As a current homeowner (investment property) and a future homebuyer (primary residence), I am trying to gauge the countervailing forces of stagnant REO volumes & shadow inventory, 1st time homebuyer tax credits, house price appreciation in 2/5/7 yrs, the possibility of a ‘double-dip’ in house prices, Federal Reserve $1.2 trn MBS purchases, HAMP/HAFA, and historically low interest rates. But as an economist, I am weighing an equally important set of macroeconomic variables that are not receiving much attention: stimulus, inflation, & mortgage rates. In October 1981, the 30-yr mortgage rate hit 18.45% due to aggressive monetary tightening. Considering the fiscal course this country has pursued over the last 8 years, it’s not impossible that inflation could be looming in the next decade. Let’s consider briefly what we know, what we don’t know, and lastly my observations.
What we know:
- $820 bn stimulus
- 10+% GDP deficit spending = not sustainable
- “We’re all dead in the long-run” JMKeynes; 8 years into the Global War on Terrorism & the worst post-WWII recession
What we don’t know:
- How much inflation to expect
o Conventional wisdom suggests that stimulus & 10+% deficit spending cause inflation
o But, we haven’t seen this yet in the data (CPI unchanged in Feb, after a meager 0.2% increase in January)
o And, some economists suggest now will be different (weren’t house prices supposed to increase forever also?)
§ “Trust me, inflation is not a problem” by David Blanchflower (Econ professor, Dartmouth; former member of the Bank of England’s Monetary Policy Committee)
- Direction of house prices
o Est. 2-4 mn foreclosures over the next 3 years
o Shadow inventory of 2 mn homes
o Federal programs stalling problems and artificially holding 30 yr mortgage rates low
§ One could make a strong argument for a ‘double-dip’ in house prices
§ One could make a strong argument for a ‘double-dip’ in house prices
- Affect of inflation on house prices
o Technical data mixed, observe the chart below [OFHEO %Chg YoY- right axis; CPI%ChgYoY - left axis]
What I think:
Today’s solutions cause tomorrow’s problems. In the words of Warren Buffett, "...enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.” Right or wrong, current fiscal and stimulus policy will lead to moderate, or possibly severe inflation. Volcker style monetary policy will be required to tame inflation with high interest rates. This could push the 30 yr mortgage rate to the teens. [Note: this could be a strong platform for the next Presidential race. Supra, Obama appointed Volcker head of his Economic Recovery Advisory Board]
Today’s solutions cause tomorrow’s problems. In the words of Warren Buffett, "...enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.” Right or wrong, current fiscal and stimulus policy will lead to moderate, or possibly severe inflation. Volcker style monetary policy will be required to tame inflation with high interest rates. This could push the 30 yr mortgage rate to the teens. [Note: this could be a strong platform for the next Presidential race. Supra, Obama appointed Volcker head of his Economic Recovery Advisory Board]
So, bringing all this back to my buy/hold/sell decisions as a homeowner and a homebuyer, one must consider 4 different perspectives; debtor today, debtor tomorrow, homeowner today, homeowner tomorrow.
today | tomorrow | |
debtor (mortgage) | good | bad |
equity holder (house price appreciation) | unclear | unclear, but probably good for the longer term |
§ How does inflation affect me as a debtor today?
o Good! Debt in today’s dollars is a good thing, tomorrow
§ How does inflation affect me as a debtor tomorrow?
o Bad. If rates rise, I can’t buy as much ‘house’ รจ downward pressure on house prices. People like me are no longer 1st time homebuyers in West LA. This could cause a flight to the suburbs for less expensive housing; return of the McMansion? Observe the table of 30 yr fixed monthly mortgage payments on a $200k loan below at 5/10/15% interest rates. The monthly payment is quite sensitive to the interest rate. A 3X increase in interest rates leads to a 136% increase in the monthly payment. Many borrowers will simply be priced out of loan that today is within their reach.
5% | 10% | 15% | |
Monthly Payment | $1,074 | $1,755 | $2,529 |
∆ [cum] | - | 63% | 136% |
How does inflation affect me as an equity holder today?
o Moderate inflation is good. In the graph above, we see that low inflationary expectations tend to reduce long rates, which helps improve afordability.
§ How does inflation affect me as an equity holder tomorrow?
o This is unclear, because tough medicine is usually followed by a pro-longed period of lower interest rates (30 yr mortgage rates below 10%), which tends to benefit house prices; but that is a longer term affect.
30YMTG lookup | 1980 to 1990 | 1990 to 2000 | 2000 to 2010 |
MAX | 18.5% | 10.5% | 8.5% |
AVG | 12.7% | 8.1% | 6.3% |
MIN | 9.0% | 6.7% | 4.8% |
Higher interest rates in the 80s, combined with a budget surplus in the 90s, paved the way for a long period of robust housing price growth; notwithstanding, geo-political stability, productivity gains, etc... But one could make the argument that house prices were relatively sustainable until the 2002 recession. Big picture, America enjoyed a low cost of consumer borrowing for this past decade (5.9% average from 2002 to 2010). Part of me believes that inflation will rear its ugly head. Tighter monetary policy will lead to higher 30 yr mortgage rates. Further, history suggests that inflationary pressures are sticky and require pro-longed monetary tightening.
Lastly, in closing, we must consider the macroeconomic forces with respect to the G20 world. There has been much discussion recently about China’s inflation and related asset bubbles. This topic is really too much to just do a "touch'n'go" so maybe I'll revisit after I've covered a few HAFA updates.
PS: For a succinct article about the prevailing arguments pointing to deflation, and the arguments pointing to inflation, see: http://www.straightstocks.com/market-commentary/buffett-russell-and-hoisington-deflation-or-inflation/
This is a very helpful blog posting!!
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