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What Lower Rates Can Do

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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.

9 Comments – Post Your Own

#1) On January 16, 2008 at 11:04 AM, camistocks (< 20) wrote:

So, the mortgage market is normalizing too... Now let's give the US consumer a few months to save some money.

BTW, the interbanking system has also normalized again thanks in part to those capital injections. From the FT.com:

We have one fewer thing to worry about. The crisis that gripped the money markets in August can be consigned to the dustbin of history.

With banks distrusting the collateral they had to offer each other, and hoarding cash to guard against losses, rates in the Libor interbank markets – critical for providing “give” in the world financial system – began to balloon. The steady relationship between Libor and the Federal Reserve’s Fed Funds rate broke down.

For the first half of 2007, Libor traded consistently at 11 basis points above Fed Funds. Once the credit squeeze started in August, this gap widened. Last month, it reached 86bp.

Normality has now returned. The gap fell below 11bp last week. On Monday, for the first time since 2004, three-month Libor actually fell below Fed Funds. Rates for commercial paper, another vital source of liquidity, followed the same pattern. So big banks’ acute difficulties in staying liquid appear to be over.

http://www.ft.com/cms/s/2dc71392-c2dd-11dc-b617-0000779fd2ac.html 

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#2) On January 16, 2008 at 11:05 AM, saunafool (98.86) wrote:

"There needs to be a law..."

Ohhh, dwot, good thing you're in Canada. Don't go to Texas with that kind of talk. They'll run you out of town:-)

Seriously, I think you've hit the nail on your head with your previous posts. There were standards, there were regulations. Sometimes, the regulations were even enforced. When I got a home loan in Chicago in 1994, I had a whole ring binder full of paperwork I had to supply.

In 2004, I could have gotten $500,000 by showing up to my local Countrywide office with a pulse and a pen in my hand. (I've long been a rentloser, so I didn't.)

On such a down day in the market, I just sit around and think I gotta buy more gold.

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#3) On January 16, 2008 at 11:08 AM, TMFBent (99.82) wrote:

Interesting thoughts.

My guess is that the surge is explained by a couple things. First, desperate, bad credit risks filing piles of applications in the hopes of getting one through.

Next, desperate, finally-realizing-too-late bubble-flipper-bagholders figuring out that, although they can't really afford a regular loan (and therefore took that option-ARM), they'll REALLY be unable to afford the usury that's coming down the road.

The RE industry will try to spin this as evidence of the bottom, but we all know that's not true. People can't afford homes at these prices even with low rates. (That's what Alt-A liars loans and option ARMs were for, after all). Prices need to fall on homes. People need to take their lumps.

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#4) On January 16, 2008 at 11:43 AM, camistocks (< 20) wrote:

From Jeffrey Saut's (up to now a bear)  weekly commentary:

In conclusion, we had an interesting conversation with the owner of a real estate appraisal business in the Tampa/Saint Petersburg area on Friday. He thinks the housing cycle is bottoming, as evidenced by a noticeable pick-up in his business. Since he is on the “front line,” we listened to his cogent comments intently. While we remain skeptical of real estate, if YOU believe the cycle is bottoming, we would watch the exchange-traded fund “ProShares Ultra Real Estate Fund” (URE/$29.56), which yields more than 6% and has good leverage on the upside.

http://www.raymondjames.com/inv_strat.htm 

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#5) On January 16, 2008 at 1:30 PM, WillSurfForFood (79.57) wrote:

 I don't know if you've seen this and it isn't really related to your blog but I thought you might get a kick out of it:

 It is about a firm introducing 401K debit cards

http://eba.benefitnews.com/asset/article/399392/cost-easy-401k-loan-Priceless.html 

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#6) On January 16, 2008 at 10:50 PM, d1david (29.26) wrote:

camistocks-

I may not be in Florida, but up here in New England... but I know an appraiser and she is very busy!  95% of her workload is bank foreclosures- You might want to ask your appraiser friend if he is busy with appraisals due to foreclosures or new homes.

Also- I have Mortgage Wholesale AE friends (they work for big lenders like Wachovia etc and drum up business from mortgage broker shops) and they have said that the appraisal guidelines are now ruthless--- maybe you friend is busy on new home purchases- not because of new homes being purchased- but because a mortgage broker has to order appraisal after appraisal after appraisal with different companies till he gets the value that is needed to get the LTV loan that the buyer qualifies for.  -So yes- your friend might be more busier- but that doesn't necessarily translate into more homes being bought.

-David

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#7) On January 16, 2008 at 11:27 PM, dwot (46.96) wrote:

Camistocks, I think you meant to say give them a few decades to save money.

saunafool, what the banks and brokers have done used to be called corruption.  When we bought our place that we just sold we "qualified" to borrow 83% more.  I have always been extremely sensible when it comes to debt, striving to pay it back.  I felt buried in debt.  We had a couple set backs and a 10 year plan turned into 20 years.  Lending is at level that nothing is allowed to go wrong and people have to give up everything else.

This matching short term deposits to long term debt thing has me thinking buying gold for Americans is probably a really good thing.  The problem doesn't go away for 30 years, and in the process they constantly issue new 30 years problems.  When I think about it, how the heck did anyone every come up with the idea of lending long and borrowing short?  At least in Canada if rates change they are all reset at the end of the term and the deposits match.

TMFBent, everyone who is applying is putting out more than one application.  I also figured the people with resets are taking a second look and working on trying to get a proper loan.  I agree the market has a way to go down.

WillSurfForFood, unbelievable... 

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#8) On January 16, 2008 at 11:36 PM, dwot (46.96) wrote:

Are The Levees Starting to Break?

This article lists the amounts of equity financial institutions  have gotten to shore up their balance sheets.

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#9) On January 17, 2008 at 9:24 AM, camistocks (< 20) wrote:

david, that's interesting. And I am sure that not all regional housing markets will pick up at the same time. But Jeffrey Saut, the chief investment strategist of Raymond James, is pretty smart and has a good feeling. I guess he must be aware of what you mention while talking to this guy.

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