Crossposted from Confounded Interest
This Friday, Chairman Bernanke will address the attendees at the conference at Jackson Hole. The question is … what will he say?
Let’s start with the evidence. The M1 Money Multiplier has collapse and M2 Money Velocity is looking peevish as well. Thus, increasing the money supply will be ineffective since banks are still nervous about lending to consumers.
And households continue to pay down debt rather than increase borrowing. [Note that the U.S. economy has used debt to fund consumption expenditures going back to Reagan. The largest increase in the “Austrian Credit Bubble” was under Clinton and continued through much of Bush’s years].
On the other hand, commercial loans have been increasing (and commercial real estate prices have increased recently). So Bernanke’s low interest rate policies appear to have some positive effect to offset the dramatic rise in prices (CPI and PPI). Here is a chart of real investment (plants, equipment, etc) showing a steady increase of around 5%. [It is one of the few things supporting GDP].
And here is monthly CPI changes (annualized). Yes, we are seeing inflation raise its nasty head:
So, will Bernanke announce further rate cuts (risking inflation), stay put, or raise rates (cooling inflation)? My bet is on … QE4 Lite where The Fed purchases MBS and other debt.
Finally, low mortgage rates don’t seem to be working in stimulating a housing recovery. Home sales are flat-lined, builders are barely building and Case-Shiller in languishing. So, I hope the decision is to raise rates to curb inflation.
Obama’s Economic Plan
The reason that I think that Bernanke will announce additional MBS purchases relates to Obama’s plan for economic recovery.
First, Obama will likely continue to push the Infrastructure Bank for roads, bridges and green development projects. [We already have the Department of Transportation and Department of Energy, so I am puzzled why there has to be another Federal bureaucracy].
Second, there will be a push for extensions to payroll deductions.
Third, the Administration will push for Fannie Mae, Freddie Mac and the FHA to refi ALL loans down to current 30 fixed-rates (and likely a conversion of ARMs to FRMs). I haven’t seen the proposal yet, but I have estimated that the Mayer-Hubbard plan will inject $90 billion into the economy AT MOST. [See my previous blog post].
Alternatives to the Mayer-Hubbard plan include lowering credit standards and costs for refis. But whatever the mechanism, SOMEONE has to pay for the $90 billion (nothing is free), and it is likely to hit taxpayers and pension funds investing in MBS.
Which brings me back to Bernanke. If Obama does propose a mass refi of F&F/FHA MBS, MBS will be about as popular at dysentery (aka, “the humming dragon”). As a consequence, The Fed may feel pressured to purchase MBS as a “buy of last resort” which like with long-maturity Treasuries.
So, my bet in on QE4 Lite.
Dr. Anthony B. Sanders, Distinguished Professor of Real Estate Finance, George Mason University
@ Antony B.,
I think the most important words you’ve shared above are “I hope the decision is to raise rates to curb inflation.”
Past cheap money decisions have been devastating to middle America, and we have also witnessed explosions in prices for such things as coffee and sugar.
There are 7 billion of us and sprouting, and we all want/need to eat. Our consumption will continue to put upward pressure on prices of all foodstuffs. However, the looming and inevitable acceleration of printing presses spewing greenbacks, will redefine “inflation.”
Now that middle America has firmly and irrevocably recognized/realized/accepted that homes are no longer a source of cash for larger TVs or Toyotas, an important way to get some confidence back into consumerhood will be to provide incentives for savings (raise interest rates). This will then shift perceptions and allow consumers to “feel” like they can stick their necks out the windows once again, and breathe the smell of new tires.
Compounded interest is a thing of beauty, which fewer Americans today than ever before, have experienced.
Banks are reluctant to lend because they no longer need to. They borrow money at 0% interest from the fed and buy T-bonds at 3-4%. Why risk lending to actual companies?
The Fed may feel pressured to purchase MBS as a “buy of last resort” which like with long-maturity Treasuries.
Putting that in plain English, that means subsidizing high risk junk loans with lower interest rates at the tax payers expense. Alternately, this is the wrong way to encourage people to purchase homes with zero down terms again in an effort to dry up the excess housing inventory. Both are completely WRONG approaches as the ONLY solution is an improving economy creating JOBS so people can qualify for (good credit risk) and PAY those mortgages.
We already know how to create jobs, all that stands in the way is the current occupant in the WH and the seat warmers in the Senate. The only thing the government can do at the moment is to GET OUT OF THE WAY and that means stop threatening businesses with taxes and regulations.
Step 1: Slash the Department of Interior budget by 75% and then let the energy companies drill and produce oil and gas to their heart’s content, that’s $300 billion a year of outsourced energy consumption that will be injected into the economy on an ANNUAL BASIS CONTINUALLY and about 2 million jobs. That means billions of dollars in tax revenue and royalties to the Treasury, a three-fer.
Step 2: Slash the EPA budget by 75% and stop the CO2 and Ozone regulation nonsense. Let utilities decide which energy source (coal or natural gas) is the most cost effective to generate electricity AND allow them to modernize the older coal fired plants with reasonable pollution controls without having to tear the whole thing down because the mandated EPA levels are nonsensical.
Step 3: Repeal ObamaCare , Frank-Dodd and the Ledbetter Act this removes billions in onerous regulations that don’t protect anyone and just makes the cost of labor more expensive. Get the Department of HHS out of deciding what health insurance covers because their recent regulations have just made it more expense, not less. Company sponsored insurance is part of an employee retention benefits package and NOT any business of the government to mandate. Were it not for the meddling of the government, insurance would be way cheaper and most people could afford it on their own. The same goes for State Insurance Commissions who lard up the coverage requirements in an effort to subsidize their PC policies like abortion coverage, etc. The biggest cost component of health care are the subsidies demanded by Medicare and Medicaid by underpaying medical care providers which forces them to charge everyone else MORE to make up the difference.
And households continue to pay down debt rather than increase borrowing.
The implication is not entirely correct, the initial drop in the amount of debt was due strictly to bankruptcy, NOT paying OFF the credit cards and mortgages. It’s not that people paid down, they lost their jobs and defaulted on their debt entirely forcing the banks to write off these debts. What really happened was the banks were forced to cancel the credit cards of those on the low end of the economic scale who were always just treading water by making interest payments. That’s where the banks were making their money on credit cards. Now the banks only have to borrow money from the Fed and make money off the spread with Treasury Bonds.
Wow!
A big nothing!
No signals to take steps to promote growth!
Just a repeat the risks to growth and the tools.
He wants CONGRESS to pass a budget that makes long term cuts.
He wants Congress to do it, not the Fed!
There are serious cause/reactions for a mandatory refinance down to current, low rates, Dr. A. And the largest will be an effective shut down of housing and lending in general. Housing prices are still abnormally high, even tho they have fallen dramatically since 2008. Getting closer yes, but still high.
The two graphs below will demonstrate the value explosion that began in 1998, and led to the 2008 collapse of the housing bubble.
I totally agree that raising rates is vital to control inflation. In fact, keeping rates so low under both Greenspan, post Sept 11th, and continued under Bernanke is a contributing factor to the bubble itself, and the degree of damage when it collapsed. As I said when I wrote the “Perfect Storm of House and Lending” a few years back, had the home values not risen astronomically, we could have weathered the foreclosures, since the property value would support replacing a defaulting buyer with a qualified buyer. However this was prohibitive since everything was, in essence, a toxic asset.
Rolling all current mortgages into refinances at the current low rates, then raising rates, has several repercussions…
1: Raising the rates will further devalue property values.
It’s not rocket science. Wages are either stagnant, or on the decline, across the board. If a borrower can pay $1000 monthly for a mortgage, they can certainly afford a lot more home value at 3-5% rates than they can at 7-9% rates. Home values will adjust accordingly with the rates, just as they have always done.
Take, for example, the first graph where housing prices in 1992 were $150K , adjusted for inflation. Freddy fixed 30 year rates in that same year ranged from 7.92% to 8.93%. HSH stats for the same year were 7.99% to 9.03%.
Fact is, extended low rates contributes to keeping a bubble inflated. Housing values, despite the dirt cheap rates today, are still in decline. This makes you wonder just how much further they’d fall with rates in the 7-9%, and our current inflation. Almost terrifying to think of rates going to what they were during the Carter years, which likelydrive down nominal housing price again to $45-55K.
This, of course, exacerbates the current toxic asset quandary into the unthinkable… the amount of loss that the GSEs, FHA, financial institutions, investors and the individual homeowners would be devasting.
So refinancing all homes at their current values to a fixed current low rate then leads to the 2nd repercussion:
2: No one will be able to refinance out of the low rate downline, and into a new higher rate.
While this proposal would be a windfall for the lenders, charging for their refinances services, this is far from desireable for homeowners or future homeowners. It means there is no way to use what possible equity may exist to improve homes and assets except for out of pocket cash or additional credit lines.
While the ratio of refi’s to new purchase has always fluctuated, the refinance business has already been slowing over the pst year. Much is due to stricter credit qualifications, combined with the plethora of homes that do not have at least 80% LTV that is generally required for a refinancing.
This effectively slices away a huge portion of profit for the lending industry. With that drop in income/profit comes higher unemployment in the lender world… from loan originators to underwriters and processors. Since most financial institutions sell their notes, and perhaps retain the more lucrative loan servicing aspect, that will remain status quo.
But the domino effect of a halt in lending activity (refinancing) spreads to construction, remodeling and suppliers of home improvement products. If, in this unemployment era, spare cash in disposal income is the only way to improve your home, there are going to be a bulk of homes with deferred maintenance, let alone upgrades…. and those that service that industry will also be paying the price.
But wait… there’s MORE!
3: Nor will owners be able to sell their existing homes to new buyers without it being a short sale.
Since the higher rates will allow buyers to purchase less home for the money, most will NOT be able to take over a $200K home (currently with a 3-5% rate), and qualify at the higher rates. This leaves only two options… a short sale, since housing prices will have declined further because of the higher rates; or assumption of the current mortgage and balance by the buyer, who is willing to pay a low mortgage rate for an over leverage home.
I seriously doubt any savvy buyer would want to assume an over leveraged balance.
The real end result will be that few will ever be able to sell their home for a net gain. Of course, that may end up being the case, with or without a mandatory refinancing of all loans to current rates. But I suggest it’s not the rates of mortgages that are the most damaging. Indeed one of the reasons we are in this pickle is that most already took advantage of the low rates, pulled out the equity, and spent the money on everything BUT the house. So how many are actually left that aren’t enjoying a somewhat reasonable, if not extremely low rate?
What is the problem is the property values as they relate to the mortgage balances… i.e. toxic assets. If the feds wanted to play “let’s control the housing and lending market”, they would mandate that all homes be reassessed for current market values, and mortgage balances be adjusted for the current value while the rates stay the same*
* using the same ratio of equity, of course. If one had paid down their mortgage and had 60% of equity at the inflated price, the remaining balance that was adjusted to current lower values should also only be 60%. Otherwise it is again punishing those who have been responsible and frugal with their investments.
Do I think that’s any better of an idea? Hang no… No doubt if that occurred, the banks/investors would, again, be lining up for a bail out for the across the board huge losses.
I don’t much advocate federal interference in the housing market as it was federal interference and policies that led to the 1998 and later bubble. But since it’s hard to keep their noses out of everything, a less sinister approach is to adjust mortgage balances in ratios to current value. At least that would allow property to either enjoy a small appreciation somewhere in our life times, or perhaps not always be a short sale.
Personally, I think the market would do this anyway without a mandate. Any loan granted on a new purchase, or refinance, is always subject to appraisal values. Thus the reason that short sales and foreclosures are going to be in our future for quite some time. This will bring the home values into line, over time, without federal intervention.
Unfortunately, there will be a lot of homeowners that will lose their current asset to this method. But there is a bright side to the dark cloud. Realistically, if a borrower keeps their noses clean in credit useage for two years following foreclosure, bankruptcy or short sale, they can again purchase a home in about 24 months…. and probably for considerably cheaper than what they had.
I would like to point out one thing the smart money people in the Obama regime refuse to talk about. If they are successful in forcing all the mortgages to be rewritten to lower interest mortgages, WHAT HAPPENS to the banks when interest rates rise? ALL banks make their money on the interest rate spread between deposits and loans. IF Banks are forced to loan money at say 3% and interest rates rise on Treasuries to 5%, this means the banks are losing money big time. Even if Freddie and Fannie bought all the low interest mortgages from the banks, the tax payers then would be stuck with the loss because money would have been borrowed to make that purchase of the mortgages. In other words, the smart morons in the Obama WH are in effect setting up someone, either the banks or the GSEs for a complete financial collapse.
Does anyone want to take the bet that interest rates will stay low indefinitely? Where will the government get all this money? Print it?
@dscott: #6,
“IF Banks are forced to loan money at say 3% and interest rates rise on Treasuries to 5%, this means the banks are losing money big time.”
While your concerns for Obama/Bernanke/Geithner policies are justified, you might want to base such concerns on other reasons.
Banking is the easiest business on Earth to be in. The Banking industry has implemented brilliant marketing and PR campaigns over the past 200 years, which few others can match. Banks have cloaked themselves in respectability. Those old bank buildings with marble pillars, for example, were part of the “image” creation – strength/confidence/reliability/durability/trustworthiness etc. Banks are guaranteed to make money unless management does something seriously stupid, which occurs regularly. Simply, . . . Banks Make The Spread. When interest rates fluctuate, the rates they pay on previously issued loans don’t change retroactively. They wouldn’t be able to stay in business under such rules.
Banks control the game, and they’ve also made it extremely difficult for anyone (new players) to get into their game. The worst example of that is seen in Canada where basically 5 banks control all of banking. Even American banks are virtually locked out of the country. If it was an open game, there would be much more choice/competition, and consolidation of power in the hands of a few majors like City, and B of A, would be be less prevalent and stifling. There wouldn’t be the level of control over Washington that currently exists.
The fact that “Investment Banking” has been allowed by those who control the game, is what has put the whole banking system at risk. The giants, including Goldman, City etc., competed for bonuses, profits etc., in an unregulated corner of the banking game. They should never have been “bailed out.”
Their stupidity and greed brought America to the “standstill” it now endures.
. . . . Just sayin’
James Raider, I might add that the banks would make a windfall in refinances… prior to them going dead in the water… with such legislation.
The evil repercussions will be borne by the market, homeowners and, in some cases, buyers.
@MataHarley: #8,
I think you’re absolutely right, under the conditions of “refinancing” as we are led to understand them, or what’s been suggested – banks will be protected. Bad management, and bad decisions will be rewarded (covered).
Some of the regionals were hurt and are still getting hit, but overall, they’re all in for some “hay making.”
Banks will be protected… but only in the short run, James. The mandate will result in windfall fees. But the piper will be paid with the future of declining prices, and more toxic assets hitting the books. Again, it’s another delay, or kicking of the can down the road. The ultimate reward would be a second bailout.
Then again, they are rewarded daily with virtually interest free borrowing under fed rates, and no risk trades.
I wish you would provide a link to the cartoons so I can read the captions. (CTRL+ makes it bigger, but makes the writing muddier._
@joovy sit and stand stroller:
Swell. Trolls, and now spammers.
Mata note: Happens occasionally when they get thru the spam filter, Larry S. Nothing personal or content related necessarily. Removed now