The Coming Change in Monetary Policy
avc.com
avc.com
https://en.wikipedia.org/wiki/Federal_funds_rate#/media/File...
Mortgage rates follow but don't match the fed funds rate. Home prices vary inversely with interest rates. Falling rates generally mean rising home prices. So with rates near zero, there is only one thing for housing prices to do - fall when they raise rates. The only hope is that inflation will balance the fall in home prices caused by raising the rates. Otherwise, prepare for crisis part II.
"In the fourth quarter of 2014, the U.S. negative equity rate – the percentage of all homeowners with a mortgage that are underwater, owing more on their home than it is worth – stood at 16.9 percent, unchanged from the third quarter. Negative equity had fallen quarter-over-quarter for ten straight quarters, or two-and-a-half years, prior to flattening out between Q3 and Q4 of last year.
While this may not seem very notable (after all, overall negative equity didn’t go up, merely flattened out), this represents a major turning point in the housing market. The days in which rapid and fairly uniform home value appreciation contributed to steep drops in negative equity are behind us, and a new normal has arrived. Negative equity, while it may still fall in fits and spurts, is decidedly here to stay, and will impact the market for years to come. "
Even so -- the raw percentage of homeowners experiencing negative equity is not a good predictor of the impact of raising interest rates and falling housing prices. Negative equity doesn't trigger a distressed mortgage, or force an owner to abandon the property. But positive equity does have an anchoring effect.
[1] http://www.zillow.com/research/zillow-negative-equity-q3-201...
[2]http://www.newyorkfed.org/research/epr/09v15n1/0907haug.pdf
Disagree. As soon as a property has negative equity, a homeowner begins to contemplate strategic default. As their property tips ever more into negative equity territory, the benefits of default rise dramatically, whether the mortgage is recourse or not.
Don't take my word for it; the Federal Reserve did a study on it:
"Our results suggest that while strategic default is fairly common among deeply underwater borrowers, borrowers do not ruthlessly exercise the default option at relatively low levels of negative equity. About half of defaults occurring when equity is below -50 percent are strategic but when negative equity is above -10 percent, we find that the combination of negative equity and liquidity shocks or life events drives default. Our results therefore lend support to both the “double-trigger” theory of default and the view that mortgage borrowers exercise the implicit put option when it is in their interest."
http://www.federalreserve.gov/pubs/feds/2010/201035/201035pa...
Furthermore, my central claim -- that the total fraction of houses with negative equity is a poor predictor of default risk -- is unaffected either way. It would be more useful to know the distribution of negative equity for those houses, or summary statistics like the mean or median negative equity. (If we knew that the median negative equity were 10%, then we could predict that about half of the 16.9% of all properties that are upside down are at risk of default if they experience a liquidity shock.)
From Zillow:
"Nationally, of the homeowners who are underwater, around half are only underwater by 20 percent or less, which is to say they are close to escaping negative equity. (Figure 2) On the other hand, 1.9 percent of all owners with a mortgage remain deeply underwater, owing at least twice what their home is worth. Of the largest metro areas, markets with above average rates of deeply underwater homeowners include Las Vegas (3.8 percent), Chicago (3.8 percent), Atlanta (3.5 percent), Detroit (3.3 percent) and Miami (2.8 percent)"
Almost half of the borrowers with negative equity have a LTV of 100% to 120% (8.2% in Q4 2014). Most of these borrowers are current on their mortgages - and they have probably either refinanced with HARP or their loans are well seasoned (most of these properties were purchased in the 2004 through 2006 period, so borrowers have been current for ten years or so). In a few years, these borrowers will have positive equity.
The key concern is all those borrowers with LTVs above 140% (about 5.2% of properties with a mortgage according to Zillow). It will take many years to return to positive equity ... and a large percentage of these properties will eventually be distressed sales (short sales or foreclosures).
The whole point of the Fed deciding to raise interest rates is that it means that the Fed believes that the economy is strong enough to start removing fiscal support. If they are right, then there should actually be not a huge effect on valuations.
That said I seem to remember Sequia talking about the party being over years ago and utterly nothing came of that.
For instance, in 2001, before 9/11 (IIRC) there was an article there about how as a response to the DotCom boom the low interest rates plus changes in the CRA would be causing a housing boom and bubble over the next decade.
In 2001 there was no boom, and after 9/11 the economy was bad. But that advice proved true, and gave me 6 years to time to invest based on the housing bubble hypothesis (alas I never found a way to short houses and wasn't the kind of person who could have bought CDOs against the foolishness) ... and I got out of the market very near its peak in 2007.
Unlike what politicians would want you to believe, Economics is a science and the consequences of actions in economics are pretty close to those in physics. They can pretend like one president or another is responsible. (the Housing Bubble was the result of the actions of Clinton and Bush, and actually Obama who was a lawyer in the lawsuit that claimed "lending only to people who can afford to repay the loans is racist"... and like economics predicted (That banks want money and will disregard race) in the end it turned out that they weren't being racist but were lending based on likelihood of repayment... and the winners in Obama's class action lawsuit got their loans... and defaulted.)
The consequences of the terrible actions in 2008- from the bailouts to the giving of one private bank (the federal reserve) the power to forcibly merge other banks (without regard to conflict of interest-- say one of the owners of the federal reserve wants to buy a smaller bank, he can just use the fed to force it to merge with him on terms he agrees to.... no way this will be abused, right?) .... these consequences are still playing out and have made the game much more dangerous than 2008.
One thing I've noticed is that the "Black Swan" events-- like 2008 which people said "Tehre's no way you could see this coming" despite the popular sentiment in 2006 being "there's no way there's a housing bubble!" showing that people did, in fact, see it coming-- really are pretty predictable at least in terms of risk.
And the risk of a Black Swan has only been going up given the past 3 decades of irresponsible governance (under congresses and presidents from both parties.)
Don't look to VCs for economic perspective. They don't have it. All they know how to do is raise funds and collect a carry. Don't look to political hacks like "A housing bubble would be good for the economy" Paul Krugman, or any politicians.... look to actual economists. (Even Keyenes disagrees with the monetary policy we've been following for these decades, even though the politicians claim its his idea. IT isn't, it's not what he said at all.)
The current bubble is the dollar, and they can't raise interest rates without popping it. Whether they intend to pop it I don't know.
Securitization and rating was the heart of the crisis. Mortgages fail all the time, and banks know how to deal with that. Failing mortgages are not enough to cause a financial crisis.
Investment banks realized that they could package low-quality mortgages into securities, and the securities would be highly rated because of tranching. This created a race to create as many mortgages as possible, in order to reap the profits from the securities sales.
It was this race for mortgages that then drove down underwriting standards among private originators--not the CRA.
The structure was strongly pro-cyclical, because when mortgages started failing, they ate away at both revenue and capital simultaneously. Falling revenue is ok if there is enough capital to cover it. But since the capital was made up of the same bad loans (now packaged as securities), the safety net frayed just as fast as the tightrope did. Result: crisis.
Also: a defining characteristic of "black swans" is that people assert after the fact that they were actually predictable (as you are now).
Don't read Mises.org, or at least not only. Read John Kenneth Galbraith's work: "A Short History of Financial Euphoria", "The Great Crash". Read Michael Lewis' work: "Boomerang", "The Big Short". Read even the pop economics works that expand on how people think, versus how they act: "Nudge", "Thinking: Fast and Slow".
Read Nate Silver's "The Signal and the Noise", and you'll see that predicting the market has improved no more than earthquakes has. There is no "physics" of the market, there are no silver bullets and predictors who understand everything will happen. If those people existed and acted on their bets, they would be wealthy beyond reason.
Skip "The Black Swan", and go straight for "Antifragile". It's Taleb's opus, according to him, but it describes the error in trying to make these predictions. They're very fragile. Your 2007 "pulling out of the market" could have been brilliance or folly, and you just happened to get lucky.
But don't take my word for it, take this quote by Keynes:
"The market can remain irrational longer than you can remain solvent."
No one can predict the future, least of all the irrational herd mentality of the market. Anyone who says they can, or they have a formula, or that they know "when to pull out of the market" is a charlatan or lucky, or both.
Huh. Austrian economics argues the exact opposite, which is generally correct for most things at a higher level than chemistry, especially something as stochastic as economic modeling.
One thing I've noticed is that the "Black Swan" events-- like 2008 which people said "Tehre's no way you could see this coming" despite the popular sentiment in 2006 being "there's no way there's a housing bubble!" showing that people did, in fact, see it coming-- really are pretty predictable at least in terms of risk.
Austrian economists are wary of making predictions in general, which goes hand in hand with their overall distaste for econometrics. Not to say that the more naive ones don't yell about incoming collapse all the time.
Even Keyenes disagrees with the monetary policy we've been following for these decades, even though the politicians claim its his idea. IT isn't, it's not what he said at all.
We've come a long way since Keynes. Like we've debunked the marginal propensity to consume since then, for instance, despite the fact that most laymen and politicians keep making the same fallacy.
Steve Keen makes the - IMO interesting - point that there are different kinds of consumption, and lumping consumption under a single Benthamite label is a gross oversimplification.
But MPC is a simple measure of economic freedom. It's not what you spend your extra earnings on that matters, because - unless you're burning banknotes - it all goes towards increasing GDP anyway.
Where things get fuzzy is a lack of appreciation for the fact that spending measures current economic activity, but savings, credit, and investment all measure faith in future economic activity.
Because faith is based on an irrational thing called "sentiment", you have a huge chunk of the economy based on hope, fear, and desire - which is maybe not the most practical and useful way to make the economy work for everyone.
How does that make any sense? By raising interest rates, they increase the value of the dollar, because they reduce its supply. Loans become more expensive. Prices across the board fall. Am I missing something?
This sentence makes less sense when you consider that Paul Krugman, ahem, is a Nobel prize winning economist.
Raising interest rates will make the dollar stronger, and will draw capital to the dollar and away from weaker currencies such as the Yen and Euro. What it won't do is pop/harm the dollar in any manner.
The primary risk to the dollar from raising interest rates, is to the US Government's finances, the cost of its $18 trillion in public debt. The US, unlike most major economies in the world, has some spare taxing capacity. In net, the US can afford to pay higher interest on its debt through higher personal income taxes, as necessary.
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Short answer: Pigs will fly.
Long answer, in order for this to happen, the high transactional costs of cryptocurrencies (FX costs, electricity, blockchain rewards, transaction fees, etc.) will have to look reasonable compared to the cost of doing business in "fiat" currency. This is currently only true for illegal activity, such as drug dealing or evading currency controls, but if the world changes enough to make cryptocurrencies a reasonable alternative to the majority of people, something terrible has happened to the world.
Agreed. I really like what's happening over at Calculated Risk (http://www.calculatedriskblog.com/). Bill seems to do a good job at taking macroeconomic information and distilling it into something understandable.
The Fed has not shown any real interest in wanting to hurt this delicate (and booming) economy with an end to QE or by raising rates. But most analysts seem to point to Oct 2015 to mid 2016 as the point when rates will rise. But we also said that about early 2015 last year, so who knows what will happen, until it actually happens!