused of being either perma-bears, or anti-Bush. That's just not the case.

I'm a libertarian, but I voted for Bush last election, and expect to do so again in 2004. Because of the way our election system works, there are really only two choices, the Democrat or the Republican. Failure to understand that just risks giving the victory to the socialist enemy.

And the fundamental moral lassitude that plagues us is a disease that infects our society as a whole. It is not the fault of the politicians. Most of them are followers, not leaders. The ones who can actually lead people to new opinions, new policies and new allegiances are few and far between. Reagan had it. FDR had it (unfortunately.) The Founders had more of it than any American leaders since that time.

As for being a perma-bear, all I can say is that I believe in dealing with things as they are, instead of the way I wish they were. The Federal Reserve isn't holding interest rates at historic lows, well below the market rate, just for fun. The take home message of the past two years isn't the tepid signs of possible economic improvement, it's how tepid the signs are given the tax cuts and Federal Reserve policies that have been wielded to jump start the economy. When you step on the accelerator, and the car barely goes any faster, something's wrong, and no mistake.

As for our discusion on interest rates, I suspect there have been some misunderstandings. Unfortunately, there's something about online interaction that brings out an aggressive, combative and competitive attitude. I don't like to interact with people that way, nor do I have the time to exhaustively debate every nuance and corollary of some issue, just for the satisfaction of having the last word.

If you'd like to be added to my economy/market ping-list, let me know.

[Phaedrus]

All of my commentary as to the fundamental determinants of market interest rates have been made in the context of the Fed supplying liquidity in balanced fashion as required by the domestic economy, as they have done for decades. Interest rates are, nonetheless, a market price for money and will always reflect supply and demand forces. Should foreign central bank holders of massive U.S. Dollar reserves tire of funding our balance of payments deficits or, worse, decide to reduce their holdings, the U.S. would be faced with a massive oversupply of Dollars which would basically require that the Treasury and the Fed raise interest rates simply to induce holders to continue to hold. That would be only a temporary "fix" however. Ultimately we must right our balance of payments deficit and that would be anything but easy to do in the short run. Severe domestic economic pain would result, I believe.

[Phaedrus]

If you'd like to be added to my economy/market ping-list, let me know.

I would, thank you, and I agree with almost the whole of your #101. Over the years I have "evolved" a very low tolerance for "technical experts" and sometimes get "snappish" when I read articles by "those who purport to know but don't". I apologize for any offense. The End of Dollar Supremacy? was a superb article, externalizing for me concerns that have been growing for many years. Most people don't have my background in international finance and that dimension usually completely escapes them. It can bite us. Hard.

[Phaedrus]

The Republicans, like the Democrats, are a "Party Of Big Government", the "Default Party" if you like, principally interested in winning the next election. The Founders most distinctly did not have this in mind. But I ramble ...

[sourcery]

The Founders most distinctly did not have this in mind.

They certainly wouldn't have approved of the way things have turned out. But the way things are is a natural and inevitable result of the mechanics of our electoral system as the Founders specified it, such as winner-take-all and single-choice voting.

[Phaedrus]

Democracy itself is flawed insofar as voters can vote money out of taxpayers' pockets. Any recipient of any form of support or payment from the government should not be allowed to vote except those who put their lives on the line for all of us through military service. Sounds kinda radical, I know, but it's the epitome of common sense.

[sourcery]

Sounds kinda radical, I know

That's an interesting idea. But it's moot unless and until we can figure out how to cause a paradigm shift in common opinion on the issue of the proper role of government in general, and taxes in particular.

[Starwind]

[Your "fundamental point" now is not consistent with your earlier posts.]

Well, now, I beg to differ. Perhaps you should again read my earlier posts

I read them and copied your earlier points verbatum into my post #90 and summarized them (which summary I didn't see you dispute) and copied your "fundamental point" into my post #96 and laid out the comparison of the two. Perhaps if this is a semantics issue, you could be more specific as to what you meant or which words in post #96 I've not properly compared?

Come on, Starwind, you are talking about the yield curve and validly correlating inflation to market interest rates requires matching maturities.

I was not correlating any specific maturities to the graph or interest rates. The juxtaposition of my description of 'duration premium' at the end of post #96 was simply coincidental (it had to go somewhere - perhaps a topic-change note was needed) and not related to the previous point refuting your specific assertions as to what was an 'in-line real rate of return variation around a mean over time' - a discrepancy between your post #91 and the graph you haven't yet addressed.

Are you suggesting the yield curve would be flat if there were (hypothetically) exactly zero inflation and zero risk of inflation over 30 years?

I simply asserted that investors expect and receive a premium for allocating their principal over a longer period of time.

Further, If I were one of your substantial customers and negotiated a $5M zero coupon bond for say, 2 years, at whatever your requested rate, plus I guaranteed you an inflation compensation premium adjusted, say monthly (so you had no risk of inflation loss), then upon agreement to those terms if I said, "Great, now lets just extend the term out 30 years" - you would agree? With no additional premiums charged? You would not charge more for my keeping your principal an additional 28 years?

What other fundamental determining factors are there?

The following are each determined independently and arise for different reasons, inherent to the nature of the loan:

Real risk-free rate
The rate of interest excluding the effect of expected inflation and compensates the investor for the temporary sacrifice of consumption.

Inflation premium
Compensates the investor for inflation and the risk of estimating inlfation wrong.

Duration Premium
Compensates the investor for lost opportunity over time of alternative investments.

Default risk premium
Compensates the investor for risk of the loan not being repaid or repaid on schedule

Liquidity Risk Premium
Compensates the investor for risk of illiquid collateral assets upon repossesion

Price risk premium
Compensates the investor for risk of having to sell originated loans at a discount

Call risk premium
Compensates the investor for risk of cash flow uncertainty and reinvestment risk introduced by a call provision

Structural Risk premium
Compensates the investor for risk associated with differing cash flows driven by movements in interest rates in different ways as new and different types of fixed income securities can encompass anything with an anticipated and measurable cash flow are candidate to be securitized.

An extreme example is the musician David Bowie who securitized his expected royalty payments on his first 25 albums over the next 10 years and received $55 million from investors.

[Starwind]

Inserted clarification underlined:

You would not charge more (beyond the interest rate already agreed on a 2 year term) for my keeping your principal an additional 28 years?

[sourcery]

Potential Dollar Scenarios

[RipSawyer]

"Meantime, manufacturing jobs and real productive activity is leaving town."

The only industry in my immediate area which is hiring for expansion is a paper cup plant. This is certainly better than a layoff, but what does it say when furniture manufacturers etc. close down while the paper cup business is booming?