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Mortgage Rate Shock Likely to Dent the Housing Market

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As regular readers know, your humble blogger, along with a lot of investors, was taken by surprise when the typically dovish Bernanke not only started using the taper word a month ago, but then made the demise of Fed heroics sound even more imminent by talking about higher unemployment “thresholds,” namely 7%, than had been voiced previously. And the reading of Fedwatchers like Tim Duy and (even before the FOMC statement) James Aitken is that the central bank wants out of the QE business sooner rather than later.

Trying to persuade investors that the Fed did not want to be in the QE forever game may not have been a bad move per se, but the monetary authority didn’t soften its taper talk of a month ago. Even the remarks of Richard Fisher of the Dallas Fed (which did lead to an easing of the market decline of Monday) and Narayana Kocherlakota of thhe Minneapolis Fed, weren’t necessarily as soothing as upbeat headlines might lead you to believe (see Bloomberg versus MacroBusiness). Nevertheless, the fact that two Fed presidents noticed that Mr. Market was having a conniption fit and decided to have a chat with him might have been reassurance enough.

The underpinnings of this spotty and tepid recovery have been improving consumer confidence due to recovery in home prices and a rising stock market (I continue to find it remarkable that many people treat stock market levels as a proxy for the health of the economy). Employment and wage improvements are tepid, but consumer borrowing (student loans, auto loans, housing) have helped drive spending.

With home price appreciation being touted as a sign that all is better, the peculiar dismissal by Bernanke of the recent sharp rise in mortgage rates is another sign of how disconnected the Fed is. I have two friends who are looking for homes and both were freaked out by the rate rise even prior to the latest ratchet up since the FOMC meeting. The increase might well produced a last hurrah as buyers rush to get deals done out of fear that interest rates are running away from them. But several posts tonight give concrete evidence of how much damage has likely already been done to the housing “recovery,” although it will take several months to translate into price and activity data.

First is from Housing Wire, in which Fannie Mae’s chief economist takes issue with the notion that 4% mortgage rates is nothing to be concerned about:

Fannie Mae Chief Economist Doug Duncan said the concern should be less about what the rates have risen to and more about the speed at which they are rising.

Duncan noted that in 1994, for instance, rates rose 2% over a 12-month period, resulting in a huge impact on home prices, which fell significantly.

“If the rise happens rapidly, it tends to have an impact,” said Duncan, who added that once rates rise 100 basis points, home sales may begin to slow.

Um, looking at Bloomberg, the 30 year fixed is at 3.51%, up 76 basis points in a mere month, and a smidge over 100 since March. So we are already in the danger zone.

Michael Shedlock has a report from the trenches that the actual increases are worse than the increase in rack rates like those reported by various data services ise would lead you to believe. From his buddy Michael Becker:

As bad as Treasuries are selling off, the sell off in MBS is much worse. I looked at some charts this morning and the prices of Fannie Mae and Ginnie Mae coupons continue to drop.

The FNMA 3.5 coupon was trading at 106 22/32 on May 2nd, and this morning it was trading at 99 9/32. Ginnie Mae is worse. The GNMA 3.5 coupon was trading at 109 1/32 on May 2nd, and this morning it was trading at 99 24/32.

In terms of interest rates, I locked an FHA purchase on May 2nd and the rate was 3.25%, and that rate carried a 2 point lender credit to help pay for closing costs. In order to get the same deal today, (a 2 point lender credit) the rate would have to be 5% today.

This as an apples to apples comparison illustrates that FHA rates have increased 1.75% in 7 weeks. You could get 4.625% on an FHA purchase, but you wouldn’t get any closing cost help.

I was locking well qualified borrowers at 3.50% on conventional loans (Fannie Mae) at the beginning of May, and now they are looking at 4.875%.

Most of this pain has occurred since the FOMC meeting last Wednesday, and I am sure the talking heads at CNBC have no idea how much interest rates have spiked. They keep saying that housing is strong enough to withstand this rise in rates, but I think they are deluding themselves.

I have people who I pre-approved for a mortgage early last week prior to the FOMC meeting, and now that they are getting their contracts accepted and ratified are shocked to learn mortgage rates have spiked one percentage point in just the last few days.

So we are actually well beyond the rate rise increase level that Doug Duncan saw as dangerous to the health of the housing market. He warned about 200 basis points in a full year as being a destructively fast rise. Becker is seeing 175 basis points in less than two months. Shedlock drives the point home (pun intended):

A one percentage point rise in rates affects affordability by 10-11%. With mortgage rates up 1 3/8 to 1 3/4 points, that equates to a rise in monthly payments (or a drop in affordability) by as much as 17%. Anyone who stretched to buy is no longer qualified unless they locked some time ago.

Clusterstock cites a different set of concerns from Paul Diggle of Capital Economics:

1. The double digit price gains we’ve seen recently are not sustainable. “If prices continue rising at 12.1% y/y – the latest CoreLogic reading – housing will be overvalued relative to rents within the next few months and relative to incomes in early-2015. And combined with the assumption that mortgage interest rates settle at their current 4.2% level, mortgage servicing costs will rise by 2%-3% of income each year.”

2. The home price gains have already made it harder for investors to find “bargains.” It will take some time before traditional homeowner demand makes up for the decline in investor demand and this should slow the pace of home price gains.

3. Inventory seems to have bottomed and “sellers are starting to return in greater force.”

Diggle does not mention that the investors will also be freaked out about the sudden decline in affordability, since some will have a sale to a real end buyer as their exit (as in at these levels, rental yields alone won’t meet their return targets, they also need capital appreciation, and that means selling it eventually to a non-investor). A further issue re investors is despite the fact that they are typically described as “all cash,” that simply means they aren’t financing with a mortgage. The fact that Berkshire Hathaway has stepped in and is offering warehouse lines (18 to 24 months) to buyers in a portfolio size range they saw as underserved (this is from memory, but I believe it was $5 to $25 million) strongly indicates that the bigger fish were using credit too.

Now that does not mean we won’t see solid housing numbers for the next couple of months. We won’t see much impact from the Fed’s moves in the releases out today, since they cover April and next month (as indicated above) might still be buoyant due to buyers either locking in favorable rates or rushing to buy before rates rise further. But it’s hard to see how you can be that optimistic about housing going forward after the Fed managed to botch its strategy, its communications, or both, and inflict a rate shock.

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69 comments

  1. Joanna St Claire

    What the heck is traditional homeowner demand? It’s almost like nothing bad happened, and home prices aren’t insane to begin with. In other words, all the fraud, control fraud and other behavior was somehow benign because the prime directive was to keep those prices up. Notice how more recent analysis doesn’t even bother to research how many foreclosures are on the way. “rushing to buy before rates rise further” I can just see realtors pushing that horsecrap on dupes.

    1. jake chase

      I read this stuff and wonder why anyone thinks mortgage financing ought to be available at 3.5%? Would you lend money to any home buyer at 3.5% for thirty years? I wouldn’t do it for two years. The capital risk in these mortgages is ridiculous. The entire mortgage market is ridiculous. Somebody’s real money must be changing hands here. I am glad it isn’t mine.

      1. washunate

        Yep. The government backstops of mortgages and refusal to prosecute fraud/title issues were two of the worst parts of the public losses/private gains bailout mentality. Not only is it regressive in its distributional consequences, but it is also massive malinvestment of resources.

        What’s crazy is that 15 years (!) after it became obvious house prices were too high and exurban McMansion sprawl and urban luxury tax credit redevelopment was stupid on a colossal scale, we’re still subsidizing it.

        1. Susan the other

          You guys are so hysterical. Trust me. Everything is A-OK. FNF (Fiduciary National Financial or some such name) is a nice new title insurance company that will indemnify you for all your title mishaps. Everything is cool. Except bedrock property law. Never mind that stuff.

        2. nonclassical

          ..”washunate”,

          please supply documentation of “government backstops of mortgages”?? Please time date and specify? Certainly government has NOT done any job at all of “backstopping” individual mortgage holders since Wall $treet economic disaster, 2007, but anti-government fundamentalists have long proposed the absurd notion that fanni-freddi-therefore government was at fault for economic debacle…

          should this be your agenda, please follow the $$$$ and show proof? for example, how much total subprime did fanni-freddi carry?

          1. washunate

            You must be joking. Please supply documentation that there is a private mortgage market in the United States.

            This is information that can be found in 30 seconds on The Google. I particularly enjoy the asterisk on link #3.

            http://www.ritholtz.com/blog/2011/03/97-of-all-u-s-mortgages-are-backed-by-the-government/
            http://www.cbo.gov/publication/21992
            http://www.ginniemae.gov/consumer_education/Pages/ginnie_mae_and_the_gses.aspx
            http://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Mac
            http://articles.washingtonpost.com/2013-05-01/business/38957583_1_fannie-and-freddie-housing-market-freddie-mac
            http://online.barrons.com/article/SB50001424053111904548404576397962652638484.html#articleTabs_article%3D1
            http://www.propublica.org/thetrade/item/congress-bungles-fannie-and-freddie-reform
            http://www.nakedcapitalism.com/2013/05/david-dayen-hedgies-bet-on-fanniefreddie-status-quo.html
            http://www.nakedcapitalism.com/2009/09/i-am-changing-my-name-to-fannie-mae.html

            Shall I go on?

          2. washunate

            P.S. Why do you get defensive about government backstops? Who here said Fannie Mae and Freddie Mac caused subprime and the bubble and everything?

            The point is that those were private companies. Their debt was sold explicitly as NOT being backed by USFG. It is the government bailout and the government refusal to prosecute fraud that’s the problem, not the existence of Fannie and Freddie as shareholder owned corporations.

            You know, plus, there’s this -

            http://www.chicagotribune.com/news/local/chi-rahm-emanuelmar26,0,1946702.story

  2. Joanna St Claire

    I mean come on, when are we going to start asking what role investors play in the sorry state of a lot of things.

  3. Ptup

    Simple. Rates go up, prices go down. This is good news for those waiting to buy.
    In 1995, the ex and I bought a one bedroom co-op in Bronxville, NY. The owner wanted 81,000 (nice building, walk to train), but, he accepted 62,000 in a flash, no negotiation. I was shocked, but, that’s what happens when an asset sits there draining a wallet for a year and a half. I would suggest that, if one wants to buy, wait for rates to hit 6%, and start shopping, carefully.

  4. killben

    “But it’s hard to see how you can be that optimistic about housing going forward after the Fed managed to botch its strategy, its communications, or both, and inflict a rate shock.”

    So in effect what are you trying to say. Housing market should be propped up for ever by the Fed with low rates.

    1. Yves Smith Post author

      Did you somehow mention the point made twice in the post, that an over 100 basis point move, which looks like a 175 bps move in terms of costs to borrowers, is simply unprecedented? This is a faster rate than going back to 1984, which was cited as the last ouch in speed of rate rise.

      I don’t know how many times I have said:

      1. I thought QE was a bad idea and targeting quantities was really poorly thought out (impact is uncertain and varies over time).

      2. Two mistakes don’t make a right. Exiting from it rapidly (or causing a market freakout which is tantamount to a rapid exit) is gonna do a lot of unnecessary additional harm.

      When the Fed tightens rates, it does so in a measured and deliberate manner. The change in short term rates mean (absent some weird exogenous upheaval independent of the Fed action or communication botch) produce gradual changes in bond prices. That’s no accident. Gradual changes help participants adjust and also helps prevent Fed overshoot (in practice, they get it wrong anyhow due to leads and lags and their biases in reading data, but they’d get it even more wrong with rapid moves). And it reduces damage to investors and the financial system.

      Are you seriously voting for another crisis because you just want the Fed to dump QE since it offends you? We have to start from where we are, like it or not.

      1. killben

        It is not a question of my wanting the Fed to dump QE. Your implication is the 100 basis point move is only because the Fed wants to exit now. My point is you are likely to get 100 basis point move if the Fed wants to exit in 2015 (Market is also likely to throw a fit). Additionally you could have a crisis due to unintended consequences the longer you go with QE.

        As an aside, I also wonder given that the Fed likes to be as accommodative as possible and is not generally interested in the Main Street, is it also likely that the Fed may its own reasons to exit. Also is there a bubble in housing again could be a pertinent question to ask now. If so, rising interest is not a bad move.

        1. Malmo

          Is there a newly formed bubble in housing? Maybe ( a big maybe), but the likely catalyst to pop the so called bubble would be a 50% rise in rates over a six week period, which, in fact, we’ve just experienced. How is that sane policy? Even the myopic central bank can’t be that dense. Also, QE is merley an asset swap. There is no new NFA’s created. Read Cullen Roche to enlighten youself on this function. Much of the idea behind QE was to tamp down rates, which has helped many undrwater homeowners significantly, whether that was the primary intent or not. That’s a bad thing? It’s only bad if you’re a stuck in permabear ideology and want this contry to crash and burn.

        2. Yves Smith Post author

          No, that’s EMPIRICALLY not true.

          1. We got a 50 basis point move when Ben said the Fed was thinking of exiting QE. The 100+ basis point move was due to a. changing the benchmarks and more important b. sounding hell bent for leather to do it, state of the economy be damned.

          2. Most people had thought the Fed would wait for stronger evidence of a self-sustained recovery. That would mean QE exit would be much less likely to make much difference. The Fed has instead decided to declare more loudly that we have a self sustaining recovery. If you think this economy is on a trajectory to solid growth, I have a bridge I’d like to sell you.

          3. As indicated elsewhere, the evidence is that ending extraordinary stimulus too early leads to a resumption of the balance sheet recession/depression (US 1937, Japan 1997 and 2000) and can also produce a new wave of financial firm failures. 1937 had the largest # of bank failures in any year after the introduction of deposit insurance till 1982, which was the first big wave of S&L failures, induced by Volcker driving interest rates super high. And the next biggest year after that was 1938. Japan has a series of financial firm failures in 1997.

          By contrast, the record is that when extraordinary stimulus is ended on the late side, the damage is pretty minor.

          1. Kokuanani

            *** the evidence is that ending extraordinary stimulus too early . . . can also produce a new wave of financial firm failures ***

            A little gallows humor: maybe that “new wave of financial firm failures” will allow us to get the remedy [closing them down; nationalizing banks] right.

            No more bailouts.

      2. Jimmy B. Sanders

        There it is, it’s the same warning as it was in 2008. It’s the guy from Blackrock warning your credit card won’t work at Starbucks. When the decision was made to invade Iraq the people were told things like mushroom clouds and hating us for our freedoms and most importantly be very afraid.
        A good part of the riff raff simply doesn’t swallow it anymore. The servicer that became the terrorist of their own doing, was fortified relentlessly, why should I have to pay for them? The greater good?

        1. Yves Smith Post author

          Straw man on multiple levels. You gotta do better to be taken seriously.

          1. The folks in 2008 were demanding a bailout, which imposed costs on the public at large and benefitted banks. Here we are talking moves that impose costs on the public at large right now AND potentially destabilize banks. Bond losses affect you, buddy. Start with underfunded state and municipal pensions which show up in taxes and fees and more expensive insurance. You are exposed whether you own bonds directly or not. And that’s before we get to economic damage with lowers tax revenues and increases government spending (automatic stabilizers).

          Do you want another “take from everyone to help the banks” exercise? I sure don’t.

          2. An overly rapid exit from QE that produces dislocations greatly increases the odds that the Fed changes its mind and keeps QE going. If you hate QE, you should vote for a gradual exit. That is the only way the policy might be permanently terminated.

          3. Sevicers have nothing to do with this. They don’t take interest rate risks. They get fees for service. The only way they are exposed is by funding advances to investors on delinquencies which they then recover in foreclosures. Many people believe, but can’t prove, that they don’t even fund that much, that they steal from refi principal payments instead and don’t fund much/any advances even though contractually they are supposed to. Banks fund that short-term and that’s unaffected the exit from QE. ZIRP (super low Fed funds rates) are still firmly in place.

      3. Ptup

        “Are you seriously voting for another crisis because you just want the Fed to dump QE since it offends you? We have to start from where we are, like it or not.”

        Where we are is in a car, teetering on the edge of a cliff. Shift your weight a little, maybe sneeze, and, hoo boy.
        All Ben had to do is hint that maybe sometime sort of soon they might possibly cut a little back on bond purchases, but, don’t fret, no way we’re raising rates, and, bam, markets go absolutely nuts. So, therefore, I think it’s quite evident that “another crisis” is inevitable, unless we just keep on keeping on with the same old same old. How long can that continue? How long do we keep the plates spinning in the air?

  5. scott

    Hedge funds and large players can borrow from FNM/FRE at less than 1%, and give that money to shadow buyers to pay over listing for houses using “cash” to distort prices and create the illusion of a recovery. Why would these cash shadow-buyers care what mortgage rates are? They are just following the Fed’s plan to inflate the housing bubble again because bubbling the stock market didn’t seem to help the economy.

    1. Jimmy B. Sanders

      Yet Mafia Mae doesn’t consider similar largress for the excorciated rank and file. Hedge fundies seem more dangerous than Al Qeada, but I’ll go with the morally hazardous JimQ idiots on this one. It’s food stamps, the post office and freeloaders and the Gov’mint that get in the way of our welfare. Yeah, that’s it.

  6. MacCruiskeen

    Around here the for-sale inventory has been so low that there’s been we’re hearing early-stage bubble mania talk again–bidding wars and so on. My neighbor just got 5 offers on his house within days of it being listed. Throwing a bucket of water on this now wouldn’t be such a bad thing. Yes, I think some people are rushing to get in before rates get much higher (they’ve been rising for months, so it’s not really that much of a surprise), and that higher rates will temper things somewhat. You might recall that a prior central banker destroyed his reputation in part by letting low rates feed a bubble.

    Mortgages rates are still lower than they were four years ago. I also recall that when the Great Bubble burst, there were suggestions floated that the Fed could save the market by forcing rates all the way down to 5.25 percent. That didn’t work. What works is jobs. We have a relatively good employment rate here, so people are buying. And the Fed can’t really do much to give people jobs. That’s become pretty clear over the past four years of QE.

    1. susan

      We do not have a relatively good employment rate here. There is a new term out there, evolving from the slime. It insinuates that the “employment market” is good but “unemployment is high.” WTF does that mean. I’ll guess: it means that unemployment is off the charts.

  7. wunsacon

    >> I have two friends who are looking for homes and both were freaked out by the rate rise

    Why “freaked out”? As interest rates rise, home prices will drop to make the monthly payment the *same*. Better yet, these houses will become MORE AFFORDABLE to those people that *saved* enough to buy a house without becoming a debt slave to banks. That’s a good thing.

    1. endthefed

      >>As interest rates rise, home prices will drop to make the monthly payment the *same*. Better yet, these houses will become MORE AFFORDABLE to those people that *saved* enough to buy a house without becoming a debt slave to banks.

      I wish home buyers were that rational: http://cowles.econ.yale.edu/P/cd/d16a/d1632.pdf

      1. Jimmy B. Sanders

        All the famous players, whom readers are expected to associate with credibility, and not one word of fraud. Joshua Rosner farted lofty pontifications about some psychological phenomenon within the shelter seeking herds, that helped bury the holocaust. Way to read the tea leaves.
        It’s all white tower, chicken scratch justification for slavery, that’s all it is. ‘Member when we used to look at 3rd world countries from the USA and wonder how the people could tolerate rulers that screw them 24/7? /rant off

        1. Yves Smith Post author

          If you are gonna attack someone, might help if you actually were familiar with what they said, rather than just making shit up.

          Rosner has never been a fan of the “everybody needs to own a house” view. He wrote a paper in 2000, “A Homeowner with No Equity is a Renter With Debt” for instance.

          1. Jimmy B. Sanders

            You’re still missing the point, everyone needs a place to live. What is it with you and money? Why don’t you go help the 20K+ in your own city, I’ll help.

      2. Yves Smith Post author

        No, prices are sticky and people have cognitive biases. Google “anchoring”.

        When housing was more affordable, like a year ago, people were afraid of buying because prices had fallen and homeowners do not want to take on a mortgage and see their equity drop. With leverage, your % losses multiply. And you also have 5-6% sales costs thanks to brokerage, so you are already in the hole when you close. You need appreciation just to break even.

        So if housing prices fall, which may be the result (may, I stress, it may also be that gains slow or stall), people will pull back because they won’t be sure whether this is a blip or a trend.

        1. Dave

          “You need appreciation just to break even.” Yves, maybe that is the root of the problem. Folks expect to break even or even make money on a house. A house is an expense, a liability, not an asset. The era of inflation that we have just experienced has folks completely confused as to what is a liability and what is an asset.

          Houses never did make money for the average household unless they moved from an area of high housing price increases to one with low. California to Nebraska for instance. All they could really accomplish is keep pace with inflation. Now folks expect to be able to live in a nice home and show a profit in the process. Such a deal!

          Prior to 1960 houses generally went down in value as they aged. This makes perfect sense, as they deteriorated. Perhaps we are now re-entering reality?

        2. Ed S.

          Yves,

          Well, the prices are sticky on the downside but not so much on the upside. From the “belly of the beast” (Bay Area), selling prices are up 30-40% in less than 12 months, and asking prices are now solidly 50% up over 2-3 years ago. A great deal of the action has been driven by “cash buyers” coupled with kow inventory, low interest rates, and well qualified buyers. It makes a great sellers market.

          It will be interesting to see how quickly the market changes (or even if). I’ve been actively looking for 15 months — it’s hard to stomach looking at a place at $720k asking that you saw a comp for in July 2012 sell for $489k.

          The price run-up has absolutely been enabled by the low interest rates; well-qualified buyers who could put 40% down at $500k can now only put 25% down at $800k — but the mortgage principle doubles AND it’s 150 bps higher?

          To put numbers to the example, the monthly goes from $1850 to $4,000. Same house.

          It will be interesting to see how many “cash buyers” are still around and how sticky prices are 6 months from now.

          1. Yves Smith Post author

            I don’t think we are disagreeing. The guy at the top of this thread was saying, “HIgher mortgage rates are no biggie, housing prices will drop and people can buy them cheaper.” Tons of people simply sat where they were during the crisis, unwilling to recognize losses (or unable to due to being underwater on their mortgage) even if they really wanted to move.

            I suspect a lot of people have internalized the recent price move. They won’t want to validate any fall from current levels unless they really have to.

          2. wunsacon

            >> Tons of people simply sat where they were during the crisis, unwilling to recognize losses (or unable to due to being underwater on their mortgage) even if they really wanted to move.

            You didn’t give them time to adjust mentally. You, Yves, and Bernanke didn’t want to let the market continue to find firmer footing; to clear. So, now, once again, we have thinly capitalized buyers rushing to buy homes they’ll be trapped underwater in the moment rates rise a mere 1%.

            >> When housing was more affordable, like a year ago, people were afraid of buying because prices had fallen and homeowners do not want to take on a mortgage and see their equity drop.

            Because they were and *should’ve* continued *dropping*. Bernanke wanted to arrest that. And while you ridicule some of the Establishmentarian Economists’ methods (fraud, self-dealing), you apparently approve of their results.

  8. Eleanor

    What ever happened to clouded titles? Has it just been decided that this problem does not exist?

    1. susan

      Yes and no. It has not been decided that clouded titles are no problemo; but it has become policy. Financial policy. Of course you and I never hear about “financial policy” because those orchestrating it do not want any democracy interfering with their theft.

  9. Aaron

    Had an interesting conversation with a Houston area buyer yesterday. The couple had recently sold their home, and they had made purchase offers on several different replacement properties. They were outbid every time. Now they’re looking to rent, re-evaluate their strategy. I would expect more of the same as buyers try to digest the whipsaw they just experienced with home affordability.

    Welcome to the new, new normal.

    1. susan

      A finance orchestrated bear market run, followed by a finance orchestrated bull market. Fuck you.

  10. Tyler Healey

    “[H]igher [interest] rates will raise the income of many middle-class people who tend to keep their savings in bonds, certificates of deposit and savings accounts that yield very little return.

    “[I]nterest income has fallen sharply since 2008, … taking hundreds of billions of dollars a year out of the pockets of middle- and working-class families. By contrast, those with high incomes tend to put more of their savings into stocks that have benefited from a rising stock market, thus contributing further to income inequality.

    “In short, from the point of view of workers and those with modest savings, rising interest rates are unambiguously a good thing, because they will raise personal income…”

    - Bruce Bartlett, today
    http://economix.blogs.nytimes.com/2013/06/25/labors-declining-share-is-an-international-problem/

    1. Yves Smith Post author

      Has Bartlett ever owned bonds? It appears not.

      People who moved into bonds when the stock market tanked, or bought the usual 50/50 or 60/40 bond allocation and stayed there have big gains on bonds. They get brokerage or fund manager statements. They think those gains were real and part of their net worth.

      The losses they will suffer if they don’t market time with some success (and all the conventional literature says not to do that) meant the losses they will suffer this year will exceed what they can earn in interest income over the next few years. When interest rates are really low, seemingly small movements in interest rates produce MUCH larger losses than when prevailing rates are higher.

      I like Bartlett but most economists should NEVER write about investing.

      This is what Keynes was referring to by the phrase “liquidity trap”. it was meant to combat people (Irving Fisher in particular) who thought raising nominal interest rates would increase the real rate of return and thus compensate inflation.

      Keynes’ argument was that raising interest rates would cause capital losses all across the yield curve when longer rates didn’t fully build in “correct” expectations of future short rates. Thus interest rates would have to rise incredibly to adequately compensate creditors on longer maturity bonds. This has nothing to do with the short rate being at zero but everything to do with long rates being inconsistent with an uncertain future.

      1. Tyler Healey

        Thanks for your response, Yves. Here’s what I found from L. Randall Wray:

        “If you were a bank that was stuffed full of all the NINJA mortgages (no income, no job, no assets) made back in 2006, you’d be quite willing to sell those to the Fed—if the Chairman wants to play the role of dope, you’ll happily dupe him. I suspect that as a result of the bail-out plus three rounds of QE, a lot of the trash has been moved to the Fed’s balance sheet.

        “That’s good for banksters but it’s horrible public policy.”

        http://www.economonitor.com/lrwray/2012/11/12/demystifying-quantitative-easing/

        1. Kokuanani

          And WTF HAPPENS to those mortgages once the Fed relieves the oh-so-grateful banks of them?

          Does anyone within the Fed attempt to “restructure” those pieces of crap, perhaps adjusting the interest rate and, quelle horror, cramming down the balance?

          Have the borrowers on those mortgages all fled, so that restructuring is impossible?

          Who owns the houses that secured those mortgages, and what will the Fed do with them?

          Inquiring minds want to know the answers to these, and a bunch of other questions related to QE.

          QE could be structured to bring some GOOD to Main Street, instead of just rescue for the stupid, stupid banks. Why isn’t it?

      2. jake chase

        People have no proper business in bonds or bond funds with interest rates at historic lows. You don’t need an MBA to know that long rates have nowhere to go but down. Now we’re protecting dupes gulled by asset allocation models? Who’s next? Penny stock buyers? Horse players? On line poker addicts?

        When does it become time for people to be responsible about their investing behavior?

        1. jake chase

          Of course that should read nowhere to go but up. It’s the prices that have nowhere to go but down. That’s a natural mistake since I don’t have an MBA.

        2. washunate

          To offer some defense of asset allocation :)

          Generally, the problems associated with being ‘duped’ are about the mechanics of the decision-making, not the concept of diversification. I agree investing one’s life savings in Treasuries 3 months ago would have been pretty dumb. But maintaining, say, 30% of one’s investable assets in bonds over the past 30 years with regular rebalancing into one’s other assets would have been quite beneficial.

          But really, what this boils down to is wealth concentration. The vast majority of American households simply don’t own enough financial wealth for this to matter. The most important thing for most people is to have some concept of a budget, some sense of long-term goals and how to get there, to build up an emergency/rainy day fund, and to avoid excessive debt.

          Whether you buy Apple stock or gold or TIPS doesn’t really matter to people whose entire financial net worth is $30,000. The vast majority of that should be in cash, preferably a demand account (ie, non interest bearing).

          That’s why I wholeheartedly agree with the rant about backing gamblers. It’s idiotic to be using public resources to bail out stupid investments. And I notice that when people advocate such bailouts, the distribution of wealth is almost never discussed. It’s always ‘the economy’ that will be saved.

          1. Dave

            Stupid investments should include homes. As I mentioned previously, a home is seldom an investment unless it is not your home. In addition, the word “investment” is greatly overused these days. Probably because of all the TV ads portraying various consumer products as investments, but also because there are very few real investments made these days. True investments are found mainly in growth economies.

            Instead we have bets, bets made in the biggest casino of all. Our financial, insurance, and real estate sectors. With the exception of government, they appear to be the only areas that have shown any real growth lately. All of the above are just a means to profitable financial transactions, mainly for the wealthy, with little or no real value in exchange.

          2. washunate

            Well said. The NAR sleazefest that a house can somehow be as safe as savings and as lucrative as investing has infected every corner of our society.

            A home is where you live.

            An investment property is where other people pay you to live.

            It’s funny that when times are good, you don’t see liberals donating the proceeds from their real estate sales to the taxman. Yet for some reason when times are bad, their losses are supposed to be backed by the government. Or else we’re all doooooomed.

            :)

        3. Yves Smith Post author

          Jake,

          First, every study every done of investing shows if you diversify by asset class, you lower your risk without lowering returns. If you are an investor and not a speculator, you own some bonds. A lot of people don’t like being speculators and make portfolio changes only once a year, in December.

          Second, people who WERE in bonds due to prudent asset allocation saw monster gains. There was no particular reason to sell, in fact, they’d look like the folks who sold the stock market when Greenspan said “irrational exuberance” in 1996. I’m not suggesting that normal people bought more bonds, simply followed traditional allocation principles (which oh BTW every pension fund consultant imposes on the professional money managers they advise, like endowments and public and private pension funds). Now if they were allocating, they would have likely have been selling some bonds all along or at least not buying more to maintain their allocation ratio.

          Third, the Fed had said repeatedly it was big on transparency and would communicate any policy change well in advance. So most people who got the huge gains figured they might give some of them up but if they were the sort who would change allocation in response to rate trends.

          Fourth, a lot of investors have little/no latitude. Many investors in 401 (k)s can change funds only 1X a year. The only option for them per your logic would have been to go into cash as their first opportunity as the Fed announced QE, since it would obviously goose securities prices.

          Fifth, a big swathe of investors are obligatory bond holders, most importantly, insurers. They can change duration and mix, but they still hold a lot of bonds to meet expected payment obligations.

          1. jake chase

            Investment strategies look good mostly in retrospect. Whatever may have worked thirty or forty or fifteen years ago isn’t necessarily prudent today. I know people who put $85,000 into ten stocks in 1982 and watched their ‘value’ soar to $1 million in 2000. The question is ‘what is prudent today’? The answer: nobody knows. Every financial asset is a gamble and nothing else. Its future value depends on the Fed, on the bank derivative books, on market manipulation by traders, on executive looting through stock option giveaways. Look at IBM. Under Gerstner, the stock skyrocketed as a result of asset sales, pension plan finagling, stock buybacks, trumpeting of vapor ware, services. Gerstner made himself over half a billion dollars. Thousands of IBM employees were fired, some killed themselves, the company has been hollowed out and nobody can even say for certain what it does. Is the stock worth $200? One day last month it cratered 10%.

            You don’t seem troubled by the essential dishonesty of all this Fed finagling. What about people who have saved money honestly earned and are now impoverished by QE? They should embrace asset allocation models? You ought to know that retail investment advice is not worth the hot air it generates. The people giving it are shills and nothing else. I admit I have no idea what to do these days about money, and I made quite a bit back in the days when investments made sense.

          2. washunate

            Yves, I hear what you’re saying and generally agree.

            But there’s a part of that tone that strikes me as incredibly naive. You’ve been talking about problems for so long, perhaps you don’t give the rest of us enough credit that we’re also highly skeptical? How could anyone who remotely is involved in managing more than a piggy’s bank worth of money simply blindly take what the Fed says at face value?

            Reading the tea leaves has been a hobby long before the most recent recession. Interest rate risk and political risk are so basic you learn it as a teenager in any halfway decent course of higher education.

            Furthermore, the whole point of hardcore index asset allocators is that it doesn’t matter what happens in the short term. You pick your allocations and your benchmarks and whatever, and you let it ride. To suggest that public policy should worry about bond prices or stock price is to quite directly argue that the whole concept of asset allocation should be replaced by direct government ownership of financial assets. We should just nationalize the investment business and have public policy dole it out.

            1. Yves Smith Post author

              Even though I’ve been skeptical, particularly regarding the manipulation of housing inventories as well as the role of PE investors in the housing recovery, I’ve refrained from making market calls. You will note this is not a market call.

              Go read Fedwatcher Tim Duy, or see Gayvn Davies at the FT, who describes what the last 2 major Fed tightening cycles were like. Or read Martin Wolf today. Or read Richard Fisher’s remarks yesterday, where he says investors are feral hogs and the Fed won’t be deterred by them.

              The Fed has gotten much more hawkish. Andrew Haldane (no investing alarmist, he’s the head of financial stability at the Bank of England) on June 12 said that central bankers had blown the biggest bond bubble in the history of the world, by design.

              The Fed is very serious about getting out of QE. It also, as Duy makes clear, is actually calendar driven, not data driven. His take is the data will have to be really bad for the Fed to relent. And the record of the Fed is also that it is much more attentive to the health of banks than the real economy. Witness what it did in the crisis versus its refusal to back off in the 1994 bond crash, which it precipitated.

              As for standard rules, go read Benoit Mandelbrot’s (Mis)Behavior of the Markets and that will tell you why standard methods have you taking far more risk than you think you are.

              Despite the fact that I hate (and I mean hate) trading, so I do it little and often not well (and am managing a family account which is almost entirely in an IRA, which further means I am super duper restricted in what I can do) and furthermore have really not been on top of the markets at all in the last 3 years (too busy on the mortgage abuse mess, following too many econ/political topics and generally overworked and overstressed), and as you would surmise, have not been a believer in what’s been happening in the stock market for some time, I’ve still done better in the time I’ve been managing this money than if I had followed standard allocation rules, and by a meaningful amount. But I don’t give investment advice, nor do I pretend to. My big message is the risks of these markets are much bigger than most people think. Unless you like active trading and have a record that says you are good at it, if you are not cautious (which is what I’ve been), you’re more likely to lose out than the orthodox types would have you believe. Particularly now, in a balance sheet recession, when we are way out of bounds of historical norms.

          3. washunate

            If that was a response to my post, thanks for the thoughtfulness. You really touch upon several aspects that are long-term interests or layers or pieces of the puzzle that intrigue me. I think we are going to be exploring these areas repeatedly over the next few years, since it seems pretty obvious our current leadership is simply incapable of change.

            “The Fed is very serious about getting out of QE.”

            Is the Fed the boss, or a support staffer? I think that is a key question, one of the primary points of obfuscation.

            “As for standard rules, go read Benoit Mandelbrot’s (Mis)Behavior of the Markets and that will tell you why standard methods have you taking far more risk than you think you are.”

            Who follows standard methods? Why do they do that? How do standards change as the environment changes? (During the last major depression, dollars were backed by gold and silver and copper, the internet didn’t exist, alcohol was illegal, there was a leftist political movement, and a host of other differences large and small.) Mandelbrot is definitely on my long-term reading list.

            “My big message is the risks of these markets are much bigger than most people think.”

            Wholeheartedly agreed. So the public policy question is, who should pay? (or more subtly, riskier than the pundits claim – I think a lot of average citizens understand the risk better than the drivel from the MOTU, particularly Millennials and generations before the Boomers.)

            “if you are not cautious (which is what I’ve been), you’re more likely to lose out than the orthodox types would have you believe”

            What is cautious? What is orthodox? What does losing out mean to people whose entire financial net worth is $30K, or $10K, or zero? Wealth concentration and the two tiered justice system is the huge elephant in the room.

            “generally overworked and overstressed”

            Yep, I think that is one of the gravest threats to our social construct and general order in society. People are pushed to the breaking point just in the day to day things, there is so little time to think about, let alone counter, the systemic threats posed by the psychopaths and their enablers.

            Which suggests that if the educated technocratic ‘liberal’ class of doctors and lawyers and university administrators/tenured professors and hospital executives/managers and journalists and nonprofit leaders and union heads and, ahem, the general veal pen of the world, doesn’t come around to agitating for real reforms sometime soon, the only possible outcome is going to be massive social upheaval as our institutions simply disintegrate.

            Or as I like to ask the rhetorical upper middle class Democrat, who is going to buy your house? A barista? A home healthcare aide? A daycare teacher? A hospital housekeeper? A school lunch lady? A retail clerk? A FedEx driver? An office assistant? A social worker? An adjunct?

  11. Expat

    How is this news or a surprise? It has always been the elephant in the room for this housing market. When, not if, mortgages return to 8% and 20% down (or close), we will see prices back at the long term price to income ratio.

    Of course, as someone pointed out, all these temporary measures might remain permanent until we implode. Just like temporary Powers of War under the Patriot Acts. Temporary bail-outs of the banks. Temporary relaxation of environmental regulations. All leading to…

    …a Temporary America.

    1. Jack Frank

      I’ll head to Ecuador with Snowden, word is, is that the place is less corrupt. One might be able to be reasonably housed, have a job that isn’t a commerce driven prison sentence. Just imagine, housing without being on the wrong end of pen or gun point, which has been the recent experience of many Americans. The leading bastards in the US think they own the place, and they won’t budge.

      1. Ptup

        Really? Do they have unicorns in different colors there, too?

        You’re actually going to escape to South America to escape fascism. That’s rich.

    2. washunate

      Well said.

      I think I may start referring to the Democrats who support the two-tiered justice system and corporate welfare and other such public policy as Team Trickle Down.

      It’s almost like policy makers are purposefully eliminating all options other than implosion.

  12. Chris

    What I don’t understand is the move in mREITS, especially some of the larger, agency & non-agency players. Before they were getting hammered because they had to compete with the Fed who was driving down rates of return on purchased paper and refinancing was taking out existing loans. Now both of those concerns are mitigated. Why are they all going down now? I thought for sure people were getting out of them before and the price of those assets was closer to fair value as opposed to consumer discretionary stocks. What am I missing?

    1. barrisj

      “Agency-bond” REITS are indeed cratering – as an investor in American Capital Agency Corp (AGNC), I’m openly weeping at the speed with which these REITs are falling – dividend cuts can’t be too far behind, tant pis!

  13. kevinearick

    surprise. surprise…

    Promises, Promises

    So, you can employ any form of gravity to sling-shot your development, to create space, in a trade-off, with opportunity cost. History is arbitrary and self-serving to the passive aggressive, because its gravitational machine is peer pressure, which may just as easily be a DC circuit. It is always the beginning and the end, of times.

    The shelves are separated by threshold circuits, which may be constricted and expanded at will, making the multiplexer. The part of the tornado vortex you don’t see is underground. Time is separated accordingly.

    The upper middle class is about to see itself, for what it is. You might want to have a new dress ready, or not. Once again, the empire has immobilized itself, in its attempt to immobilize and replace labor, for maximum extraction. You’ll have that, from time to time.

    You always have a choice, to extend or implode the empire. Choosing not to decide leaves nothing but bad choices behind, best as the enemy of better. Be diligent or be weary. The empire feeds on stupidity. Keep it in check and it will serve you. Let it grow like a weed and it will strangle you.

    Practical, expedient civil marriage is its own worst enemy, because its result is peer pressure robots and rebel robots without a cause, seeking their own least common denominator, which, to their ultimate horror, is 0. Once they pass unity, 1, momentum gets ugly. The natural response to passivity is aggression, which, if undisciplined, results in chaos, MAD insurance.

    Military law is about positioning, reconnaissance. The derivative weapon presents itself. Civil marriage cannot produce self-disciplined children, regardless of technology. All it produces is a hollow military, encapsulated by a mercenary force, under central control, elite scapegoats for hire. Shock and awe cannot replace a real economy.

    It’s not the job of the military, much less The Imperative, to enforce fiscal and monetary expansion, in a positive feedback loop, which is exactly what the empire majority has built the US Navy to do, through its scapegoat, Congress, a damsel in distress, and paper promises, beginning with the US Constitution.

    Sorry folks; John Wayne was a draft-dodger, like all the other pretenders employed as an example to spawn the empire illusion, in the master slave game of ladders. His grandparents were specimens though. They sold me my first John Deere tractor and wagon. It was plastic and leg-driven, but I got a lot of work done with that outfit, learning what they don’t teach you in school – the value of your word, the ability to count, and the means to swim against the current.

    The US Navy is just an entertainment company that can’t get out of its own way.

    ———

    From Holley Gerth

    Yes, Your One Life Matters

    There has never been and will never be another you. That means the bravest thing you can do is to be who you already are. Because it’s safer to be like someone else. It’s easier to hide. It’s simpler to say “I’m not good enough” and walk away. But we need you friend.
    We need your gifts.
    We need your strengths.
    We need your smile.

    When you are who you’re created to be, you become a mirror of the heart of the One who made you. The enemy of your soul will try to tell you to change who you are because he would love to interfere with that reflection. Say no, my friend.
    No to comparing.
    No to competing.
    No to copying.

    Instead open your heart, spread out your wings, lift up your head and live with divine confidence. You have much to offer. You are a one-of-a-kind original. No one can ever be better than you at being you. Say yes, my friend.
    Yes to boldness.
    Yes to beauty.
    Yes to being who God made you.

    Say that “yes” with all your heart for all of your life. Speak it with everything you do and all that you become. Because one of the very best ways to change the world is by refusing to change who God created you to be.

  14. Bore Thyself

    I’m somewhat surprised with all the talk of mortgage rate hikes and its effect on RE trends that I have read ZERO anywhere about the impact of the Biggert-Waters legislation which will end all flood insurance subsidies over the next four to five years, beginning this October.

    With NOAA saying 39% of the US population lives in areas designated as Coastal Shoreline Counties, the impact of rising flood insurance, higher standards to be above baseline flood levels and the wider use of wave action damage standards, you are talking about a huge hit to US real estate.

    And that’s just the schedule for EXISTING properties that are already covered by the National Flood Insurance Program. If you’re a new home buyer or the existing home you purchase doesn’t have current NFIP cover, you get the full Monty from Day One this October.

    I am hearing stories–admittedly some worst case–of yearly premiums going from $600 to $2400. And that’s not even for some of the more expensive coastal residential areas on the East Coast.

    This surely will make another deep dent in demand for home ownership in many of the fastest growing areas of the US.

    Might be time to look into all that RE in the heartland that has been emptying of population for the last 40 years.

  15. susan the other

    Did anybody catch Chris Whalen on Zero Hedge saying that Timothy Geithner was a “childhood friend” of Obama? And Bernanke was gone because he is too honest?

    1. Massinissa

      I can understand the Bernanke being too honest part actually, but when in gods name were Barry and Turbo Timmy childhood friends?

      1. NotTimothyGeithner

        No. They weren’t childhood friends. Geithner and Obama both traveled as kids in Southeast Asia, and I think one of Geither’s parents knew his grandmother through careers. It was something like this. There was a series of articles a few years ago about Obama’s crush on Geithner.

        I thought the stories which though a mix of propaganda made sense in conjunction with Obama’s desire to find relatives of his father who were like him (see “Dreams of my Father”) as opposed to rural foreigners. Personally, I think Obama is motivated by his desire for a strong father figure and has styled himself as our Dear Father while supporting the people who could have filled the role of his fantasy father. The smart bankers, Tim Geithner, Tim Kaine, Chuck Hagel.

  16. Tim

    Yeah, 2 houses on my street in a upper middle class neighborhood in San Diego (buyers ALWAYS stretch here) both fell out of escrow late last week.

    I can’t see further home price appreciation with such a drastic change in monthly payment affordability. I assume a lot of would be buyers are going to boycott. How would you feel if you were on the verge of buying a specific house, and then are told sorry, now you can only afford a house that is 17% less nice than when you started looking? People have way to much invested in their hopes and dreams to swallow that bitter pill.

    We’ll be lucky to hold price gains for the past year.

  17. Conscience of a Conservative

    I don’t think the rate rise has much effect. Most of the mortgages driven by low rates have been refis, not new purchases. Mortgage rates are still relatively low compared to historical norms and a great deal of purchases have been investor proprerties, financed with cash not mortgage debt. Lastly you have a relative shortgage of purchasable properties and some pent up demand from the past few years. I think mortage rates would have to go up a great deal more than they have for this to be a serious issue for housing prices.

    I do think the growth in prices has to moderate at some point though, there are too many people in debt with student loans, unemloyment is too high etc, but these are not issues solved by the general interest rate level.

  18. ChrisPacific

    I continue to find it remarkable that many people treat stock market levels as a proxy for the health of the economy

    I presume this is sarcasm. A thought experiment that I often find useful is to imagine that the USA is a corporate nation governed by and for businesses (its ‘citizens’) and regarding its actual citizens as an exploitable resource, and consider government policies in that light. Many policies that initially appear nonsensical suddenly make perfect sense in this framing.

    1. Conscience of a Conservative

      I had to laugh a few weeks ago..

      One commentator said stocks were rising because the economy was improving and then a second commentator later said a rising stock market boosts consumer confidence which is good for the economy.

      It’s all so circular, an made up. People will attempt to say anything to justify a rising or falling stock market and very little is provable, just a bunch of anectdotes. Yes over the very long term stock prices track earnings which are derived from the macro economy, but over the short term, its all influenced by speculative apetitite, Fed policy etc.

  19. Malmo

    It’s not the rate increase that’s the problem. It’s the parabolic trajectory. I didn’t think it was possible, but Bernenke is actually worse than his predesessor in this regard. He’s essentailly lost control. Given the backdrop of the econmic condition the past five years, it’s simply inexcusable for him to be so nonchalant, especially when he has the power to stop this in its tracks… I’d fire him on the spot, right now.

  20. Conscience of a Conservative

    Yves,
    I think this is wrong. Looking at the indices, it’s clear refis are getting smacked, not home purchases. Mortgage rates are still low from a historical perspective. If anything, we may see some panic buying with folks looking to lock in while rates are still at generational lows.

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