patrick.net

From a layman's perspective -

At the risk of upsetting all those FB's in ARM's about to rest - I think to battle inflation (if nothing else) interest rates need to rise and it will also protect the buying power of the dollar, if they can't battle inflation and protect the dollar value, then incomes will have to rise as everything (especially imports) will cost more - either way FB's are cooked as incomes won't increase quick enough.

Mortgage rates are linked to long-term rates, not overnight rates which the Fed directly controls. In fact, long-term-rates remained stubbornly low during the Fed's recent longest consecutive series of rate hikes. Thus the yield curve inversion.

The dichotomy of "low rates saves housing -or- high rates saves the dollar" is false for numerous reasons.

* As mentioned above, overnight rates don't drive mortgage rates.

* Interest-rate-parity does not fully explain or describe currency exchange rates between major, convertible currencies. (If they did then there would be no global macro hedge funds making billions per year.) If I recall, there are at least five major economic theories about how exchange rates vary outside of basic interest-rate-parity.

* The dollar is still the reserve currency.

* The Fed does not care about housing per se. They care about inflation and recession, so they only worry about housing vis-a-vis consumer confidence. If confidence remains high enough to prevent a deep recession, they'll be agnostic about deflating housing.

* The US, along with only the EU and Japan, fall into the category of nominal-rate-power economies. That means these economies can maintain a nominal rate in disequilibrium from implied real-rate-parity. (This is all ISLM, Aggregate Demand & Supply stuff). By a large measure, the US has the most nominal-rate-power. Global demand for US dollar debt is not 1:1 linked to our nominal-rates. Probably not even 1:100 linked.

Sorry for the winded response, it's just that these pop "A or B" scenarios may make for good USA-Today InfoGrafix, but they do great damage because they create very rigid false beliefs about how things work. I'll guarantee that at least one response, probably many, to the original topic insist quite emphatically and authoritatively that the A or B scenario is fact. All of this merely from echo repeated junk economics.

"create very rigid false beliefs"

Wow! Yeah that about sums it up. So false and so rigid in fact even NAR's chief economist seems to believe that lowering rates can salvage the situation!

Even if they do it will only help a limited number of FB's. Those w/some equity won't have the fico or their DTI is out of whack. Those w/decent fico's won't have any equity etc. Lower rates across the board shouldn't be construed as the "white knight".

Now that it's drawing to a close 2006 has exceeded my wildest expectations! 2007 looks even better. Any lowering of rates would, no, should be seen as further signs of RE weakness. What's the 30 yr. FRM at anyway? 6-6.5%? How much cheaper should it be? RE has a lot of problems right now but sky high rates isn't one of them.

I disagree,

Look up "debt monetization" and figure out why we don't need foreigners to buy our junk... we just print some more and write some more IOUs to ourselves.

Hey, I'm a bubble believer as much any other, but I'm cynical as all he**, and know that the federal government will just order the montization of our entire deficit. Randy is right... they don't care about housing, just what the people inside of those houses spend each month. It's a recipe for inflation... it's simpler and easier to devalue the currency because we're the consumer of last resort.

As far as depressed spreads... that's only based on the current false assumption that lending in general has gotten more efficient in the back office, so it's cheaper. In reality, when risk premiums return, then spreads will return.

John Doe

Randy says "Mortgage rates are linked to long-term rates, not overnight rates which the Fed directly controls."

I think that's true for long-term mortgages, but short term ARMs are directly affected by Fed moves, and an ever-larger fraction of mortgages are those ARMs. So housing could take a big hit in the short term from Fed moves upward.

Patrick

I found 40 EU and also a 50 pound British on the pavement predawn some months back. Both the Pound and Euro are both rising on the USD, so I will continue hold.

Decades ago we were on a Gold Standard. I've heard that floating currency exchange rates are bringing us to a Barrel of Oil Standard in this ever increasingly energy hungry world.

I would rather see higher interest rates, a better protected USD and more affordable housing.

SFWoman,

Dr. Bannerman's letter to the editor was absolutely hysterical!

"When Calfornia's population doubles in the next couple of years!" Really?

Any time I've read one of Carol's articles I'd have to say she chooses her words pretty carefully so I'm not seeing the same purveyor of doom and gloom the good doctor is?

Btw, this is what the other side of "buy now or you'll be priced out forever" sounds like. Desperate and angry. Could it be that she meant CA's pop. would double in the next few DECADES?

Put me down into the "Fed is likely to choose inflation over deflation" camp. There hasn't been a real inlflation fighter at the Fed since Volcker, and probably won't be again --at least not in our lifetimes.

I have long suspected that they would choose inflation over practically any other scenario and could not give a rat's ass about the USD's strength or "reserve currency" status, especially considering that there's practically no other way to reduce the government's twin gargantuan debt obligations (the National Debt & Medicare/SS liabilities).

SP's points about tanking the USD being bad for the U.S. in the very long run are valid, but I don't think this Fed (or this Congress/Administration) really cares about the long run. They only care about holding onto power right now.

Also, another Enzo bursts into flames story:
http://www.kommersant.com/p725048/Suleiman_Kerimov/

If my husband had one I’d sell it while he was at work.

If you can afford a Ferrari Enzo, who cares if it bursts into flames when it crashes or not? Would love to have such "problems"! :-)

www.wreckedexotics.com

Pretty amazing pictures!

Patrick,

I think that’s true for long-term mortgages, but short term ARMs are directly affected by Fed moves, and an ever-larger fraction of mortgages are those ARMs. So housing could take a big hit in the short term from Fed moves upward.

That's not really true. ARMs are set by government security indices. From Investopedia: The interest rate for the mortgage is adjusted according to an index (usually a bundle of government securities) plus a predetermined margin..

The real problem with ARMs is, and has been all along, the unrealistically low risk premiums ... the spread. The lenders are *not* applying spreads well correlated with the real underlying risks. Lenders, in turn, are only reacting to the (global) demand for the MBS products that ARMs are resold as. And these investors are not demanding a spread, so Lenders don't charge it in order to remain competitive. It's kind of been a big volume game, not a quality game.

You could argue that Fed moves affect shorter dated gov't bonds. But not so much by the overnight rate, instead by Fed bond market activity (they Fed will buy & sell gov't bonds "secretly" on the market in order to impact goal rates). But, someone here will know more accurately, I'm pretty sure that ARMs are not priced by and large by short bonds, but by a bundle that is heavy in longer bonds. This all has to do with the way that they resell ARMs and match the 'duration' of the debt.

Yeah the "Malibu Enzo Crash" has one picture (looks like PCH?) where there's about a 1/4 mile of various car parts scattered along the road! It looks like one of the straighter stretches so I can't imagine what might have gone wrong?

SP,

I'm starting to wonder if some of these high profile crashes don't actually work to the mfr's benefit? Every "jackaxe" that hears or reads about these incidents seems to think he can handle the machine, so now he WANTS one!

The real problem with ARMs is, and has been all along, the unrealistically low risk premiums … the spread. The lenders are *not* applying spreads well correlated with the real underlying risks. Lenders, in turn, are only reacting to the (global) demand for the MBS products that ARMs are resold as. And these investors are not demanding a spread, so Lenders don’t charge it in order to remain competitive. It’s kind of been a big volume game, not a quality game.

On the other hand, ARMs have a big advantage (for the lenders) over 30-year fixed. In a stagflation scenario, lenders either get paid at much higher interest rate or else they get an asset that has appreciated in depreciated dollars when the property lands on their lap. Either way, they are hedging against inflation.

What the 30-year fixed lenders are thinking with their low spreads over treasuries, I have no idea.

The current frenzy in private equity to buy companies for cash is somewhat scary. Do the monied elite know something about the future value of cash that we patient savers don't?

Borrow and buy something... anything... before your government pulls the great 3-card monty maneuver.

Not Investment Advice and I am sadly still in cash.

dryfly,

I can agree with your "A or B" because it involves Aggregate Demand as a function, not just nominal rates. It is usually wise to involve both Keynes and Friedman in any reasonable model.

I also agree that the Fed's levers are losing their power, thus all the consternation of late about Fed strategy, tactics, and alleged abuses (and conspiracies). The simple answer is that ISLM is playing out, and Large-Open economies are slowly losing their nominal-rate-power because of the "Open" part of "Large-Open". I'm not sure the Fed can win regardless of what they do.*

However, this all unwinds rather slowly; not instantaneously. Like the worry about the USD as a reserve currency. It will take many years, probably decades, to disentangle global reserves from the dollar. That is unless every other country in the world -- namely large exporters and resource extractors -- want to commit economic suicide.

*The Fed does still have one lever they haven't used in decades: reserve requirements. I'm not enough of an expert to know how it would work, but the Fed could set a higher reserve requirement for banks, effectively soaking up liquidity without raising rates. I'm sure there's a gotcha in there somewhere, and that's why they don't use it.

FRIFY,

I wonder the same thing. The scale of PE activity is bewildering. I'm not sure it's all explainable by "section 404" (sarbox) and other listing encumbrances. There was a great piece in the Weekend FT that sought to explain it with M&M theory -- that is that taxes + (perceived) default risk have narrowed to a point where debt is much cheaper than equity. I tend to agree with this, although I think risks are understated. But debt is very cheap compared to the current cost of public equity. If you believe this, then PE firms are just "arbitraging" capital structures.

TN

I'm curious if you are as skeptical as I about the longer-term prospects of the EUR as a reserve currency? I don't see unified happiness in EULand's future. Let's see, two majors have rejected the constitution. Scandinavia is checking out. The Netherlands is looking more right all the time. France might well elect a very attractive Socialist who wants to "remake the EU", meaning lose the East and cull German power. UK abandons the GBP? Not likely. Coordination of fiscal policy to match the ECBs monetary harmony? And how about that friendly big neighbor to the east who shuts off the gas lines to freeze people as a negotiating tactic and feeds dissident spies radioactive lunches, not to mention what they do to journalists and CEOs.

I’m not sure it’s all explainable by “section 404″ (sarbox) and other listing encumbrances.

True - I forgot that reason (although I read the Economist's leader this weekend about the same thing).

Maybe it's just arbitrage on the low spreads of corporate debt in the classic raider pattern; take them private, saddle their cash flow towards new debt service and take the borrowed capital out of the company to play the game again. Since they're out of the public eye it wouldn't be as visible as it was in the junk bond era.

I like either explanation better than my conspiracy speculations. Too much tryptophan last week I guess...

Home builders gearing up for 2008

http://www.mercurynews.com/mld/mercurynews/16108990.htm

Randy H,

Good points as always. I for one have always been a little skeptical regarding the "Union" part of the EU. Thanks for spelling it out for those of us that don't follow int'l politics.

What's more interesting though is the prospect of raising the reserve requirements. I can see this having a very positive effect. Firstly it shuts up the REIC. An accomplishment in and of itself. Secondly it shows the lending community if they won't take underwriting standards seriously...... then fine, we'll do it for you! Thirdly it shows our trading partners we're not oblivious to challenges our currency faces and will take steps to correct the situation.

Had the NYSE raised margin req. in the late 90's we could have avoided a lot of speculative excess there as well. The argument they would make to the REIC is that there will still be plenty of mortgage money to go around for QUALIFIED borrowers! Agreed, we haven't seen this in years but perhaps it's time we did!

SP,

“denouement” for the win!

DinOR

Of course we agree on the SEC dropping the ball on margin requirements during the dot-com. My guess is that a raising of bank reserve requirements would cause a huge shock, if for no other reason than because it hasn't been used since anyone can remember. (Did it get used in the early 80s? I can't seem to find the answer easily).

Imagine all the bickering, moaning, and CNBC office-chair critics who'd be screaming bloody murder about how the Fed is wrecking the economy. Maybe the Fed thinks they can't control the kind of shock that would deliver. My only fear would be that somehow jacking up reserve req'mts causes a sudden and immediate risk-premium adjustment, and causes a credit crunch. Credit crunch = big nasty recession, like the old days when recessions could last the better part of half a decade.

Personally, I'd like to cheer on such a Fed move, but again I secretly fear that what happens as a practical result ends up screwing me just as bad as the current vector. Imagine house prices crash by 30%, but lending standards tighten so much that I can only efficiently borrow, in a rising rate environment, 50% of what I could today. Sure, I come out ahead in real-dollars. But it won't *feel* like I won (mental accounting), because I won't be able to buy what I thought I should have been able to after the crash.

lunarpark,

That article was pretty funny actually. To say that homebuilders are "gearing up for 2008" is like a guy in "re-hab" sneaking a cell call out to his buddies telling them to be ready to 'really' party the day he gets out!

Uh lets see..... we've had almost a decade of unbridled growth so yeah, one slow "selling season" should just about wrap this thing up! Oh and don't you just love the way they're now trying to go back further and further chronologically to establish the bottom?

The further back they go, the earlier they can establish exactly when we went into "recovery"?

dryfly,

Good points, granted. Wouldn't those guys have already made that move during the big run-up and re-fi craze though? I mean if they were going to do it? At that point your collateral (security) would have been appreciating. Now? A lot of risk and not a whole lot of reward. I could be wrong.

Maybe you should gently nudge your husband towards yachting. Preemptively.

Either that, or take out a large insurance policy on him with a double indemnity clause that covers dying in a fiery Enzo crash (_ducks_).

Wow, is this board posh or what? Instead of discussing (Indian, African, Indonesian...) bus plunges, it discusses Enzo crashes. Rich or poor, fiery crashes fascinate everybody.

BTW, the Casey Serin trainwreck continues. The kid has jumped so many sharks that he should be a sideshow at Sea World.

I found 40 EU and also a 50 pound British on the pavement predawn some months back.

wow. there's plenty of brits who have never seen a £50 note... ;)

hmm, I didn't realise EVERY recent Hyundai model was named after a place somewhere in CA...

November 27

USD reaches 20 month low against Euro. Wall Street falls sharply.

HOWEVER, it's the banks who've gotten all adventurous and dreamt up loads of new, easy-credit products of late, and offer them to all and sundry. that's been one of the big triggers for the boom, and it's one of the main reasons everyone's savings are in negative territory. who's running the banks and devising these schemes? how many of them are multi-national or have multi-national inputs into devising credit products? etc

Meanwhile, our guy is clearing brush in Crawford.

and talking to his dogs -
To dog on the ranch
'How ya doing?'
'I love the nature. I love to get in the pickup truck with my dogs.'
To dog, in his pickup truck, on the ranch
'Oh, hi.'

The Fed raising interest rates is meant to 'curb inflation'. Can anyone describe the chain of cause and effect where raising interest rates curbs inflation? It seems a little A and B also, but it is always put forward. Inflation (CPI) is running at around 4% p.a. right now, which is relatively high.

Housing in California to fall till 2008:

http://www.banknet360.com/news/NewsAbstract.do?na_id=6288&service_id=1&bi_id=

john,

I will temporarily pause my Troll-dar and assume you are the skeptical newbie you appear to be (for now)...

It's true that the current RE bubble has affected different parts of the country very unevenly. Most major metro areas in CA, FL, AZ, NV, HI, IL, the Pacific NW and New England have seen 200-300% nominal increases since 2000, while MI and the Dakotas have seen little to no appreciation. Problem is, most people don't live in Fargo or Flint. Much of the U.S. population tends to be concentrated in those (primarily coastal) large cities.

It may have been true 50 years ago that "all real estate is local". But thanks to the international carry trade, mortgage-backed securities, and the greater mobility of capital and labor today, it no longer is. The liquidity bubble that has been driving this madness is global, not local.

RE interest rates: I personally don't believe it's necessary for the Fed to further raise rates or even hold them steady for this thing to unravel. It's already starting to unravel right now. It's now out of the Fed's hands --stick a fork in this bubble, it's over. It's just a matter of time until the most delusional RE perma-bull realizes the jig is up. Which is probably about the same time he gets his first reset notice in the mail and realizes he cannot refi because the place is worth less than the equity he "liberated".

john,

Please explain to me why we are now living in a new paradigm. Why have fundamentals shifted so dramatically so as to justify over a 3x distortion from the past 50+ years of real-price real-estate appreciation as related to affordability? HSBC did an enormous amount of quantitative work, as have others, attempting to find any possible explanation that doesn't rely upon speculative bubble appreciation. Rent yields, rent-to-holding costs, traditional affordability, etc. must all revert to mean. ...or, you'll enlighten me as to what has changed that warrants approaching a 75% of income for housing and negative savings rate equilibrium.

@john,

Well, it all depends on what your definition of the word "crash" is. For stocks/equities, it might be defined as (a NASDAQ-style) drop of 50% of value or more in relatively short order (weeks-months). Do I expect the same to happen in real estate? Of course not.

RE is notoriously sticky and illiquid as an asset class, so --in terms of crash duration & scale-- the same expectations would not apply. "Crash" for housing might mean a 25-40% drop in nominal prices in the bubbliest areas (like CA) over a 5-6 year period, while real (infl. adjusted) values decline a bit more. "Soft landing" might mean roughly flat nominal prices, while very high inflation erodes 50% of real values over a similar time period. Moderate "correction" might mean a 10-20% decline in nominal values, with inflation taking care of the rest, and so on...

Either way, prices in most cities are way out of whack with supporting rents and incomes and must "revert to the mean" by *some* mechanism, whether it be nominal price drops, inflation, or some combination thereof. To believe otherwise would require a belief in New Paradigm thinking. Which I don't have.

USD reaches 20 month low against Euro. Wall Street falls sharply.

Conveniently I'll be going to Europe soon.

I never win. :(

john Says:

> There are cities that experienced 48% appreciation in 2006!!

Wow!! I thought that the most appreciation in CA was the in the (unnamed) Peninsula city where Confused Renters friends bought a condo and they were up less than 30% in 2006…

eburbed,

As opposed to going to Borneo?

dryfly,

I'm frankly a little doubtful of some of these MB "confessions". It seems that 82% of loans written in CA last year were of the ah-hem of the adjustable variety but I'll be damned if I can find a mortgage broker that wrote one?

All of a sudden MB's can't spell (let alone sell) Interest Only Mortgage. WTF? To me it's as incredible as finding a tribe so remote they haven't made the connection between intercourse and birth.

Look, all these guys are doing is cleaning up each others mistakes, oh and getting paid for it all over again btw.