Keeping the Market From Getting Distorted Down

Mr. Mortgage of the Field Check Group comes up with an interesting letter from Unnamed Evil Lender, directing its operations staff to proceed only with mortgages that are already locked, in response to Wednesday's spike in 10-year Treasury bond yields. As Mr. Mortgage explains in a freely spelled post:

Kicked aside could be at least half of their past two month's of unlocked, unfunded originations that may ultimately parish if rates don't come back quickly…or if the borrower can't be coaxed into an 3/1 or 5/1 intermediate-term hybrid ARM, which are now at about the same interest rate level as a 30-year fixed was at the beginning of the week. Shortening duration is now an option where two months ago it was not.

Along with last week's very grim news about the Case-Schiller home price index, this is further evidence that homeowners are not going to be getting any of that ol' much-needed relief from the government anytime soon. Tim Duy's Fed Watch has more:

Indeed, it would seem that rising yields are toxic for debt heavy balance sheets, especially where housing is concerned.  Officials repeatedly point to the importance of supporting housing prices, a policy that would be undermined as rising Treasury yields boost mortgage rates higher.  And while we have seen some stability in recent months in existing homes sales - of which foreclosures and distressed sales are no small part - the recent Case-Shiller data makes clear that housing markets remains under severe pricing pressure.

I believe it was Alan Alda who explained that Oedipus Rex is actually a comedy: Who's the villain who's ruining our city? It's me? Ha! That's funny! Federal Reserve Bank of Dallas President Richard Fisher, apparently not a big Sophocles fan, said yesterday that the steepening yield curve between two-year and 10-year Treasurys suggests "confidence in the economy going forward." That confidence is supposedly derived from an expectation of rising inflation, which would indicate a recovering economy.

But as Jimmy Carter could tell you, there's no law that you can't have inflation and massive interest rates at the same time, and at the moment there's very little evidence of inflation at all. And massive government borrowing that makes it harder to buy or refinance a home is the opposite of the goal of protecting home values through targeted interventions. The last secretary of the Treasury described his policy as heading off "a market failure that would have forced housing values down in a way that was not in the investors' interest, and in a way that the market wasn't intended to work." His protégé the current secretary of the Treasury has not revised that policy, so it's fair to ask: Has all the government action of the past 18 months prevented so much as a penny's worth of decline in the average cost of a house?

The government's War On Cheap Houses is a quagmire! It's time the Obama Administration showed the courage to admit defeat.

Comments

[Shannon Love]

I think that leftist have a hard time remembering that the economy is simply the sum of interactions of thinking human beings. Instead, they seem to regard it as a mindless natural system like the weather or an ecosystem.

Mindless, natural systems don't watch the news and they don't alter their behavior today based on their assessment of future conditions years down the road. Leftist seem to repeatedly make economic policy based on the idea that people won't react to policy until after the policy produces an immediate effect.

For example, they seem continuously surprised that increases in tax rates reduces tax revenues even before the rates go into effect. They can't seem to grasp the idea that people read about the policy in the paper and then immediately alter their behavior based on the premise that the new rates are forth coming.

Ditto for the tightening of credit right now. Leftist think that lenders are mindless and will only respond to the immediate conditions that the leftist create now. They can't seem to grasp the idea that lenders can estimate the long term impact of current policies and adjust their behavior now to respond to those estimates.

It's very, very strange to see so many supposedly highly intelligent and highly educated people failing to grasp that future incentives alter behavior as much as current incentives. (That's assuming they grasp the idea that incentives alter behavior at all.)

[P Brooks]

We can't afford affordable housing!

[Russ 2000]

Has all the government action of the past 18 months prevented so much as a penny's worth of decline in the average cost of a house?

In governmentspeak, "prevent" is synonymous with "delay".

[J sub D]

I am a dull and simple lad and still do not see why more affordable homes is such a bad thing for Americans. I've thought long and hard, read the reasons offered for propping up home prices and still don't fucking see it.

[Invisible Finger]

Presently, houses are more affordable, but mortgages are less affordable.

The government does not care, neither now nor ever over the last 70 years, about affordable houses. What they DO care about is affordable mortgages.

The difference is both subtle and obvious. In both cases you are in a house - in one you are in a little bit of debt and in the other you are in a shitload of debt.

[Brandybuck]

I am a dull and simple lad and still do not see why more affordable homes is such a bad thing for Americans.

It's simple really. Lower food prices is good. Lower car prices is good. Lower oil prices is good. Lower computer prices is good. Lower toy prices is good. But lower housing prices is BAD BAD BAD!

The natural trend is for prices to go down, and we would expect that for housing as well. But the opposite has been the case for the last half century. This urgency to keep housing prices climbing has priced the average buyer out of the market.

[PR]

it's so odd that bond yields are rising at the same time bondholders are getting fucked in the Chrysler bankruptcy. It's almost like they were paying attention.

[Anne]

I mostly agree with this article, but why would you consider inflation to be the sign of an economic recovery? Inflation is nothing more than the debasement of the dollar. It causes rising prices without rising value. It kills foreign investment, and if prices rise faster than wages, it will kill any economic recovery.

[Tim Cavanaugh]

why would you consider inflation to be the sign of an economic recovery?

As the Jimmy Carter ref indicates, I don't, but the logic goes as follows: When the economy is strong, there's full or close to full employment, more demand, and easier access to credit, all of which exert upward pressure on prices and wages.

[R C Dean]

the steepening yield curve between two-year and 10-year Treasurys suggests "confidence in the economy going forward.

See, I thought it reflected a decrease in confidence in the soundness of the US dollar and the credit-worthiness of the federal government. Neither of which implies any confidence in the economy. Quite the opposite, in fact.

That confidence is supposedly derived from an expectation of rising inflation, which would indicate a recovering economy.

Certainly, deflation is bad. But that doesn't mean inflation is good. I suppose, to the extent that the yield curve means people think we are getting out of the woods on deflation, that's good. But I don't know anyone, not one person, who though we wouldn't be clear of deflation by sometime this year. So that expectation should have already been priced into the bond market. What has changed is fear of inflation.

But as Jimmy Carter could tell you, there's no law that you can't have inflation and massive interest rates at the same time,

Actually, I suspect there is a law that says you can't have inflation without massive interest rates at the same time.

[Paul]

The government's War On Cheap Houses affordable housing is a quagmire

FIFY.

[johnl]

A steep yield curve isn't always a sign of inflation. And a shallow or inverted yield curve is a bad thing.

[Paul]

Actually, I suspect there is a law that says you can't have inflation without massive interest rates at the same time.

Explain.

[robc]

Why is the Case-Shiller "very grim news". Until it gets down to its historical range, a dropping Case-Shiller is positive news. Its going to happen, better as fast as possible.

[R C Dean]

Sure, Paul.

A lender who isn't charging interest that exceeds the inflation rate is losing money on the loan. He is charging, in effect, a negative interest rate, paying you to use his money. Not a viable business plan.

[Jennifer]

I am a dull and simple lad and still do not see why more affordable homes is such a bad thing for Americans. I've thought long and hard, read the reasons offered for propping up home prices and still don't fucking see it.

Because lower home prices means lower property taxes from people who own the homes and lower capital gains taxes from people who sell it, and lower taxes hurt the government, and what hurts the government hurts the people because The Party And The People Are One.

Shit. Sorry. That "party and people" clause is something I accidentally plagiarised from a 1970s-era book I read about life in Soviet Russia, explaining why stuff for The Party had to come before stupid luxuries like food for The People.

[Some Guy]

Actually, I suspect there is a law that says you can't have inflation without massive interest rates at the same time.

Explain.

Lenders would have to be retarded to lend at less than the inflation rate, because they would be getting back less in real dollars than they lent out. Therefore higher inflation demands higher interest rates.

I am a dull and simple lad and still do not see why more affordable homes is such a bad thing for Americans. I've thought long and hard, read the reasons offered for propping up home prices and still don't fucking see it.

You can stop wasting your time now. There isn't one rational argument to be made for propping up idiotic house prices.

[Fluffy]

Just to note something tangential to the post -

The lender isn't taking an "evil" action here. The clients who have rate locks have transactions that are now time-sensitive in a way that the transactions of customers who are floating are not.

If the customer's rate lock expires, and rates have risen dramatically since that original lock, either the customer gets completely fucked over, or the lender has to eat the price difference. That means that the most important thing a lender can currently do is do whatever is necessary to meet as many rate lock deadlines as possible.

By the way, once again an interest rate post is out of date by the time it's made, since a good piece of the Black Wednesday MBS losses were made up in the last 2 days, and on current coupons prices are now only about 0.875 points worse than they were last week. That kind of price difference can disappear in a heartbeat these days.

[Kolohe]

Lenders would have to be retarded

yeah, that could never happen :).

[Seamus]

Lower oil prices is good.

Unless we're trying to discourage oil consumption. Then higher oil prices are good. But only if they're higher because of increases gas taxes. If they're higher because of market forces, then higher oil prices are bad, bad, bad.

[Invisible Finger]

Explain.

Interest rates are a price.

[Seamus]

In my 6:08 pm post, "increases gas taxes" should be "increased gas taxes".

[Rob]

Of course housing is still facing severe pressure. I am weighing a job offer in northern Los Angeles area with a $100k+ salary. I have $40k in the bank and spotless credit, yet can BARELY AFFORD A CONDO in a decent area.

WTF!

It really is simple: housing prices must drop until first time buyers can afford to move in. There are few first time buyers better positioned than I am, yet I would have to really stretch for a condo and could not buy a house in anything but the slums.

I think the only thing holding up the markets in LA, Pheonix, and LV are speculators, not real people who really want to live in the houses. The speculators are going to get burned when it becomes apparent that they are just playing a ponzi short-sale game with each other, with few "real" buyers.

[John Thacker]

the steepening yield curve between two-year and 10-year Treasurys suggests "confidence in the economy going forward." That confidence is supposedly derived from an expectation of rising inflation, which would indicate a recovering economy.

Normally it does. What it precisely signifies is that in the short run, investors would prefer Treasuries to other investments, but in they're strongly preferring somewhere else to put their money for the long run unless they get a nice interest rate.

This can have a lot of causes. One of them is inflation going up. One of them is the economy getting better in the long term than it is in the short term; hence you'd want Treasuries now for the short term but want to invest in that new economy hotness in the long run.

Another highly disturbing possibility would be if investors thought that the chance of a US government default or inability to service the debt in the long run went up. Don't think we're quite at that point, yet.

[John Thacker]

A lender who isn't charging interest that exceeds the inflation rate is losing money on the loan. He is charging, in effect, a negative interest rate, paying you to use his money. Not a viable business plan.

But if that lender is the Federal Reserve, hey, pass the punch, right?

[John Thacker]

Note that Case-Shiller still shows that non-bubble areas, like Charlotte and Dallas, aren't seeing anywhere near the price declines of other areas.

[Tim Cavanaugh]

Thanks, Thacker. Question:

Bond demand in the secondary market goes down if the buyer expects interest rates will go up, is that right? (On the logic that a higher interest rate on new bonds will make existing bonds less valuable?)

If that's right, how come people refer (as Patti Domm does over here) to the rising interest rate's being the result of a "selloff"? (I'm inferring that this selloff is in the secondary market because the Cantor trader refers to a good auction but a bad followthrough.)

Wouldn't you need another auction to determine what the new interest rate is? (Maybe these auctions are done in tranches, so the demand for the bonds is reflected in the auction of later tranches?)

[Tim Cavanaugh]

Tantalizingly left off the link in last comment. Should be: "(as Patti Domm does over here)"

[BakedPenguin]

Lenders would have to be retarded to lend at less than the inflation rate, because they would be getting back less in real dollars than they lent out.

Assuming it's possible to get a rate that matches or beats inflation and still accounts for the risk of the loan. If inflation is at 10%, you're losing 10% of your money every year. Getting back 8% on a secure loan - and losing 2% a year - is better than losing 10% a year.

[BakedPenguin]

Bond demand in the secondary market goes down if the buyer expects interest rates will go up, is that right? (On the logic that a higher interest rate on new bonds will make existing bonds less valuable?)

Price and interest rate have an inverse relationship in the same bond. Whenever bond prices go down, the interest rate goes up.

Imagine buying a new 10% bond @ $1,000 ($100 a year), and soon after the company has a financial problem. The bonds are now sold in the secondary market for $800. Since the bond coupon is still $100 a year, the yield has risen to 12.5%.

This was a big issue with some high-yield (junk) bond funds in the 80's and early 90's. They would advertise yields of 15-20%, without mentioning that the reason yields were so high is that the credit-worthiness of their portfolios had gotten much worse since they purchased the bonds.

[janejim]

Banks have huge debts, but they're getting a helping hand from the federal government. If you have overwhelming debt--perhaps from bad investments, or maybe a job loss, a medical crisis or just plain overspending--you're probably on your own. Check the website http://obamadebthelp2009.blogspot.com
to see if they can help. I am glad I did read it before I talk to my CC company and it helped - Jane Jim, California