patrick.net

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.

YOU are betting that rents will not double. Pure and simple. And if you claim that you are not betting, then your “non bet” is at least as risky as my non-bet.

Huh??

Sorry Jack, but I don't see how renting is equivalent to committing to a NAAVLP 0-down special solely due to your 'guaranteed' windfall from 20%/year price appreciation. For starters, you can always move. Second, the only thing you're "risking" is moving costs (vs. being upside down to the tune of hundreds of thousands on your "investment property").

Shoot, if rents double in five years, then this means incomes will have to double as well (unless you assume most working class people can devote 50-75% of their gross incomes to rent). At that point (assuming housing prices remain relatively constant) the "Buy vs. Rent" equation would tilt strongly in favor of buying and the current imbalance. This is what's been referred to as the "optimistic" scenario in past threads --and for good reason (ain't gonna happen ;-) ).

YOU are betting that rents will not double. Pure and simple. And if you claim that you are not betting, then your “non bet” is at least as risky as my non-bet.

Sure, I'll butt-in here :)
The correct answer is:
Yes, he is betting on this. But this is approximately the same as betting that incomes will not double in 5 years. Likely a pretty safe bet. The relationship of rent rates & incomes should be pretty reliable. So, if rents double, pbass' income will likely double.
(NOTE: I'm ignoring the possibility of a new paradigm in the relationship between rental rates & median incomes. I sure as hell hope it's safe to ignore this possibility).

Meant to say:
"At that point (assuming housing prices remain relatively constant) the “Buy vs. Rent” equation would tilt strongly in favor of buying and correct the current imbalance."

And who sees a skyrocketing of those in the next year or two?

5-YR yield and 2-YR yield have been steadily rising.

http://tinyurl.com/8wrv7

http://tinyurl.com/87ae2

The Fed goals are stable prices, full employment and more generally a stable financial environment for the economy.

I think the Fed will continue to do well at accomplishing their goals, and prevent or counteract high inflation or any hint of deflation…

With price stability we will have rate stability.

And who sees a skyrocketing of those in the next year or two?

5-YR yield and 2-YR yield have been steadily rising.

tinyurl.com/8wrv7

tinyurl.com/87ae2

If you could’ve bought for the long term 2 or even perhaps 1 year ago and you didn’t due to prices, you’ve gambled and lost.

I gambled and lost. So what? Losing is part of the game.

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

No way. The ACLU would block this with a court order on behalf of the short, the blind and those who tend to stay indoors.

If you could’ve bought for the long term 2 or even perhaps 1 year ago and you didn’t due to prices, you’ve gambled and lost.

You're assuming the gains from last 1-2 years are permanent and will not reverse at some point. If you could've bought 4-5 years ago but didn't, sure, you screwed the pooch, but 1 or 2? I think not.

Rents tend to follow a long term trend line of about 4% in California. In Southern California this has been pretty steady. In the Bay area it has been volatile -- more of a roller coaster ride.

"No way. The ACLU would block this with a court order on behalf of the short, the blind and those who tend to stay indoors."

Perhaps we could give them a one hour head start.