patrick.net

Easier credit makes the buyer more able to buy. However, easy credit does not cause stagnant markets to thrive. Markets have risen while rates were rising as often as while rates were falling.

I agree that easy credit is not always a required precursor to a bull RE market; however, the current run-up in prices (100%+ increases in CA since 2000) does seem to directly owe its existence to it. I see a clear cause-effect relationship here, especially with an explosion of lax lending in the form of IOs, neg-ams, no-docs, teasers, etc. only happening after the Fed lowered rates. Flippers/Specupants/Invesculators --whatever-- only seem to care about short-term payment "affordability" and assume record price appreciation will go on forever. Lenders sell off most of these toxic loans as MBSs to investors, so don't really care whether they go south or not.

Real estate has been about half of the new jobs, but still a small part of the total jobs. It can not do it by itself.

According to a 2003 California Builder online article (that's the newest stat I could find) RE accounted for approximately 13 percent of all economic activity in the state. It may be a little higher now, but even 13% is pretty significant. If, say, 25-50% of those jobs go *poof* in the next few years, the macro impact will be very significant.

californiabuildermagazine.com/internal.asp?pid=39

SJ_Jim, you said: “I’d be curious to know exactly how they calculated the 50% national average number.”

I do not know, but I think it is based on the aggregate numbers.

allah... "You are missing my point…it’s not just the low rates….it’s the fact that NOW you can get a loan without any collateral or good credit. Anyone with a pulse can get a loan….It was NEVER like that before. When this housing orgy ends, who is going to do the mopping up?"

Allah, the house is collateral for the loan.

Yes, credit is more easily available than before. Although it was very loose in the 1980s and during the rise to other cycle peaks.

What you might not have noticed is that there are definite credit cycles in the economy. Not always the same, but they do repeat.

The world is awash with excess capital. Credit is not likely to dry up severely in the near future.

Zeph,
Thanks for your thoughtful replies.

I have a further comment:

In the bubble markets the average equity tends to be higher because the appreciation has been higher, thus adding to the owners equity position.

This is one factor. Another factor is that in bubble markets people are putting less money for down payment & are more likely to do interest-only payment. This occurrence acts to decrease equity compared to non-bubble regions, where 10-20% is put as down payment, and principal is payed each month.
So, there we have two opposing factors contributing to the % equity figure in bubble areas--one increasing it, the other decreasing it.
The danger, of course, is that equity by appreciation can disappear, and even become negative, whereas equity by cash infusion cannot (well of course there's always inflation).

So yes at already low interest rate using IO to stretch is more serious than at high interest rate, but it is hardly suicidal if one’s income rises by 5.8% a year (last YoY data).

5.8% while not your average yearly raise is still not enough.

http://tinyurl.com/cggm7
http://tinyurl.com/e4hgm
http://tinyurl.com/cwx6n

Here's something I found entertaining:

http://tinyurl.com/8fy89

One of the more batty collections of logical fallacies I've seen.

Sorta like Lyndon Larouche on real estate.

Data point: assume a loan of 100K 30 yr fixed + 5 yr IO
if interest rate is 8.5%, during IO monthly 708, after 5 yrs 805
if interest rate is 6%, during IO monthly 500, after 5yrs 644

H.Z., I don't know what the underlying assumptions you used to calculate the monthly payments here, but this sounds rather optimistic to me. Most IOs today (never mind neg-am/"option-ARMs" which are even worse) are being offered with a "teaser rate" of 1-2 years, which can be as low as 1% --nowhere near the 5-6% interest on current standard mortgages. It is this rate --not the eventual "real" rate-- that many speculators are basing their monthly "affordability" on, because they intend to sell for a fat profit before that period expires.

On top of that, the payments will go up even more once the non-amortizing period on the mortgage ends --usually 3-7 years out. Again, the typical speculator/flipper believes s/he will sell for a profit long before then, so this "doesn't matter".

Regardless of where interest rates go from here, many of these marginal buyers are going to be in for a rude awakening.

I do not know, but I think it is based on the aggregate numbers.
I think so too...it would probably be easier to calculate it that way.
It would be very interesting, IMO, to compare the two different calculations.

HARM,

Yes, the multiplier effect of real estate is very strong. We are at the top of the cycle where the impact is greatest. As the housing market cools, the effect will be amplified by the loss of jobs resulting from the decline. As I said before it is self-accentuating.

As for interest rates and easy credit, it is important to understand that the flipper model includes only a relatively short holding period, so the interest rate is not very important. Access to credit is important.

The Fed lowered the overnight lending rate. It is an artificial rate target used to influence the market. It has direct impact on the short end of the yield curve. The capital markets including the mortgage markets work from the longer rates – principally the 10 year treasury. These are rates are driven more by inflation expectations than by the short term rates. In addition the capital markets are more international and much larger than ever before. This dwarfs the action of the Fed as far as affecting long rates is concerned.

Thanks for the laugh, KurtS. Kind of reminds me of the NYT article MP posted way back about how people not buying right now were mentally disturbed & suffered from "fear of committment". :mrgreen:

Wish I still had the link for it. Anyone?

Allah, the house is collateral for the loan.

The house being purchased is not collateral...If a borrower can get a no money down loan on an over inflated house....The lender is assuming that if the buyer cannot service his debt, he can take the house and sell it for the full amount of the loan...obviously you are assuming that it can be sold for at least the same price....this may work as house prices are on the rise, but they aren't now.

It use to require 20% down with good credit and verifiable income to get a mortgage.......now you can not only get zero down, but you can have closing costs baked right in....and your credit and income are no longer important...why?

because the bank will sell the note to fannie and is no longer liable for it. Fannie will package the note up with other notes and sell them as securities to investors.

What happens when the holder of the no-money down loan walks because his house is worth less than what his mortgage is......remember...when you put nothing down, you really aren't losing anything! This can happen with even a 5% dip.....and if it happens on a large scale, what do you think will be the outcome?

The Fed lowered the overnight lending rate. It is an artificial rate target used to influence the market. It has direct impact on the short end of the yield curve. The capital markets including the mortgage markets work from the longer rates – principally the 10 year treasury. These are rates are driven more by inflation expectations than by the short term rates.

Not so sure about this. Changes in the Fed overnight lending rate do seem to powerfully influence long-term rates. Each time the Fed lowered short-term rates back in 2001, the 10-yr rates dropped almost in lock step with them. They are rising even now as the Fed hikes continue, though not nearly as fast --which may very well lead to the dreaded yield curve "inversion". I don't view low interest rates as the ONLY cause of the bubble, but they were certainly the main catalyst.

"IO itself is an option that can be attached to a mortgage, including a fixed rate mortgage. It is not inherently evil."

This is true, but when people take these loans out they tend to depend on the option. There was a study on this I read somewhere...they compared these loan options to credit cards and how so many Americans depend on just paying the minimal monthly payment....that is why the government has decided to increase the minimal monthly payment so people will pay of the principal of the loan instead of just the interest.

dismissing outright everything containing any trace of bovine excrement or inconsistent with one’s beliefs is to do yourself an extreme disservice.

Provided only as entertainment only
I'm not asking anyone to endure a painful process of connecting those il/logical dots.
Data/noise too high...but anyone's welcome.

HARM, you said "Each time the Fed lowered short-term rates back in 2001, the 10-yr rates dropped almost in lock step with them."

This is not true. The average Fed Funds rate was 6.4% in December of 2000 and dropped to about 1.8% by Dec of 2001. A major decline. During the same period the 10 year treasury declined from 5.25% to 5.09%... an insignificant movement.

PeterP, et al.
Here's another coined word: di-worse-ification

"A letter to a financial advisor at CNNMoney goes like this. "Q: I'm single and make about $80,000 a year. I own a home that's worth about $550,000, which is more than $100,000 than I paid for it, and I've just used $60,000 I previously had invested in a diversified portfolio of stock mutual funds to buy a $140,000 vacation home in Arizona that is now valued at $190,000. My question is, should I continue with this investment strategy for retirement or do something different?"
"A: Investment strategy? I don't see any investment strategy. I see someone who went from having his wealth divvied up between real estate and a diversified portfolio of stock funds to a position where everything he owns is now pretty much riding on the fortunes of the real estate market. I'd be more likely to call what you did 'di-worse-ification', and more speculation than true strategy."

Allah, Just because the liability can exceed the value of the asset does not mean that the house is not collateral. It is collateral. If there is a shortfall the lender will have a loss equal to the amount of the shortfall, but they will collect on the sale of the collateral to fund the majority of the balance due.

Found it!

Fear of Committing?
By TERI KARUSH ROGERS
Published: July 31, 2005
NYTimes Real Estate section

http://tinyurl.com/ddhp5

Requires registration (or just use BugmeNot.com)

Newsfreak,

Could you clarify your question...

She has all her eggs in one basket.

Newsfreak--

Or, all her bats in one belfry

IO does not have to be a balloon. The change in payment when the IO period ends is not huge, so it is not speculation as long as the borrower can reasonably expect an increase in income.

So yes at already low interest rate using IO to stretch is more serious than at high interest rate, but it is hardly suicidal if one’s income rises by 5.8% a year (last YoY data).

But many people bought using 4% IO.

During IO period, the 100K loan will cost 333 per month. After 5 years, it will adjust to the current interest rate. At 6%, the payment jumps to 644, or 93% more!

The 10 year rate moves on many factors.

Any TY/ZN trader here?

Historically, the Fed has been a bit slow to react to needed interest rate changes. They got much better during Greenspan’s years. In the slower days I believe that the Fed was largely following the market… so it appeared that there was more causal connection than what really existed. The Fed has been far more proactive and has kept the measured inflation in a tight and low range, so the bond market stayed stable. When the Fed dropped to an artificially low level, the bond market did not move so much.

With the Fed artificially below the market for while, the market did not need to rise as the Fed came back toward the natural level for interest rates. Hence the conundrum…

Of course, in the final analysis it is all supply and demand for capital, and these various factors are all influences on that reality.

H. Z.,

I believe that most commercial investors do seek to maximize return within the context of maintaining a reasonable duration match or profile.

The foreign central banks seem to be very motivated by currency/trade considerations.

Peter P Says:
“Any TY/ZN trader here?”

Care to elaborate? Obviously I am not one.

10-YR Note future.

TY is the pit-traded symbol.
ZN is the electronic symbol.

I always admire people who trade bonds successfully.

I always think that the bond markets are much less emotionally driven.

Would the percent remain the same?

Yes. Just multiply them.

Zephyr Says:

This is not true. The average Fed Funds rate was 6.4% in December of 2000 and dropped to about 1.8% by Dec of 2001. A major decline. During the same period the 10 year treasury declined from 5.25% to 5.09%… an insignificant movement.

Zephyr,

Good catch --I believe "lock step" is overstating the relationship between Fed funds rate & the 10-year. However, if you look at the movement of both over the period when the Fed was cutting (Jan 2001 to June 2003), I think you'll see there is a definite correlation, though not one-for one as you pointed out:

See second graph under "HOW ARE MARKET RATES STACKING UP?"
tinyurl.com/ayl27

I think it's also worth pointing out that the Fed Funds rate's direct influence on the mortgage market is greater now than ever before, due to the predominance of ARMs over fixed-rate mortgages in the last few years.

the Fed Funds rate’s direct influence on the mortgage market is greater now than ever before, due to the predominance of ARMs over fixed-rate mortgages in the last few years.

As in the 10-yr bond rate only matters to you if have a fixed-rate mortgage, which most who have financed or refied recently do not. OTH, the Fed funds rate matters a great deal to you if you took out an ARM, option-ARM or IO-ARM.

Newsfreak,

I agree with your points. But it is a complicated issue… here is my take on it:

The immediate aftermath of the tragedy is a unique period, and can not be relied upon heavily for indications for other times.

The fear of a recession or worse in the wake of the terrorist attacks on 9/11 was an important consideration and the Fed lowered the Fed Funds rates during the following three months to 1.75%, and left it there for about a year and then lowered it again until reaching 1.00% by mid 2003. At that point they were worried about the risk of deflation.

On the declining inflation numbers the bond yields crept slowly lower… living in the neighborhood of 4% for most of the period. The Fed started its quarter point march upward in mid 2004, as the strength of the economy became clear. The bond rates continued to track with the low inflation and changed very little as the Fed funds rate rose from 1% to almost 4%. However, as inflation expectations grew (oil price shock…) the bonds began to stir. Then with the Sept inflation report (suddenly 4% inflation) the yields have started to climb.

The bond boys are constantly debating this situation. Some say it is a buying opportunity, while others insist that we have only seen the beginning of the movement.

The world is awash with excess capital. Credit is not likely to dry up severely in the near future.

I thought the world was awash with excess capital during the Roaring 20's.

I am surprised that for a self proclaimed financial conservative, you are so into options/futures.

I am a moderate conservative, both socially and financially. I am risk-adverse but I have to say that leverage is not all bad. Exposure matters more.

pbass, Look at the world capital markets for a better view.

Peter P,

The real question is whether the Fed will choke the money supply into a deflationary spiral at the end of this cycle, like they did at the end of the 1920s.

The real question is whether the Fed will choke the money supply into a deflationary spiral at the end of this cycle, like they did at the end of the 1920s.

No, of course not. I hope they learned the lesson. :)

ARMs are directly linked to various short term rates and once they start adjusting will follow them… of course, the 3 and 5year ARMs have been very popular and most are probably still in their fixed rate period. Those starting rates are a function of the longer rates.

Those starting rates are a function of the longer rates.

Last time I checked they are a function of shorter (2YR, 5YR) rates. Maybe I have mistaken.

If an emergency need for liquidity should arise, the Fed could always drop cash from helicopters if needed to stop deflation…

Our incoming Fed Chairman Ben Bernanke is famous for that reference… Hence the nickname of “Helicoptor” Ben.

Peter P, Yes, matching or close to the duration of the starting period. But definitely longer than the Fed Funds, Prime Rate and others that are used for the more volatile adjustable features.

The USD is the main reserve currency of the world. We can do a lot to affect dollar inflation, if we must.