About the housing affordability problem.......

 

............................there are two main culprits.   The first is the huge swath of the local building companies that could not survive the Great Recession.  Since we decided several decades ago that every high school graduate needed to go to college, there was no back filling in the building trades.  No local builders building equals a shortage of supply.   The second is the following chart.  Don't let anyone tell you differently, very low interest rates are inflationary for the single-family housing markets.  Since buyers tend to pay based on their monthly payment, low interest rates enable buyers to borrow more, thus pay more, which is a great boon to sellers.   Very low interest rates combined with limited supply quickly allowed the sharp increase in home values.  Voila—an affordability "crisis".

chart courtesy of this post

the risk of yield chasing..............

 

As a banker and financial journalist, Bagehot observed that outbreaks of financial recklessness did not occur at random.  Rather, they tended to appear at times when money was easy and interest rates lot.  He expressed this insight in his own inimitable fashion: "John Bull can stand many things, but he cannot stand two percent."  When interest rates fell to such a low level, investors reacted to the loss of income by taking greater risks.  In modern language, they engaged in "yield chasing".  John Bull—that personification of English common sense—made his first appearance in Bagehot's writing in an article for the Inquirer published on 31 July 1852:

‘John Bull’, says someone, ‘can stand a great deal, but he cannot stand two per cent . . .’ Here the moral obligation arises. People won’t take 2 per cent; they won’t bear a loss of income. Instead of that dreadful event, they invest their careful savings in something impossible – a canal to Kamchatka, a railway to Watchet, a plan for animating the Dead Sea, a corporation for shipping skates to the Torrid Zone. A century or two ago, the Dutch burgomasters, of all people in the world, invented the most imaginative occupation. They speculated in impossible tulips.

-Edward Chancellor, The Price of Time: The Real Story of Interest

The fifty year mortgage..................

 

Been reading that the idea of a 50-year mortgage is being bandied about.  Lots of commentary about why this is a horrible idea.  The amount of extra interest the home buyer would pay—if they kept the mortgage for all fifty years—over a more traditional loan is staggering.  But, while it is not for everyone, it could have its uses.  It is essentially an interest-only loan.  If your intent is to only live in a place for a few years, and you believe housing prices will still be inflating, then it could be a very viable option.  Just be careful to avoid any pre-payment penalties.  It is certainly not a panacea for the affordability problems we are currently facing.

the natural rate..........................

 

"That which they obtain too cheap they demand in too great quantity," lamented the prudent banker.  In so many words Thornton was suggesting that providing paper credit at below the natural rate of interest created the conditions for an unstable financial boom.

In Locke's day, at least, money was backed by rare metals.  In the modern world, however, money is created whenever a bank makes a loan and the link between acts of saving and lending has become more tenuous.

Even though it cannot be known with certainty, it is useful to hold in mind how the world would look if the natural rate held sway; a rate that was set, as Locke imagined, by individuals freely lending and borrowing money in the market, like any other commodity; a rate that accurately reflects society's time preference; which ensures that we neither borrow too much nor save too little; which ensures capital is used efficiently, and puts an accurate value on land and other assets; a rate which provides saver with a fair return and is not so low as to subsize bankers and their financial friends, nor so high as to bite borrowers.

-all excerpts from Edward Chancellor's The Price of Time: The Real Story of Interest

induced......................

 

     To twenty-first-century policymakers, the interest rate is simply a lever used to control inflation and tweak economic output.  Yet an acquaintance with the Babylonian origins of interest should give pause for thought.  Interest has always been with us because resources have always been scarce and must be rationed somehow, because wealth is unequally distributed between creditors and borrowers, and because, as Böhm-Bawerk says, 'interest is the soul of credit.'  Interest exists because loans are productive, and even when not productive still have value.  It exists because those in possession of capital need to be induced to lend, and because lending is a risky business.  It exists because production takes place over time and human beings are naturally impatient.

-Edward Chancellor, The Price of Time: The Real Story of Interest

the time value of money................

 

For Turgot, as sum of money delivered immediately and the promise of the same amount of money at some future date could not possibly have the same value.  Time preference explains why Aristotle was wrong.  Interest is the difference in monetary values across time, the rate at which present consumption is exchanged for future consumption.  Interest represents the time value of money.

-Edward Chancellor, The Price of Time: The Real Story of Interest

about those rates................

 

In truth, Child's advocacy for lower rates was intensely self-interested.  Like a modern buyout baron's, his control of the East India Company, where he was shortly to become Governor, was maintained through the extensive use of debt: the greater the gap between the company's profits and the cost of borrowing, the greater his personal gains. . . .

There was a sense that higher interest rates improved the quality of lending.  The author of 'Usury at Six percent Examined' (1669) claimed that a reasonable lending charge ensured that money got into the best hands:  "Tis much better for the publick,' . . . Thomas Manley added that lowering the rate of interest would involve robbing Peter (the creditor) to pay Paul (the borrower).

-Edward Chancellor, The Price of Time: The Real Story of Interest

regulatory arbitrage.....................

 

     It is a curious fact that the earliest known set of laws, Hammurabi's Code, which dates back to around 1750 BC, is largely concerned with the regulation of interest.  The Babylonian king codified existing credit practices with the customary interest rates set in stone—quite literally, since the Code survives for posterity engraved in cuneiform script on a basalt stele. . . .

     Drawing up financial regulations is one thing but getting people to follow the spirit of the law is another matter.  What we call 'regulatory arbitrage'—namely, the attempt by financial practitioners to evade regulation—turns out to be as old as the law itself.

-Edward Chancellor, The Price of Time: The Real Story of Interest

who benefits....................?

 

As Bastiat understood, a very low rate of interest may benefit the rich, who have access to credit, more than the poor.

-Edward Chancellor, The Price of Time:  The Real Story of Interest

About interest..................

 

     "The emergency of interest to incentivize lending is the most significant of all innovations in the history of finance," writes the financial historian William Goetzmann.  This point is well made.  Finance allows people to transact across time.  The farmer borrows barley to sow his fields but must wait until harvest before repaying the debt.  Industrial processes—even the light crafts-based industries of the Ancie4nt Near East—require time in production from raw materials to the sale of finished goods.  A text from third-millennium Mesopotamia shows that the preparation of cloth took over a year.  Foreign trade consumes a lot of time.  When capital is tied up in industry or trade, the interest charge bears some connection to the time used in production.

     In any society with private property, whether in Mesopotamia or later civilizations, the payment of interest is required to induce people to lend their resources.

-Edward Chancellor, The Price of Time: The Real Story of Interest

My crystal ball is a bit cloudy...........

 

We’ll get another recession someday. Maybe in a year. Maybe in 7 years. Who knows?

Whenever an economic contraction occurs, we’re likely to see lower rates. These things aren’t scientific but mortgage rates have fallen by an average of around 1-2% during past recessions.

If that happens this time around I think you’re going to see an explosion of housing activity from pent-up supply and demand that has been sitting on the sidelines. We could also see a big uptick in cash-out refis and HELOCs if rates are at more reasonable levels because so much equity is tied up in homes these days.

People would be very confused by this but the housing market already went through a recession so it wouldn’t surprise me to see it lead us out of the next one.

-Ben Carlson, as cut-and-pasted from here

A good question for today...........

 

Who spends money better: the person who spends his own money, or the person who spends other people's money?

-from the Calafia Beach Pundit, who loves his charts

such as this one...........................

For a stock market guy...................

 

...........he has a pretty good sense of the real estate market:

We won’t be in this situation forever because something unexpected always happens eventually, but for now, we’re in a damned-if-you-do, damned-if-you-don’t housing market.

If anyone tells you low interest rates help buyers, ignore them.  Low interest rates help sellers - because low rates enable a buyer to pay a higher price while maintaining a lower monthly payment.  Much of the "affordability" crisis in housing has been brought on by over a decade of ridiculously low interest rates.  In real estate, low interest rates are inflationary.

You didn't ask, but I'll tell you anyway: any interest rates for borrowers that do not allow financial institutions to pay an interest rate to savers that exceeds the rate of inflation is too low.

It's an election year.....................

....................so all bets are off:

 The Federal Reserve declared victory today, projecting a soft landing as its base case in the years ahead, with more cuts in short-term rates, and with inflation gradually getting back to its 2.0% goal without a recession.  Unfortunately, we think the Fed is declaring mission accomplished too early.

Brian Wesbury, from here

In case I needed it.....................

 ...........................more proof I'm getting old.  Younger investors and real estate agents are bemoaning the "high" current mortgage rates.  For half of our career, we would have been thrilled with this sort of rate:

A little context:

pretending.......................

 One of my rules is to not forecast markets. Neither stock markets nor interest rates markets. Partly that’s because I will always be wrong and I don’t like being wrong. Partly it’s because it really bothers me when finance media people pretend they can predict the future. In reality, that specific habit of forecasting by otherwise supposedly serious finance media people should earn them a fortune-teller’s cap (with all the stars and lightning bolts) to signal their likely accuracy.

-as extracted from this Bankers Anonymous post

A good question................

 Our friend Ben Carlson opines on, Why Higher Interest Rates Haven’t Mattered (Yet).  Included with this post is this handy pie chart:

The proposition is that the overwhelming majority of home borrowers have locked in very low rates and are unaffected by the recent rate increases.

It is hard to disagree with that, but we're pretty sure it doesn't tell the whole story.  Most commercial and investment loans are variable rate mortgages.  Typically, they are fixed for a three- or five-year period, then they adjust to reflect the current market conditions.  We believe that there is a bit of turmoil ahead as those loans adjust over the next year or so.  As an example, we recently had a five-year adjustable-rate mortgage adjust from 3.75% to 8.25%.  Yeow.  Fortunately for us, we were able to pay the loan off.  Not all borrowers we be as fortunate.  Stay tuned.

This chart measures.................

 .........the growth of interest payments on the U. S. debt.  Hang on.  It will be an interesting ride.

What happens when.......................

 .............................money is free?  A list of eleven things here.

We experienced a decade of quantitative easing and declining interest rates that culminated with an unprecedented multi-trillion-dollar infusion of capital in 2020. But three years later, the party had to end.

The Fed is raising rates, money isn't free anymore, and companies have to once again rediscover the lost art of "turning a profit." Outrageous stuff, isn't it?

-via

I'm sure this makes sense...............

 Let's hope this continues; let's hope the Fed doesn't feel compelled to squeeze the economy just because inflation is a little higher than they would like to see. The truth is that on the margin, inflation pressures are receding (and by some measures inflation is already back down to 2%—see Chart #1 in this post) and the best way to keep inflation low is to allow the economy to continue to grow while keeping interest rates high enough to keep the demand for money from plunging. A greater supply of goods and services, after all, will help absorb any extra money that is still sloshing around. 

-via the Calafia Beach Pundit