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.
My quarrel with the article is that the author implies he understands the problem. He doesn't and his "answers" are thus worthless. I agree that there is a problem, which may surprise you. But technical analysis doesn't describe the problem and won't solve it.
Markets are stictly human phenomena and are as complex in the particular as are individuals. The roles of law and the sanctity of property as reliable bases for economic activity are completely ignored. They are crucial. The corruption of the law will ultimately be our downfall.
Law in turn is a reflection of values and that corruption has been going on for some while. It has been our enduring beliefs in hard work, contributing and keeping what we have earned in the form of property that has made this the greatest economy in the history of Man and sustained it.
How things go bad no one can say but I would wager that nobody will see it coming, given the complete blindness among the "experts" to the relevance of law and property. And they will, as usual, describe the debacle in fine technical detail after it happens. My 2 cents.
I guess this is where we differ. There are always problems in the economy, and I don't disagree with you about everything. I just think all the macroeconomic nonsense that affects the way you look at the world is not helpful. The other day you even quoted some obscure prognosticator with a phychology degree because it supported your belief that there is a huge credit bubble about to take down the economy. The posting of these comments from Weiss, whose newsletter is anything but a stellar performer, is in the same category.
In the long run, who knows. Maybe the credit bubble fear mongers will be proven right all along. I doubt it, but it's possible. Does that mean there aren't great investments out there that will prove profitable regardless? NO. That's the real and only reality I deal with. The economy in a macro sense is basically unpredictable. You and your cohorts are basically buying into a belief that it is. To the extent my comments have sounded like an attack upon you, please accept my apologies.
Ultimately, that will definitely bring the end to our society and our nation as we know it. I cannot disagree with you. In the shorter term, I believe that the necessity of fractional reserve banking to continually and increasingly expand debt will bring our economic and financial system to its knees.
Richard W.
I put my application in, please be patient.
I never said inflation is irrelevant. If that's what this is all about, please understand that I consider inflation to be a very significant subcomponent of interest rates.
However, inflation cannot be a factor or determinant of real interest rates, now can it? And yet the real interest rate is not a constant. Why does it change?
What event(s) are you suggesting is going to change this favorable situation for the United States, and which economy will replace ours as the safest place in the world to invest?
Phaedrus: post #78: 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.
Phaedrus' arguments were:
Phaedrus post #49:The lower graph in Sourcery's post #72, is the Real Interest rate adjusted for the inflation rate - i.e. real interest rate excludes inflation, thus removing the 1st of your 2 components.
Interest rates track exceedingly well to actual inflation alone. Expectations have a minor, short-term effect, offset by reality in the medium term (months).Phaedrus post #63:
Interest rates track to inflation nearly perfectly and exchange rates track to relative inflation nearly perfectly, statements to the contrary notwithstanding.Phaedrus post #66:
Interest rates are generally considered to have 2 components: the "risk-free" rate, the proxy for which is typically the 1-year T-Bill, and an "inflation premium". Add the 2 and you've got today's rate.Phaedrus post #67:
Our discussion revolves around interest rates to those who pay their debts timely, however.
As you agree the conversation centers around individuals who pay their debts timely and the graph covers T-Bonds & T-Bills, there should be no variation in the risk premium, thus removing the 2nd of your 2 components.
Yet after removing both components, clearly, the real interest rate graph shows a variation of:
1.5% - 4.5% for the long bond, and;over the last 2 years - 24 "months", the "medium term" you asserted over which "expectations have a minor short-term effect".
-2% to 1.5% for the T-Bill
Variations of 3 to 3.5%. After effects of inflation and risk have been factored out.
I presume a 20-year corporate banker would not consider 3-3.5% real, risk-free interest over two years to be an insignificant. No? After negotiating terms, would you be willing to reduce the rate to creditworthy borrowers further by those points? I suspect not. I suspect you view 3-3.5% real risk free interest very significant.
So I fail to see how the graph supports your assertions that:
Interest rates track exceedingly well [or nearly perfectly] to actual inflation alone.The 2 components, the "risk-free" rate and an "inflation premium" sum to the current rate.
Interest rates, the price people are willing to pay for money, reflect every human motivation imaginable. That the real rate of return varies 2% - 3% around a mean over time is not at all out of line. Do you take issue with the market rate being a reflection of the sum of the real interest rate (generating a real return) and an inflation premium as a general rule and over time? This is the fundamental point and consistent with my earlier posts. If you do, please elucidate.
Let me add from personal experience. I watch mortgage rates move with the 10-year Treasury bond daily. The spread between the 2 varies all the time as a function of what bond traders think the Fed will do, retail sales, employment and on and on. If you're looking for perfect correlation, you will never find it.
I should have copied you on my response to Starwind. I think we're looking at a pretty good fit, all things considered.
It's actually closer to 40 but you notice I don't lean on this much in my posts. The point is that those who only do theory come and go and their forecasting track record is generally abysmal. Another point is that in my experience many claimed they were able to forecast exchange rates (I managed corporate currency risk for 22 years). Most failed, and those who employed econometric models failed the worst, but there were a few individuals who could develop an accurate "feel" for where markets were going and could indeed accurately forecast, not always but way better than the averages. FWIW ...
Your "fundamental point" now is not consistent with your earlier posts. You have altered your argument
from:Your new "fundamental point" real rate of return varies 2% - 3% around a mean over time is a much more general statement.
[over months, medium term] interest rates track exceedingly well [or nearly perfectly] to actual inflation alone. The 2 components, the "risk-free" rate and an "inflation premium" sum to the current rate.to:
That the real rate of return varies 2% - 3% around a mean over time is not at all out of line. Do you take issue with the market rate being a reflection of the sum of the real interest rate (generating a real return) and an inflation premium as a general rule and over time?
However, again from the graph, over time now (say 10-years for example from '80 to '90) the real risk free interest rate varied:
9%-3% for the T-Bond; and,Considerably outside 2-3% range you feel is 'in line' i.e. outside the "medium term" of "months" looking at 10 years the variation of real risk free interest is 3 fold greater than what you feel is in line.
7%-0% for the T-Bill;
Further, another component (among others) omitted from your sum is duration. Obviously, lenders want a greater interest rate of return, after inflation, after risk, for longer terms - a 'duration premium' if you will. That's why we have an rate "curve" (slope) of increasing rates from 0 to 30 years. Right?
Well, now, I beg to differ. Perhaps you should again read my earlier posts. I am aware of their content since I wrote them and I have not entered my dotage quite yet.
LOL!
It's funny how little things like that slip by when looking for something more profound!
Ha! I gave this article even more credit than it deserved!
Duration premium? Come on, Starwind, you are talking about the yield curve and validly correlating inflation to market interest rates requires matching maturities. So, help us out. Comprising market interest rates are 1) a real rate of return required by investors that varies somewhat over time, and 2) an inflation premium that is subject of measurement variation. What other fundamental determining factors are there? Please bear in mind that "Length Before Strength" is a rule that works only in Bridge.
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