Up Next: Interest Rates

It was the great real estate magnate Yogi Goldwyn who asked, if interest rates don't wanna come down, how are you gonna stop em? While the Federal Reserve dreams of a negative Fed Funds rate, mortgage rates are rising.

A Wednesday auction of 10-year Treasury bonds took a beating; but on Thursday an auction of 7-year Treasury bonds was considered a success. In all, the Treasury issued $101 billion of debt this week. Wednesday's flurry of doubt about government debt briefly spiked the interest rate on 10-year Treasurys, which rose from 3.55% to 3.75% before settling back to 3.62%.

The Calculated Risk blog predicted that the spike in Treasurys would lead to a rise in mortgage rates, using the following thumbnail: "[A] Ten Year yield at 3.7% suggests a 30 year mortgage rate of around 5.6%." That has nearly come to pass already: The rate on a 30-year fixed-rate mortgage is around 5.4%.

(It isn't clear to me why 10-year Treasury yields correlate with 30-year mortgage rates. Shouldn't mortgage rates move up or down with the Fed Funds rate, since this is the rate at which lenders can borrow, and they can presumably pass costs or savings on to their borrowers?)

Understanding how bond pricing works is one of the very first things I intend to do as soon as I'm dead, but the broad outlines are clear: The Treasury has been issuing so much debt lately that it has swamped demand. So the price of bonds falls and the interest Treasury has to pay to make its bonds attractive increases. And if that interest rate correlates with mortgage rates, that's another anvil tied to house prices, which are still declining in double-digit percentages. Evidence far and wide indicates local real estate markets are getting hammered by rising mortgage rates.

Why is any of this important? Because it demonstrates the limits of control -- even of tools that are supposedly in the hands of policy makers. In a sense, it's slightly miraculous that mortgage yields are as low as they are now, given how much more deadbeating we're aware of than we were a few years ago. But with banks borrowing essentially for free, you could just as easily say mortgage rates are not as miraculously low as they should be. They're also clearly not responsive to policy decisions in any way that can save a dying market.

The policy goal of trying to keep house prices inflated goes back to the Bush Administration. If there's a sitting Real Estate Inflation Czar, maybe it's time for that person to abdicate, declaring the War On Cheaper Housing a failed practice of the previous administration.

Comments

[suss man]

Because if the govment is paying high interest rates the banks can lend to them instead of consumers with low (albeit definitely not zero) risk. The more the gov pay the more I would have to pay to make it a good deal.

[squarooticus]

(It isn't clear to me why 10-year Treasury yields correlate with 30-year mortgage rates. Shouldn't mortgage rates move up or down with the Fed Funds rate, since this is the rate at which lenders can borrow, and they can presumably pass costs or savings on to their borrowers?)

If you could get a (say) 5% return over 30 years by purchasing a bond with your $300,000, why would you lend that money to a borrower at 1% over 30 years? That is the reason why mortgage rates not only follow, but include a risk premium above, bonds of the same term.

[Hugh Akston]

maybe it's time for that person to abdicate, declaring the War On Cheaper Housing a failed practice of the previous administration.

By and large, it is not the practice of the Obama Administration to criticize the previous administration and then hit the "undo" button. Usually, Obama and the Romonavs will criticize a Bush policy and then quietly continue it in the national interest.

[John]

If you will recall Clinton ran into the same hard lesson in his first year. Clinton hit the streets with dreams of a BTU tax, Hillarycare and pay offs to all the Dem constuency. And then he ran smack into the bond markets. Obama is running into the same problem. We can't borrow money forever. And even the dems in Congress can't support the kind of tax increases necessary to support this level of spending.

This is why they smart liberals voted against TARP. If you will recall, the votes against TARP came for fiscal conservatives and hard liberals. The smart liberals understood that TARP was busting the bank right before the Dems took over the government.

The third and least desireable option beyond raising taxes or cutting spending is to just print money. That is what Obama is doing right now by having the treasury buy its own bonds. I have never been a gold bug. And I have never bought into the predictions of hyper inflation that they have been making for the last 40 years. But, I have never seen the government borrow and spend like this either. The gold bugs are looking a lot less crazy than they did a year ago. That is scary.

[Spoonman]

We look less crazy every day, John.

I'm not so much of a goldbug as a free-market-in-currency-bug, but that's much more of a mouthful.

[Mango Punch]

Avg Contract Rate on 30-yr fixed rate mortgages was 4.81% last week

The steepening of the yield curve was engineered and while it helps banks immensly, it destroys the current worth of the dolar. It essentially fucks over people who have their wealth in cash. That said, it helps anyone who has a debt burden, and since prices (especially housing) are sticky down (and prices must stabilize for markets to normalize) it is faster to have high inflation catch up with prices, rather than weight for prices to fall to where they should be...

[John]

"It essentially fucks over people who have their wealth in cash. That said, it helps anyone who has a debt burden,"

Like say I don't know the government? I am actually starting to think the crazy evil bastard is going to try to inflate his way out of the debt.

[P Brooks]

I still think they just really *are* that stupid.

[R C Dean]

It isn't clear to me why 10-year Treasury yields correlate with 30-year mortgage rates.

Because debt, like anything else, only reflects cost as a floor on price. The LIBOR rate paid by banks to get money to lend is only relevant as a floor: you can't loan money at less than it costs you to get the cash you are loaning.

The rates on long-term debt reflect risk - the risk of default and, wait for it, the risk of inflation. If 10 year rates go up, that reflects inflation risk and, for the first time, the risk that the US will default. Mortgage rates reflect the same risk, so they will move roughly in tandem.

[stubby]

Mango, John, and RC:

quick, before Pro or Epi or any of the others show up and sneer at me for my cluelessness - can someone explain to me - just once more and then I swear I'll understand -- how inflation helps the debtor? Also - doesn't it only help you if you're in debt with a fixed interest rate? Does inflation drive interest rates up? For instance, it doesn't hurt you on your home loan, but can kill you if you have consumer debt?

I keep trying to tell myself that Geithner will pull the plug on liquidity -- I don't understand how he'd do it, but I understand why he should -- before we go into Zimbabwe hyperdrive, but I'm not believing it.

I understand economics a little better than the average librarian. That's like saying George Clooney understands world affairs a little better than the average actor.

[P Brooks]

doesn't it only help you if you're in debt with a fixed interest rate?

Yes. In theory, you're paying off your loan with "cheaper" dollars.

Does inflation drive interest rates up?

Yes. Evil speculators are aware of this effect, and will demand a return which incorporates their expectations of the depreciation of those dollars in the future.

[A. Paul]

While I don't trade in home loans the use of 10-year tresuries to fund them makes sense. The federal funds rate is a measure of overnight borrowing. A home loan has a much longer maturity and is financed by a longer term instrument. While 20-year treasuries exist, they are newer and have a smaller market. Banks don't want to hold the volitioty and cost of backing a Lin term loan with overnight rates

[mark]

I think we are looking at double-digit interest rates in the future, rather than double-digit inflation, but I'm just one observer.

I'm going to block Reason at work (except during lunch hours), I read it way too much. Thank you all for the insight and wit, I value all of your crazy opinions. I'm outie 5000.

[stubby]

Mark: that's what I'm hoping. Hell, I'd be relieved with double digit inflation. It's the triple digit inflation that's freaking me out. Or double digit inflation combined with double digit interest rates.

[P Brooks]

When the economy "recovers" and Bernanke tries to take the punch bowl away, he'll catch Holy Hell from Congress.

[R C Dean]

quick, before Pro or Epi or any of the others show up and sneer at me for my cluelessness - can someone explain to me - just once more and then I swear I'll understand -- how inflation helps the debtor?

Short answer: inflation lets you pay off your debt in cheaper dollars. If inflation goes up to 10%/year, what that really means is that the dollar's value is declining by 10%/year.

Also - doesn't it only help you if you're in debt with a fixed interest rate?

Yes. Floating rates will exceed the perceived rate of inflation.

Does inflation drive interest rates up?

Yes. The lender has to make money in constant, inflation-adjusted dollars, so he will charge a rate that exceeds the expected rate of inflation.

For instance, it doesn't hurt you on your home loan, but can kill you if you have consumer debt?

Yes indeed (assuming your mortgage is fixed, and your credit card company can change your rate, which it can).

[R C Dean]

I keep trying to tell myself that Geithner will pull the plug on liquidity

Won't happen. As soon as he tries to pull liquidity out of this economy, he will kill any kind of recovery that we might be having. Congress will go apeshit (can you still say that?), and Obama will Frown Menacingly in His General Direction.

The kind of liquidity they are pouring into this economy, I can't even imagine how you could get it out in the first place. The traditional method is to raise interest rates, but I don't even see how that would work, even if it could be done politically.

[Tim Cavanaugh]

Agreed on liquidity. These guys are all pro-inflation. Plus, there's still not a lot of evidence of hyperinflation or any other kind of inflation. Food costs are down; real estate continues to fall like Dorothy's house; nobody's buying new cars. The consensus here and everywhere seems to be that big inflation is coming at some point, but facts on the ground are stubborn things.

[Russ 2000]

I'll be concerned when 30-year fixed rates are at 9%.

5.4% is still almost as low as 30-year fixed mortgages have ever been in my lifetime.

[Russ 2000]

It essentially fucks over people who have their wealth in cash.

That's been the US policy since 1933 without exception.

[stubby]

Yeah, but Tim - isn't big inflation inevitable, given that they won't turn off the spout? Won't big inflation and high interst rates wipe out whatever gains the economy's made at that point? And why are Obama and Geithner concerned about that?

[Russ 2000]

The consensus here and everywhere seems to be that big inflation is coming at some point, but facts on the ground are stubborn things.

I keep saying that the inflation-deflation debate is a way to get people to stop thinking about the real issue - purchasing power. Either way, you have less.

[Tim Cavanaugh]

How do you have less purchasing power if the cost of stuff is falling (and you still have a job)?

[Russ 2000]

You hit the nail on the head with your parenthetical. During deflations, unemployment goes up much more than it does during inflations.

[Russ 2000]

Also, still having a job presumes "at the same wage". Deflations usually mean falling wages, too. Minimum wage doesn;t stop people from being laid off - if you make $10 an hour the boss can cut your wage to $7.25 an hour or $0.00 an hour.

[P Brooks]

Inflation doesn't happen all at once; some asset class(es) will begin to absorb that liquidity, before long. Like commodities.

[bondbomber]

Err, the Wednesday auction was for fives. It went well as did the two year on Tuesday because people are comfortable in the short end. The seven year yesterday wasn't terrible. Get your facts right gents.

The real test will be the ten year and thirty year sales the week of June 8. Those may not go well.

[masstexodus]

Most 30 yr mortgages are not paid off in 30 years - they get paid off earlier, hence the coupling between 10yr rates and mortgages.

[Tom Armstrong]

30 year mortgage rates are not derived from t-bill or any other treasury notes. They are directly derived from 30 year Mortgage Backed Securities. Kinda makes sense doesn't it? And while the two bond types (treasury and MBS) generally move in tandem, they can move substantially in opposite directions when there is craziness in the market. And there is no shortage of craziness in the market right now. If you really want to understand mortgage bond market movements, subscribe to the rss feed at http://www.mortgagenewsdaily.com/mortgage_rates/blog/ . They make a very arcane subject fairly approachable.

[eshamus]

Worried O & G might be trying to inflate our way out of debt? You mean like Germany tried?
This book is expensive, hard-copy, but free online, "When Money Dies: The Nightmare of the Weimar Collapse": http://www.mises.org/web/4016
Chief difference, immediately obvious to me: Germany had to physically produce bills to increase money flow; President Obama does not. Such production would necessarily mask the (normally) slowly accumulating evidence of inflation-becoming-hyperinflation... Suddenly striking hyperinflation w/o clear warnings?
Perhaps G & O think they're smart & agile enough to "short" the US market by selling now then rebuying with (cheaper) inflationary dollars. Much like farmers in Weimar Germany paid off their 30-year loans with a week's salary during hyperinflation...