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Why is Analysis Wrong?



June 24, 2010 – Comments (5)

The 30-year mortgage is at a low since tracking began in 1971.  Probably since housing prices have declined there isn't as much risk for the loans to fall into default, but certainly there is still enormous risk in lending money for 30 years.  Higher inflation is one of the risks.  The inability to predict that far into the future is a huge risk, but the rate is only 4.69%.

I would have thought that by now loans would have repriced for risk, yet a loan rate of 4.69% simply does not seem to have much risk built into it.  I look at it from Canadian experience prior to the gross interest rate manipulation that started with the Greenspan era.  A 5-year loan cost you about 2% more then a 1 year loan and the odd 7 or 10 year loan was about 3% more expensive then a 1 year loan.  Canadian just didn't go for them because the rate was too high.  So, with the Canadian experience you had a premium of 2% on a mere 5-year loan and loans over that length having so much risk priced into them they just were not all that common.

That spread in the mortgage rates gradually declined in Canada, although looking at rates today for the first time in at least a year or two, I see the traditional spread is back, 5.99% for 5 years and 3.70% for 1 year, so 2.29% difference in rate for terms 4 years different in length.

So, risk has repriced itself into Canadian loans, but I can't see a 4.69% loan having risk priced into it, and it should, so why not?  Why didn't the longer term rates reprice themselves to take in account risk?

When I look at why something I'd expect didn't happen, I start to look for why.  From what I have read, my understanding of what is happening is banks are currently able to borrow at 0% from the fed and taxpayers are on the hook for carrying costs, ie, taxpayers are paying the treasury rate and the banks are borrowing that money for free.  And then it seems, by actually following the money, taxpayers are also on the hook for the huge bonuses the banks are paying themselves for being so profitable...

So, if you have government intervention, I was going to call it socialist intervention but calling it that doesn't work for me, so, if you have a group of people with grossly self-serving interests in charge of your tax dollars, well, free market analysis of what you'd expect doesn't have a chance.

The other thing that I did not consider is the wealth of the aging population.  They have tons of money that has to go somewhere.  Younger people have a much lower relative income then the previous couple generations and you no longer have a pyramid shaped population.  When you have a few with wealth loaning to many then supply and demand will push rates up.  When you have many with money to invest and relatively speaking, few looking to borrow compared to the amount of money looking for a place to invest, there will be a tendancy for rates to be lower.   The cheap fed money also has to be reducing the demand to borrow or offer term deposits to those who have money to invest.

I think a lot of how things used to be and work is going to be different because of the aging population.

5 Comments – Post Your Own

#1) On June 24, 2010 at 2:27 PM, imobillc (< 20) wrote:

Very interesting perspective.

I agree with you and the general analysis of risk and pricing.


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#2) On June 24, 2010 at 3:19 PM, Griffin416 (99.98) wrote:

Nice blog. So if I think that the 30-year will rise significantly, how would one play that, short EDV?

I have been thinking about the steep yield curve in the US and happen to think it will stay steep longer than others think it will. How does one play that? Banks seem the obvious choice, but they are going sideways. My second choice would be the broker/ dealers, i.e. GS, BLK, etc, but their charts look so horrific. What does the stock market know that I don't?

Thank you for your perspective, Griffin

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#3) On June 24, 2010 at 7:59 PM, d1david (29.51) wrote:

You are right about extreme low rates.. I am refinancing at 3.875% 10 yr fixed and no closing costs.

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#4) On June 24, 2010 at 8:12 PM, GREYWOLF4744 (< 20) wrote:

Good thoughts, but unclear writing.


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#5) On June 24, 2010 at 8:28 PM, d1david (29.51) wrote:

The US rates are artifically low due to Freddie, Fannie and FHA doing 99% of mortgage buying and all 3 entities are government backed.  Once Fannie and Freddie aren't allowed to purchase so much- the rates will rise and rise fast as the risk of default is quite high with increasing unemployment and falling housing prices.   

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