As can plainly be seen in the lower (inflation-adjusted) chart, interest rates vary substantially over time, even after subtracting out the rate of inflation.
Why is that, O ye of great wisdom and sophistication?
Posted on 10/18/2003 1:29:50 PM PDT by 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.
I've been a "corporate banker" and currency risk manager since 1969 and have been following exchange rates and money markets since before the Dollar was floated in 1971 (August 15th by Nixon). I've done my homework and I'm still involved in the markets on a daily basis. Interest rates track to inflation nearly perfectly and exchange rates track to relative inflation nearly perfectly, statements to the contrary notwithstanding. When inflation got out of hand in the late 70's and early 80's, interest rates rose in tandem. Volcker had to tighten down on interest rates, hard, i.e. push them upward, to squeeze the inflation out of the economy. It worked. Inflation and interest rates have been declining for 20 years.
You have a case to make. Make it.
Weiss has been saying this for a year now.
He also predicted Dow 5000.
I said that interest rates are a function of inflationary expectations, credit risk and supply/demand of lendable capital. The Federal Reserve report I referenced says exactly the same. If a Federal Reserve report does not suffice, I'll add the following: The US government can borrow money at a lower interest rate than any other borrower, because the credit risk is perceived to be lower. Conversely, companies in economic trouble have to pay rates considerably higher than the Microsofts of the world do. And the spread between the rates that good risks and bad risks have to pay varies independently of inflation. You should know that. Case closed.
Yeah right. All the would-be homebuyers, rather than economize or buy a less expensive house, will pitch tents in the field and drop out of the economy rather than pay a little more.
I get this guy (Weiss') advertisements in the mail, and he ALWAYS predicts doom and gloom.
As Daffy Duck used to say, "What a maroon!"
Suppose at time A, there is risk-free rate Ra and inflation premium Pa, but at time B there is risk-free rate Rb and inflation premium Pb. And further suppose that inflation at time A and at time B are the same, so that Pa = Pb--but that Ra != Rb (the risk premiums are not equal.) It's easy enough to find examples where that has been the case. Why? How does your theory account for such situations?
From Wikipedia, the free encyclopedia.
In economics, the time preference theory of interest is the idea that interest is the price that borrowers put on having money now rather than having money later.
This interest rate may be set by the chance of making profit, the estimated inflation, the preference of owning rather than renting an asset or simply a high time preference with consumption.
There is no attempt to link this with marginal production and it rejects the idea that interest is by its nature exploitative.
The theory with its stress on the marginal utility of the loan rather than any use to which it can be put suits the Austrian School's analysis, although other economists also apply this theory.
See also: time value of money
See: Why Do Capitalists Earn Interest Income? for further details.
As can plainly be seen in the lower (inflation-adjusted) chart, interest rates vary substantially over time, even after subtracting out the rate of inflation.
Why is that, O ye of great wisdom and sophistication?
Just because we deal with reality instead of pie in the sky economic flim flam doesn't necessarily mean we don't know what we are talking about. You are working way too hard trying to discredit and diminish others. We are facing very challenging economic times and your efforts to simply ignore problems and attack those who point them out is less than helpful.
Richard W.
Richard W.
There seems to be a strange reality distortion field in operation. I wonder if anyone else has noticed it? (grin)
I see real interest rates gravitating around and tending toward a few percentage points above zero over time, the "real rate of return". The graph thus supports my argument. When inflation was a problem in the late 70's and early 80's, interest rates were in the high teens. Why was that if inflation is irrelevant? You are not winning this debate, sourcery. Why should I keep asking you questions that you ignore?
Why, thank you! Pleased to see that you're following along.
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