Low Rates, Big Problems 29 comments
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Government and mainstream economists have erroneously concluded that the key to reversing the financial free fall can be found in stopping the plunge in home prices. (I would offer the corollary that the key to reducing injuries in auto accidents is to suspend the laws of inertia). But to accomplish the improbable task of re-inflating the housing bubble, the government appears ready to announce a coordinated plan to push down mortgage rates to just 4.5%. Of course, this is precisely the wrong solution to the housing crisis, but when it comes to bad ideas our government has been remarkably consistent.
The plan would require the newly created Federal agencies of Fannie Mae and Freddie Mac to lower rates to 4.5%, and then require the Fed to directly buy the loans after they were made. The idea is that by lowering mortgage rates, current homeowners will be able to afford to make their payments, and new buyers will be more likely to qualify for larger loans, provided of course they do not have to come up with a burdensome down payment. If 4.5% is not enough to convince reluctant borrowers then look for the mandated rate to drop further. Perhaps there may come a time where the interest flows to the borrower instead of the lender. Anything to get Americans borrowing again.
But artificially suppressing mortgage rates will encourage risk taking and debt assumption at a time when consumers and lenders should be acting prudently. By setting rates below market levels, and buying mortgages that no private funder would want to touch, the government is creating a mortgage entitlement. Given the size of the home mortgage market, the program could eventually become one of the largest entitlement program on the federal books.
The most obvious problem is that the government has no money. All it has is a printing press. So the more money it provides for cheap mortgages, the higher the inflation tax will be for all Americans. Higher inflation will cause the difference between where rates should be and where the government sets them to grow wider, and the entitlement to become more costly to provide.
Assuming $5 billion in mortgages are refinanced at 4.5% in an environment where the unsubsidized rate would have been 10%. The annual cost to the government in such a scenario would be $275 billion. But the subsidy will have to be provided in perpetuity, as the minute it is removed, mortgage rates would surge and housing prices would plummet. Of course, the mere existence of the subsidy will continue to create demand for mortgage credit, which the government will be forced to provide by printing even more money. This would set into place a self perpetuating spiral of rising inflation and mortgage demand, with practically 100% of mortgage money being provided by the government. Ultimately the whole scheme would collapse, as run-away inflation would completely destroy what would be left of our shattered economy.
Some argue that since the government can now borrow for 30 years at 3%, issuing mortgages at 4.5% is a winning trade. There are three problems with this analysis. First, just because money is cheap does not mean we should borrow it-you think we would have at least learned that by now! Second, this analysis does not factor in default related losses. Finally, there is no way the government would be able to borrow that much money at the long end of the rate curve without driving interest rates much higher. The only reason long-term rates are so low now is that the government is concentrating its borrowing on the short end of the curve. So to pull of the trade, the government will have to finance it with treasury bills. If we turn the government into a massively leveraged hedge fund that cycles a multi-trillion dollar carry trade of short-term debt used to finance long term mortgages, then I think we already know how that movie ends.
In the final analysis the market must be allowed to function. If real estate prices are too high they must be allowed to fall, regardless of the consequences. Lower prices are the market's solution to housing affordability. Government attempts to artificially prop up prices will have much more dire economic consequences then letting them fall. Until we figure this out, there will be no escape from the economic death spiral the government is setting in motion.
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This article has 29 comments:
Ever have anything good to say about the US Pete. Maybe you should write an article of gratitude to this country as I'm sure it has severed more than you have served it.
So the question becomes should they....thus providing the means for the credit providers to build up their accounts for another day in the sun....
Or should prices be allowed to reflect the sudden withdrawal of credit.
Progress in the past 20 years plus relied heavily on increasing credit which in turn made higher prices possible.....
No one said that risk was not present.....Risk means that prices change and thus markets exist....
The governemnt should stay out of markets and in fact become a much smaller part of the total marketplace...
Structural changes such as a 10% consumption tax only....and a new world wide exchange that is more available to individuals not just the gamers of the system such as a Goldman Sachs....would put additional tools in the tool box that could augment prices in a real marketplace way....
The government needs to be drastically reduced commensurate with the recent drastic reduction in the economy.....
Right now, the social aspect has taken over, and policies that make rational economic sense in a true free market have been abandoned in favor of policies that are believed to make (good?) social sense.
We used to deride countries that make economic policies subservient to social concepts, but now it seems to be our turn.
This is the sad but true state of affairs we have been led into.
Once the citizens have been coddled in the security blanket of entitlement this is the inevitable outcome. Entitlement to cheap mortgages is just an extension of entitlement to pensions and health care. No capitalist enterprise, including a country, can function with these legacy costs. American capitalism cannot afford this any more than GM can afford it.
Anti-capitalism is already taught in the German and French school systems, pitting Adam Smith's evil pursuit of self-interest against virtuous Marxist "compassion". In Marx's equation, "From each according to his ability, to each according to their need.", all the compassion flows toward the 'needy' while all the costs fall on anyone unlucky enough to have 'ability'.
Production of all the goods and services that will be given to the 'needy' is simply assumed. There is a pie, and here is your share. There is zero consideration given to the entrepreneur or worker who is producing these goods. This is the final disconnect between what you earn and what you are able to consume.
Marx was not a complete idiot. His early writings about money are incisive and hilarious, such as, "Money makes bedfellows of impossibilities." It wasn't until he teamed up with Engels, who offered Marx some paying work, that Marx's communism was born.
By 1848 England's industrial revolution was 100 years old and people like Marx projected that labor would be almost entirely replaced by machines. In the 1920s CH Douglas, who thought up the "social credit" monetary system as an alternative to the bank-debt money system, also believed that labor was becoming economically irrelevant.
Douglas believed that anyone's productivity had far more to do with our "cultural inheritance" of technology and industrial infrastructure than with personal effort, which justified government issuing money to its people as a "national dividend". As in, "USA Inc has enjoyed $X profits this quarter and here is your dividend." Douglas believed the moral connection between work and income had been rendered obsolete by industrialization.
100 years later we know that declarations of "the end of labor" were fantasies. The moral economy built on the end of labor is likewise a fantasy. The moral basis of the welfare state is implicitly built on the idea that work is "optional". Recent decades of US consumerism paid with debt instead of work reinforced this idea.
Unfortunately material reality has not changed to match these fantasies. Humans have material needs that can only be satisfied by working for a living. After eating the apple, God told Adam, "Cursed is the ground because of you. By the sweat of your brow you will eat of it all the days of your life." CH Douglas stated that mechanization had lifted the curse of Adam from humanity. He was wrong. Genesis is right.
The welfare state effectively enslaves producers to reward consumers. This is accomplished with a moral reversal. In a true moral economy work and ability are virtues while neediness reflects moral failing or a lamentable state of disability. In our modern welfare state capitalist producers are evil greedy monsters while "the needy" are virtuous beneficiaries of our compassion. Surely a 'just' government should punish the evil with taxes in order to reward the virtuous needy ones.
I've been watching this unfold over the past 30-odd years. Conservative commentators, including myself, have been warning about where this is taking us. Nobody listened. Here we are. Welcome to the new world order.
Socialism is not the end game. Socialism merely weakens us to the point where we will welcome the tyrant who "saves" us. There will be world government. A large majority will think it is a blessing. It is not.
I look at the question with a different slant. Is the best cure for the low interest addiction disability a "cold turkey" treatment or a gradual withdrawal? I can see this a worthwhile debate.
Peter makes a very compelling argument of the danger of a low interest mortgage subsidy by the government becoming a huge entitlement program. Bad outcome. Is there a way such a program could be designed as a bridge program with a planned phase out? I'm sure there is, but politicians in Congress are probably incapable of mustering the political will to do it properly. A properly structured gradual withdrawal cure would be too much for the right, not enough for the left and those remaining in the center would be insufficient in number for reelection. Congress people are always running for the next election.
What if mortgage rates are brought down, but loans are then made to credit worthy borrowers who have a down payment?
I think we run the risk here of going from on extreme to the other-credit was far too easy too obtain before and the risk now is that it will become far to difficult to obtain.
Whatever happened to proper underwriting standards?
We need to get housing going again, but not to where it was in the bubble. Increasing the affordability, combined with rational lending standards, is the approach which should be taken now.
1-home building must be started again.
2-mortgages must be cheap and ez, like 4pc.
3-availability must be ez and broad.
usually fed lowering rates does job, but this didn't work because of overhang of bad loans. Hence bad loans must be bought up by gov.
otherwise we have got a depression on our hands.
remember the last depression was finally fixed by WW II. i dont think we want to do that again.
i am 73 yrs old and have lived thru this all.
g oram berkeley ca.
We have been hearing the US telling us how to work our economy the last 20 years I remember.
Well maybe you believe in this, but you should consider that 400 mio people in Europe that produce high quality goods I hope, are living in this system since 50 years, and in fact we all are in fond of it that much, that most people would never ever consider emigrating to the US.
So think about it this way. The problem is that it is not meant for greedy people. This is the reason good systems collapse after some time. It is taught as the prisoners dilemma.
If corporations work well and pay their people fine they can consume. I think this very obvious equation is not working in the US since some lobbyist have convinced free world trade, to buy cheap products, so that everybody can pile rubbish in his garage.
Maybe the free system is not working that well : Steel, Automotive, Banks.
The best system is always a compromise between two extremes : Capitalist and communist.
On Dec 07 09:32 AM derryl wrote:
> prudentinvestor wrote, "The reality is that there is no boundary
> between economic policy and social policy."
>
Welcome to the new
> world order.
>
> Socialism is not the end game. Socialism merely weakens us to the
> point where we will welcome the tyrant who "saves" us. There will
> be world government. A large majority will think it is a blessing.
> It is not.
Socialism does not mean that all hard working people have nothing and give it open handed to the poor. The amount the poor are receiving is barely enough to survive, no luxury here.
In general from 100% of population 10% will be great and smart, 80 average and 10% stupid, well these 10% are part of our society and we as humans who consider us to be good should have the greatness to also care about those that are not able to cope with the system.
Again, move away from your fix idea that you work hard, have nothing and give everything to the poor. The system merely means that rich people have good income and can afford a good live, no need to have 5 houses, and the poor do not need to live under the bridge.
But I just think this has been blown into the minds of US citizens, with no way out. I travel to former communist states frequently, and people there are not that negative about it as the people from the states.
Now they might even return back to their old system, since the capitalist is close to failing as well, just with the difference that it leaves everybody in the rain.
On Dec 07 09:32 AM derryl wrote:
I would like to add something to Peter Schiff's article with this;
The actions the US government, FED are doing, shows signs, as Peter just informed you, of a new inflated mortgage bubble waiting to happen.
As you all know, we have never seen a bubble repeat itself just after the other. After the worldwide oil crisis in the '70s, a mortgage crisis in the '80s, a financial crisis in Asia during the 90's. A tech bubble at the start of the era. And now again a mortgage crisis.
So the obvious thing to happen would be another crisis other than mortgage. People do learn something now and then, so the next bubble, will probably be in commodities and gold. (overspeculation by chasing the money)
Watch it happen.
(ps: this is not a prediction, just a mere sense of stimulus)
brgds.
Well the greedy capitalist system has worked quite well for over 200 years with a few hiccups here and there. We're still the only super power. And we will rebound from this just like every other recession.
"The annual cost to the government in such a scenario would be $275 billion. But the subsidy will have to be provided in perpetuity, as the minute it is removed, mortgage rates would surge and housing prices would plummet. Of course, the mere existence of the subsidy will continue to create demand for mortgage credit, which the government will be forced to provide by printing even more money. This would set into place a self perpetuating spiral of rising inflation and mortgage demand, with practically 100% of mortgage money being provided by the government. Ultimately the whole scheme would collapse, as run-away inflation would completely destroy what would be left of our shattered economy."
The government is once again going down a path of tremendous risk and enormous consequences with no forethought. just as we started the war in Iraq without having a plan for post-Hussein Iraq, they are proposing this new folly with no regard for how it will conclude.
This is one more piece of evidence that the whiz kids in charge really have no plan. Reduced mortgage rates, and getting into the mortgage business is just the latest tactic du jour. They have goals and tactics, but are coming up woefully empty in strategy.
On Dec 07 09:32 AM derryl wrote:
> prudentinvestor wrote, "The reality is that there is no boundary
> between economic policy and social policy."
>
> This is the sad but true state of affairs we have been led into.
>
>
> Once the citizens have been coddled in the security blanket of entitlement
> this is the inevitable outcome. Entitlement to cheap mortgages is
> just an extension of entitlement to pensions and health care. No
> capitalist enterprise, including a country, can function with these
> legacy costs. American capitalism cannot afford this any more than
> GM can afford it.
>
> Anti-capitalism is already taught in the German and French school
> systems, pitting Adam Smith's evil pursuit of self-interest against
> virtuous Marxist "compassion"... In Marx's equation, "From each
> according to his ability, to each according to their need.", all
> the compassion flows toward the 'needy' while all the costs fall
> on anyone unlucky enough to have 'ability'.
>
> Production of all the goods and services that will be given to the
> 'needy' is simply assumed. There is a pie, and here is your share.
> There is zero consideration given to the entrepreneur or worker who
> is producing these goods. This is the final disconnect between
> what you earn and what you are able to consume.
>
> Marx was not a complete idiot. His early writings about money are
> incisive and hilarious, such as, "Money makes bedfellows of impossibilities."
> It wasn't until he teamed up with Engels, who offered Marx some paying
> work, that Marx's communism was born.
>
> By 1848 England's industrial revolution was 100 years old and people
> like Marx projected that labor would be almost entirely replaced
> by machines. In the 1920s CH Douglas, who thought up the "social
> credit" monetary system as an alternative to the bank-debt money
> system, also believed that labor was becoming economically irrelevant.
>
>
> Douglas believed that anyone's productivity had far more to do with
> our "cultural inheritance" of technology and industrial infrastructure
> than with personal effort, which justified government issuing money
> to its people as a "national dividend". As in, "USA Inc has enjoyed
> $X profits this quarter and here is your dividend." Douglas believed
> the moral connection between work and income had been rendered obsolete
> by industrialization.
>
> 100 years later we know that declarations of "the end of labor" were
> fantasies. The moral economy built on the end of labor is likewise
> a fantasy. The moral basis of the welfare state is implicitly built
> on the idea that work is "optional". Recent decades of US consumerism
> paid with debt instead of work reinforced this idea.
>
> Unfortunately material reality has not changed to match these fantasies.
> Humans have material needs that can only be satisfied by working
> for a living. After eating the apple, God told Adam, "Cursed is
> the ground because of you. By the sweat of your brow you will eat
> of it all the days of your life." CH Douglas stated that mechanization
> had lifted the curse of Adam from humanity. He was wrong. Genesis
> is right.
>
> The welfare state effectively enslaves producers to reward consumers.
> This is accomplished with a moral reversal. In a true moral economy
> work and ability are virtues while neediness reflects moral failing
> or a lamentable state of disability. In our modern welfare state
> capitalist producers are evil greedy monsters while "the needy" are
> virtuous beneficiaries of our compassion. Surely a 'just' government
> should punish the evil with taxes in order to reward the virtuous
> needy ones.
>
> I've been watching this unfold over the past 30-odd years. Conservative
> commentators, including myself, have been warning about where this
> is taking us. Nobody listened. Here we are. Welcome to the new
> world order.
>
> Socialism is not the end game. Socialism merely weakens us to the
> point where we will welcome the tyrant who "saves" us. There will
> be world government. A large majority will think it is a blessing.
> It is not.
The biggest change in recent years was lack of equity and
lack of guidelines. If someone has 20-25% equity in a property,
they will probably ride out most setbacks. People with 10%
equity should not purchase a home, and that includes for
tax reasons. This lack of equity has destabilized the whole
concept of owning a home for use vs using it for speculation
and tax write off- it's one to loose your credit rating but
one thinks alot harder when walking from hard earned equity.
Of course when a market drops 50%, it causes alot of
damage to traditional ownership as well. Higher equity,
fixed rate mortgages, 30 year max, make originating lender
hold the paper for some period of time, police the bogus
credit applications. By allowing re-regulation, this is
what they have created- that said housing does need to
be stabilzed at some point- it has long term effects on
a whole generation of people. Lower rates in terms of
creating another bubble are questionable, when you
think about high the cost of ownership has become-
look at real estate taxes, insurance rates, utilities,
maintenance- no question prices were to high but inflation
hits owners
from every possible angle.
There's a lot of different parties to blame for the housing fiasco but I would tend to blame the lenders more than the borrowers. Given the widely held belief that real estate prices would only go up and with easy no money down financing available, many buyers were acting rationally since they were receiving a risk free long term call on the price of real estate. If prices kept going higher, you sell or refinance and make a killing; if prices dropped you simply walk away.
I would say that the government's attempt to prop up the artificial prices of the past by delaying inevitable foreclosures will only prolong the time it takes to eventually reach a bottom in housing. If someone is in foreclosure, that would generally mean that the homeowner, for whatever reason, can't make the payment or prefers to simply walk away due to negative equity, etc. These people become renters, the foreclosed home is sold at a market clearing price and eventually supply and demand in housing is balanced.
Going forward, if the mortgage industry can restrain itself to lend money only to those that have a documented ability to service the debt, another housing bust will be avoided. Unfortunately in the meantime, there are many innocent homeowners paying a very dear price for the lending insanity that brought this housing crisis upon us all.
globaleconomicanalysis...
Much of China's recent boom is illusory and shallow. Without US and other direct investment creating labor-intensive, sweat-shop platforms for mass exporting, there would be very little left aside from the world's preminent high-tech counterfeiting and pirating industries (and a completely destroyed environment).
Peter Schiff seems to have 20-20 vision when surveying the American economic landscape, but wears rose colored glasses with the wrong Rx when gazing out across the Pacific or Atlantic. He won't admit to his investors the truth: he can run, but there's nowhere left to hide.
China holds Trillions of US treasury debt, which they can cash in or continue to suck interest from the US. The same is true for Europeans, who all have bank savings. Their banks in turn hold a lot of US government debt. The middle east..... trillions in sovereign petrodollars used to buy and hold .... .. yep US debt and some US equities. The first to bail out Citigroup lately and Disney a few years back.
They will finally figure out the US only has debt and a little manufacturing capacity, but no savings and start trading with each other.
$275 billion annual costs on $5 billion in mortgages? And claiming 10% is the "un-subsidized or ,market rate?
For an alleged expert Mr Schiff seems out to linch here ....
First off CURRENT 30 year fixed rate loans are 5.60% - not 10% .... using 10% is nothing more than typcial irrational fear-mongering ...
And while he likely meant $5 TRILLION in loans refinanced, that would be equally silly - as it would represent almost 50% of the appx $10.7 trillion in loans outstanding.
Even IF he is correct - that $5 TRILLION in loans would refi - the difference between the current 5.6% and 4.5% is 1.1% ... which would represent a $55 billion annual interest differential cost ... NOT $275 billion
A more realistic number to many economists seems to be $500 billion in refi's ... which would put the annual interest differential at appx $5.5 billion ....
Today the private market buys these loans at 5.6% - probably around 5% yield .... vs appx 4% yield on the 4.5% rate ...
On 12/5/08 the 30 year TS yields 3.11% ... the 10 year 2.67% and the 7 year 2.09% .... it WOULD be unrealistic to expect buyers for $5 trillion in Treasury Securities, but not for $500 billion - the number the Fed has I believe targeted ...
Sell a mix of 7, 10 and 30 year treasuries - to match the expected weighted average maturity of the pool and the government makes money ...
OR, instead of govt buying the mortgages - instead offer a subsidy to private investors ... if 4% yield on 4.5% notes is too low, then offer a 0.5% subsidy ... on $500 billion that would cost $35 billion over 10 years ... a small part of the proposed $500 billion to $1 trillion in "stimulus" ... this would offer existing owners, not in default, SOMETHING out of the bailouts - and would go very far towards goodwill ....
OR, to still offer an incentive to those folks, but to also limit the costs - make these refi's fixed 4.5% for years 1 thru 7, with a single adjustment to 5.875% for years 8 thru 30 .... 7 years or real, meaningful benefit - with a cap on costs to govt as well ... and the homeowners STILL end up with a very good rate at the nominal adjustment in 7 years ....
There are plenty of ways to provide some support to the housing industry without creating more and larger problems
People too often ignore that it is still a small percentage of the mortgages in the US that are creating the problems - overall, across all mortgages, only 6.9% are in default ... the vast majority of borrowers - including subprime and ALT-A - are paying their loans ...
The Global Insight/Natl City Housing Valuation Index shows nearly all the Country is now undervalued ... and the NAR shows affordability has increased dramatically - the median household income represents something like 140% of that necessary to buy a median priced home ... even in the high cost West if I recall the affordability was at 104%
Even with a 3% down FHA loan, an Orange County Median Income represents 97% of the income needed to buy a median priced Orange County home ... buyers are not stupid, no matter how much some will denigrate them ... and they are buying ... they feel despite the gloom and doom of the media and some industry pundits, that housing prices today, combined with favorable interest rates, represent an excellent value and opportunity --- even IF prices might decline slightly still ....
Housing is an important foundation - and driver - for both the economy and consumer confidence .... if we are going to hand out stimulus checks - whose real purpose in the end is to improve consumer confidence - then spending a small overall portion of the massive proposed "stimulus" to support housing seems a smart investment
Far better than the handout checks - which were shown to be largely used to pay down debt or pay normal expenses in the first round earlier this year ... mostly largely worthless at stimulating
We have become addicted to not just low, but constantly declining interest rates... politically influenced, of course (no politician wants us to "take our medicine" on his watch... not good for job security... as such, the natural tendency is to lower rates in bad times, and not raise them quite as much as we should in good times, resulting in a steady downward march to zero and a steady upward march in asset prices and reelection prospects).
A childish tendency to stop markets from correcting on the downside (but a great eagerness to let them fly on the upside) has led to tremendous imbalances in our economy. These are starting to unwind now, and we should not interfere the process. Paul Volcker was the last guy to force us to take our medicine, and our reward was a 20-year period of prosperity. Thank goodness he is involved again.
And who, exactly, would want to assume a mortgage on an underwater property?
On Dec 07 03:17 PM cadoggy wrote:
> Some people are quick to declare the end of Capitalism. No matter
> what country you live in people love to see the top dog fall from
> grace and they think the US is now getting its come-uppance.
>
> Well the greedy capitalist system has worked quite well for over
> 200 years with a few hiccups here and there. We're still the only
> super power. And we will rebound from this just like every other
> recession.