Mortgage Meltdown?

Safemoney Report ^ | 18 Oct 2003 | Martin Weiss

[sourcery]

A funny thing happened last week. Mortgage rates remained basically unchanged, inching up just 2 basis points to 5.81% from 5.79% a week earlier, according to the Mortgage Bankers Association of America. But demand for refinance loans and purchase loans dropped. Like a rock.

This was not your garden-variety drop. It was a huge plunge: Applications for refi loans sank more than 22%. Applications for purchase loans crashed 19%.

Refinance applications are now down MORE THAN 75% from their late-May peak while purchase applications are at their lowest level since April.

What's going on? It's pretty obvious ...

* The big reason consumers were rushing to refinance their mortgages until May of this year was FALLING mortgage rates. Whenever rates fell another notch, it generated a new crop of mortgage refinancing. But when rates STOPPED falling, the new demand began to dry up. And now, although mortgage rates did not rise very much in the most recent week, they are still up 75 basis points (three quarters of a percent) from the multi-decade lows set in the spring. That's killing the mortgage refi boom.

* When mortgage rates were falling, new home buyers could thumb their noses at rising home prices. "So what if the house is more expensive?" they said. "As long as our monthly payments are lower, who cares?" Now, though, the price increases of the past five years are finally going to cause sticker shock. Indeed, during that period, personal income rose 23% while the average price of a new home jumped 27% and the average price of an existing home skyrocketed 39%.

Combine the two factors -- higher mortgage rates AND higher home prices -- and the result is a significant jump in monthly payments. That means big trouble for the housing market.

Remember: The mortgage boom is what powered demand to the frothy bubble level where it still rests today. Now, what will happen as the mortgage boom comes to an abrupt end? What will be the impact on the rest of the economy?

Consider this scenario ...

* Higher mortgage payments end the boom in home sales ...

* Home prices stagnate and then actually begin to decline ...

* Homeowners can no longer easily tap into their home equity ...

* A huge source of new cash into the economy -- for spending or even stock market investing -- dries up ...

* Real estate, mortgage and construction industries -- among the few that were ramping up their hiring -- start shedding workers ...

* The real estate industry drops many of the 64,000 jobs it has added since May 2000 ... the construction industry drops many of its 70,000 ... and the credit intermediation industry (which includes mortgage lenders) drops a big portion of the nearly 250,000 jobs added since 2000.

* All industries that feed off of a booming housing market -- furniture, carpeting, home appliances and more -- fade quickly.

* The entire consumer economy sinks, setting off a chain reaction of declines in virtually every industry.

This won't happen tomorrow. But as long as mortgage rates continue moving up, it's hard to imagine how it can be avoided in the months ahead. And whether this scenario starts unfolding now or next year, it's certainly not too early to take protective action: Reduce your debt. Avoid sinking more money into investment real estate. Build liquid cash, regardless of how low the current yield may be.

[ghostrider]

This article and its posts reinforce my opinion, that investors are in a Las Vegas style, blind man's crap shoot.

[arete]

I don't really disagree with you, but as Keynes said, in the long-run we are all dead. So juicing the economy via the rates probably delayed the inevitable, but at least it kept things humming for 3-4 more years.

Keynes was an idealist and his thoughts on government interventions into the markets were never intended to be used with such frequency and undisciplined fashion as they are now. I'm sure he would be shocked to see just how far astray the application of his therory has gone. Keynes actually advocated paying back the debt -- something that will never happen. It's crossed the line of no return. The debt can never be paid so we have to keep mortgaging more and more of the future to feel good today. We all may be dead, but our children and their children will not. Which gereration is going to be buying a loaf of bread with a $100 Federal Reserve note?

Richard W.

[mickie]

Do you know of a good web site I can go to to check out current interest rates?

[sourcery]

Federal Reserve Board

Mortgage rates

[A CA Guy]

Yep, I would expect an eventual 10% in value drop for every 1% increase in rates.

[SteveAustin]

The debt can never be paid so we have to keep mortgaging more and more of the future to feel good today. Which gereration is going to be buying a loaf of bread with a $100 Federal Reserve note? Yep, we will inflate our way out of this mess. But right now it isn't a bad deal. We are getting all sorts of foreign goods for US Fiat money. I am more worried about the pension and social security problem though than the national debt and the mortgage rate bubble. (although they are interrelated) Too many promises for retirement to too many workers. That and medicare and medicaid expenses the next 20 years will dwarf this mini-bubble IMHO.

[Starwind]

Yep, we will inflate our way out of this mess. But right now it isn't a bad deal.

It is at best a mixed deal. Oft ignored in praising efforts to stimulate the economy or dissolve debt through inflation are:

• The very real effects of raising the cost of living (food, energy, shelter, transportation, education, health care, etc) for the average worker such that their employers find them priced out of the market and go offshore for new labor if not replace existing labor; and,
  
• All of that stimulus is borrowed by us, but 4/5ths of it ends up improving the GDPs of other countries, while only 1/5th goes into the GDP of the US...

i.e. we are 'inflating' and 'stimulating' ourselves into debt while building the workforces and economies of our creditors.

We are borrowing from them to buy their rope which will be used to hang us.

[arete]

Yep, we will inflate our way out of this mess.

Not so sure that is possible either. The FED painted itself right into a corner when Greenspan decided to politicize the FED. How do you debase the currency to the extent necessary, keep interest rates low, attract foreign buyers of debt and promote real inventment here rather than overseas . . . and keep the public solvent all at the same time? If you figure it out, call Alan Greenspan immediately.

Richard W.

[Phaedrus]

Interest rates are a function of a) inflationay expectations, b) perceived credit risk, and c) the supply of lendable capital relative to demand.

Interest rates track exceedingly well to actual inflation alone. Expectations have a minor, short-term effect, offset by reality in the medium term (months). Examples of inflation correlating extremely well with inflation alone are Japan and Brazil. As to available capital, here in the US, it's the Fed's job to ensure there is adequate liquidity (capital), which they do pretty well, all things considered.

[Phaedrus]

So in a deflationary debt collapse such as we are about to experience ...

It hasn't been established that this will happen. What makes you think it will?

[Beck_isright]

"Fannie is dragging the bottom of the river now by offering new home financing to low income no money down high risk buyers. In other words, you only qualify if you can prove that you can't afford the home. Hummm . . . yep, that is going to work out really well."

I think the bb's have missed the point. The gubment corporations are in deep trouble without a constant cash flow. If home purchases dry up, they will have to cash in some of their hedge options. Which of course triggers the bank and mutual fund hedge options. Which of course triggers the specialist and foreign hedge options. Which of course eventually comes home to roost to the poor sap who doesn't pay attention to the off market gyrations then bears witness to a 15% swing in his mutual or stock fund and cashes out or gets a margin call. Which brings us back to FNM. Who's stock is part of said margin call. Etc., etc., etc.....

[AFPhys]

I remember those 21% rates. I had to get a home with a 17.5% mortgage. Didn't have it long, thank goodness, due to an ability to liquidate some stock after a little while and eliminate that mortgage. It hurt just a tad at the time, though. Thank goodness for Reagan!

[Shanty Shaker]

Interest rates on mortgages actually have many factors that support the relatively "high" rates you are currently seeing. The amount of money to be loaned via mortgages is finite therefore the laws of supply and demand are a significant factor. A collapse in new loans would lower demand and "could" draw even lower rates.

[sarcasm]

Home loan sharks?

[lodwick]

Smart folks will heed Martin's advice.

Thanks for this post.

Cheers.

[Tauzero]

The bullish responses here are telling.

[sourcery]

Interest rate components

Valuatations and Interest Rates

Treasury Sec. John Snow: US interest rates 'to rise soon'

[sourcery]

What Determines Interest Rates by the Federal Reserve Bank of Chicago.

[sourcery]

It hasn't been established that this will happen. What makes you think it will?

I don't have time to produce an essay or thesis on this subject. I will simply say that Austrian economic theory predicts it--as was also the case in 1929. You can do your own research from there.

[Paul C. Jesup]

A funny thing happened last week. Mortgage rates remained basically unchanged, inching up just 2 basis points to 5.81% from 5.79% a week earlier, according to the Mortgage Bankers Association of America. But demand for refinance loans and purchase loans dropped. Like a rock.

This is pure BS because I know for a fact that some banks are lending at over 6%, the rise solely driven by the high demand of morgages and not the Fed