What Lower Rates Can Do
January 16, 2008
– Comments (9)
The news story "Home Loan Demand Surges to Near Four-Year High" is what lower rates can do.
If people are now able to get out of their short term debt and refinance it at a long term fixed rate they will be able to remove their risk of higher rates. If people are increasing their debt at this rate that is just going to add to the whole problem.
Reducing rates now that investors have lost a bundle to bad loans means that it never stimulates the gross degree of mal-investment the economy has experienced until there is an generation that has not been through it. If it is as bad as I think it will be, most of us won't likely see this kind of mal-investment again in our lifetimes. And I really believe that the fact the economy was prevented from going through healthy corrections by Greenspan flawed ideology has truly screwed the working class over and has ensured that future generations will be paying for it their whole lives. Reading Edward Chancellor's stuff enabled me to understand what he had done and the degree to which the next generation will pay for his incompetence.
However, the whole system of economic financing is an enormous problem in the US. I never really thought about the difference in that you can get a 30-year-fixed rate in the US whereas in Canada you might be able to find a 7- or 10-year term on a 25 year amortization, 1 to 5 year terms are the most common. Our interest rates on our debt automatically reset at the end of a term and it has been that way since before I worked in banking. This is a table of current rates with lenders and the length of the terms.
When I look at that table, Canada has become foolish. There is practically no rate spread anymore between 1 and 5 years whereas there used to be a 1-2% rate spread. And for 7 or 10-years the spread was even more. It means that there is less risk priced into the longer term debt, but with 20-years of Greenspan lowering rates and manipulating the market to not reset rates to what would be a balanced economy I can see why there are low expecations for rate increases.
The US is offering 30-year debt at crazy low rates that don't have a hope of having risk priced into them and the debt is not matched with long term deposits, but short term deposits. So, what happens to banks when they can't raise capital at the current low rates? We are already seeing their inability to raise capital at low rates, the recent foreign equity offerings are at 9%, 11%, 14%...
This is an enormous long term problem, enormous. The lower rates are needed to reduce the economic destruction because of rate mismatch problem, but the very nature of offering low long term interest rates further increases the problem. There needs to be a law limiting the maximum that banks can loan to new clients. I think if such a law had existed, low interest rates would have done real stimuation of the economy without the asset price inflation. I am not sure what the maximum debt ought to be, but I am thinking somewhere around 2.5 times household income.
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