by Barry Habib
Just Like An Episode OF "Ripley's Believe It Or Not"...
The Recent Fed Rate Decision to lower rates actually helped to increase mortgage Rates.Strange, but true… When the Fed has hiked the Fed Funds Rate in the past, interest rates on mortgages have actually gotten better. So it should be no surprise that when the Fed lowers rates, interest rates on mortgage loans would worsen.
But how does this work and why?
Although it may seem counter-intuitive at first, it really does make perfect sense.
First, put yourself in the position of a mortgage bondholder… like the mortgage lender. If you lend the money, you receive interest over time. If that were a mortgage, it could be a full 30 years worth of repayments and interest. Let's say you were going to be receiving $1,000 per month for the entire 30-year term. At first, that $1,000 may be a very fair return, as you calculate what you can do with that money every month. But over time, inflation requires that you spend more money to purchase the very same goods and services that you can purchase today for less. That same $1,000 just doesn't go as far in future years as it does today. This eats away at the value of a long-term fixed instrument like a bond or a mortgage, and explains why inflation is the main enemy of bonds. Because bond investors are very aware of this, they will require a higher rate of return or interest on their investment to compensate them, if they feel that inflation will be increasing.
In today's improving economic environment, inflation is expected to be on the rise. In response, interest rates on long-term bonds, like mortgages, have moved markedly higher in expectation of this. Interestingly, the increase in mortgage rates during the first half of the year has occurred without any movement by the Fed, and some mistakenly think that this is anticipation of a Fed rate hike. Not true. Reality is that bond rates are simply pricing in the expectation of higher inflation over time.
Now think about it - a move to tighten or hike rates by the Fed is designed to slow inflation, and we can now see why tempering inflation is very good news for bond holders or mortgage lenders. With inflation reduced, the buying power of their future returns will face less erosion from the effects of inflation.
So believe it or not, this is why a Fed rate hike actually helps reduce mortgage rates, and vis versa. This being said, when we see that inflation is within the "ideal" range of 1-2%, this also has a positive effect on mortgage rates. The last numbers showed us that our year over year core inflation rates are sitting pretty at 1.8%. This is good news for bonds, meaning that inflation is in check thus increasing the long term value of the dollar.
Friday, September 28, 2007
Friday, September 14, 2007
Falling home prices could dent economy: Why is this good news?
By Rex Nutting, MarketWatch
Last Update: 3:20 PM ET 9/14/07
WASHINGTON (MarketWatch) - Just as rising home prices helped fuel the economic expansion of the past six years by making people wealthier, falling home prices could put a big dent in economic growth in the next few years by making them poorer.
At this point, few economists expect the economy to sink into a recession, but almost all of them agree that consumer spending would slow, perhaps significantly, if home prices were to fall.
With the number of excess homes rising amid falling demand, the negatives in the housing market will "continue putting downward pressure on prices," said Seamus Symth, an economist for Goldman Sachs, who says home prices were plunging at a 9% annual rate in the most recent data. Goldman expects home prices to fall 7% this year and another 7% next year.
The path of home prices could be the key to whether the economy grows or stalls.
"A big issue is whether developments in the relatively small housing sector will spread to the large consumption sector, perhaps through declines in house prices," San Francisco Federal Reserve Bank President Janet Yellen said in a recent speech. "Should the decline in house prices occur in the context of rising unemployment, the risks could be significant."
Economists are forecasting that home prices will decline more than 5% this year and nearly 4% next year, according to the latest survey by Blue Chip Economic Indicators. Those same economists expect consumer spending to slow from 3.1% last year to 2.8% this year and 2.3% next year.
While a cumulative 8% drop in home prices (after nearly doubling in the previous six years) doesn't sound so ominous, such a decline would be the largest since the Great Depression.
Sticky home prices
Because most owners are reluctant to sell at a loss unless they are forced to, it's extremely unusual to see nominal home prices fall. In economists' jargon, home prices are "sticky" on the downside, but not on the upside.
By comparison, prices in the stock market adjust quickly to new perceptions about values, as investors take their losses and move on. During market corrections, the volume of shares traded doesn't fall, because the market quickly finds a new equilibrium between supply and demand.
The housing market is completely different. Sellers don't quickly adjust their prices to a new market reality. And because prices don't fall to bring demand into balance with supply, the volume of houses sold plunges during a correction. Home sales are now down 23% from the peak more than two years ago. The housing market can take years to find an equilibrium. In most housing corrections, sales remain very weak until excess supply is worked off. Prices can be flat for years.
So why are prices falling now? There's every reason to believe that supply and demand are getting even further out of balance. The number of vacant homes is at a record level, and more new homes are coming on the market every day. Foreclosures are rising, further increasing supply. More adjustable-rate mortgages will reset to a higher monthly payment in coming months, pressuring more homeowners to sell or default.
At the same time, the rationing of credit is reducing demand. The subprime and Alt-A mortgage markets, which represented about 40% of mortgages last year, have almost completely dried up. Lenders are increasing their standards for approving a loan, and interest rates for jumbo loans have risen substantially.
The wealth effect
The difficulties in the mortgage market will not only depress home sales, it will also reduce consumer spending. In recent years, consumers have taken advantage of the mortgage market to withdraw and spend some of the equity they've built up in their homes,
"We've given people the ability to spend more, and it's going away now," said Paul Kasriel, chief economist for Northern Trust.
Economists can't agree on how much spending has been boosted by mortgage-equity extraction, also known as MEW.
Some theorize that each additional dollar of wealth (from appreciation in assets such as housing or stocks) boosts spending by about 3 cents. By that account, the $8.1 trillion gain in real estate values since 2001 added about $243 billion to consumer spending over those six years, an insignificant amount compared with the $46 trillion they've spent.
But other economists say extra housing wealth is more likely to be spent than extra stock market wealth. Former Fed chairman Alan Greenspan and Fed economist James Kennedy concluded in a study published in 2005 that consumers spent about half of what they took out of their homes, and invested the other half in home improvements.
According to Kennedy's unofficial Fed data, consumers have taken $2.2 trillion in equity out of their homes though refinancing their mortgage or through a home-equity loan since 2001.
MEW has been slowing for more than a year now and was only half as big in the first quarter as it was in 2005. The Fed will report on second-quarter MEW next week, but remember those numbers will be from before the credit crunch hit in August.
"To the extent that MEW has been dying, it is now officially dead," said Alec Crawford, a mortgage-backed securities analyst for RBS Greenwich Capital.
Households will also be hit with another piece of collateral damage from the credit crunch, Kasriel said. Cheap credit not only fueled the housing boom, it also fueled the leveraged buyout boom. Corporations have also been borrowing money so they can buy back shares from individuals.
In the past six years, corporations have bought back $1.3 trillion in shares, mostly from the household sector. The credit crunch will probably mean corporations will be buying fewer shares from households, at least for a while.
Relenting already
"Consumers are already relenting," said Mark Zandi, chief economist for Moody's Economy.com. With home prices falling, gas and food prices rising and job growth flat, "there's nothing supporting consumer spending at this point."
Sales of some durable goods have already fallen. "There's no purchase that's more discretionary than a Harley," Kasriel said. Last week, the motorcycle maker (HOG) cut its profit and production forecast, saying it's "a difficult time for the U.S. consumer."
The consumer is facing other headwinds too, of course. Energy prices and food prices are cutting into disposable incomes.
Job growth will be the wild card. There's already been a significant slowdown in hiring, but job losses have been scant. Jobless claims are flat.
"By far, the biggest risk is if businesses get skittish about hiring," said Zoltan Pozsar, an economist with Moody's Economy.com. "Consumption can chug along as long as people keep ahold of their jobs."
Last Update: 3:20 PM ET 9/14/07
WASHINGTON (MarketWatch) - Just as rising home prices helped fuel the economic expansion of the past six years by making people wealthier, falling home prices could put a big dent in economic growth in the next few years by making them poorer.
At this point, few economists expect the economy to sink into a recession, but almost all of them agree that consumer spending would slow, perhaps significantly, if home prices were to fall.
With the number of excess homes rising amid falling demand, the negatives in the housing market will "continue putting downward pressure on prices," said Seamus Symth, an economist for Goldman Sachs, who says home prices were plunging at a 9% annual rate in the most recent data. Goldman expects home prices to fall 7% this year and another 7% next year.
The path of home prices could be the key to whether the economy grows or stalls.
"A big issue is whether developments in the relatively small housing sector will spread to the large consumption sector, perhaps through declines in house prices," San Francisco Federal Reserve Bank President Janet Yellen said in a recent speech. "Should the decline in house prices occur in the context of rising unemployment, the risks could be significant."
Economists are forecasting that home prices will decline more than 5% this year and nearly 4% next year, according to the latest survey by Blue Chip Economic Indicators. Those same economists expect consumer spending to slow from 3.1% last year to 2.8% this year and 2.3% next year.
While a cumulative 8% drop in home prices (after nearly doubling in the previous six years) doesn't sound so ominous, such a decline would be the largest since the Great Depression.
Sticky home prices
Because most owners are reluctant to sell at a loss unless they are forced to, it's extremely unusual to see nominal home prices fall. In economists' jargon, home prices are "sticky" on the downside, but not on the upside.
By comparison, prices in the stock market adjust quickly to new perceptions about values, as investors take their losses and move on. During market corrections, the volume of shares traded doesn't fall, because the market quickly finds a new equilibrium between supply and demand.
The housing market is completely different. Sellers don't quickly adjust their prices to a new market reality. And because prices don't fall to bring demand into balance with supply, the volume of houses sold plunges during a correction. Home sales are now down 23% from the peak more than two years ago. The housing market can take years to find an equilibrium. In most housing corrections, sales remain very weak until excess supply is worked off. Prices can be flat for years.
So why are prices falling now? There's every reason to believe that supply and demand are getting even further out of balance. The number of vacant homes is at a record level, and more new homes are coming on the market every day. Foreclosures are rising, further increasing supply. More adjustable-rate mortgages will reset to a higher monthly payment in coming months, pressuring more homeowners to sell or default.
At the same time, the rationing of credit is reducing demand. The subprime and Alt-A mortgage markets, which represented about 40% of mortgages last year, have almost completely dried up. Lenders are increasing their standards for approving a loan, and interest rates for jumbo loans have risen substantially.
The wealth effect
The difficulties in the mortgage market will not only depress home sales, it will also reduce consumer spending. In recent years, consumers have taken advantage of the mortgage market to withdraw and spend some of the equity they've built up in their homes,
"We've given people the ability to spend more, and it's going away now," said Paul Kasriel, chief economist for Northern Trust.
Economists can't agree on how much spending has been boosted by mortgage-equity extraction, also known as MEW.
Some theorize that each additional dollar of wealth (from appreciation in assets such as housing or stocks) boosts spending by about 3 cents. By that account, the $8.1 trillion gain in real estate values since 2001 added about $243 billion to consumer spending over those six years, an insignificant amount compared with the $46 trillion they've spent.
But other economists say extra housing wealth is more likely to be spent than extra stock market wealth. Former Fed chairman Alan Greenspan and Fed economist James Kennedy concluded in a study published in 2005 that consumers spent about half of what they took out of their homes, and invested the other half in home improvements.
According to Kennedy's unofficial Fed data, consumers have taken $2.2 trillion in equity out of their homes though refinancing their mortgage or through a home-equity loan since 2001.
MEW has been slowing for more than a year now and was only half as big in the first quarter as it was in 2005. The Fed will report on second-quarter MEW next week, but remember those numbers will be from before the credit crunch hit in August.
"To the extent that MEW has been dying, it is now officially dead," said Alec Crawford, a mortgage-backed securities analyst for RBS Greenwich Capital.
Households will also be hit with another piece of collateral damage from the credit crunch, Kasriel said. Cheap credit not only fueled the housing boom, it also fueled the leveraged buyout boom. Corporations have also been borrowing money so they can buy back shares from individuals.
In the past six years, corporations have bought back $1.3 trillion in shares, mostly from the household sector. The credit crunch will probably mean corporations will be buying fewer shares from households, at least for a while.
Relenting already
"Consumers are already relenting," said Mark Zandi, chief economist for Moody's Economy.com. With home prices falling, gas and food prices rising and job growth flat, "there's nothing supporting consumer spending at this point."
Sales of some durable goods have already fallen. "There's no purchase that's more discretionary than a Harley," Kasriel said. Last week, the motorcycle maker (HOG) cut its profit and production forecast, saying it's "a difficult time for the U.S. consumer."
The consumer is facing other headwinds too, of course. Energy prices and food prices are cutting into disposable incomes.
Job growth will be the wild card. There's already been a significant slowdown in hiring, but job losses have been scant. Jobless claims are flat.
"By far, the biggest risk is if businesses get skittish about hiring," said Zoltan Pozsar, an economist with Moody's Economy.com. "Consumption can chug along as long as people keep ahold of their jobs."
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