The Fed – Walnut Creek Lifestyle

The Big Question – Rates?

My friends at JVM Lending wrote an interesting blog recently, and I wanted to share a summary, plus my input on the topic: “why the Fed can probably never raise interest rates.” Read on:

The Fed Funds Rate is a rate that banks charge each other to borrow “reserves” overnight, which is currently at 0-0.25%. Paul Volcker was a Fed Chairman in the late 1970s and early 1980s who sent the U.S. into a massive recession by raising the Fed Funds Rate to 20%.

The result of Volcker’s actions were a horrible recession, a crashed economy, and 11% unemployment. To recover, it took enormous political will – the likes of which we are in short supply of nowadays (for many reasons).

Last week, the Fed talked about the possibility of raising rates almost two years from now. Stocks tanked and interest rates shot up. Markets reacted negatively because even the mere mention of higher rates down the road causes a reaction. Investors know that our economy can’t afford higher rates.

Here’s the thing: the Fed likely can’t afford to raise the rates. Our total federal debt is about $28 trillion and growing, while State and Municipal debt is approaching $4 trillion. The interest paid by the federal government for its debt this year will be just under $400 billion, with government debt rates around 2%.

So, if rates returned to even 1990s levels (6-8%), interest owed would triple or quadruple and quickly bankrupt the government. Even more concerning, potentially, is corporate debt. There is $11 trillion in corporate debt in the U.S. and many of those corporations could not begin to service their debt if rates went up. They depend entirely upon cheap capital and bailouts.

In terms of real estate, existing mortgages do not depend on low rates. They are long-term and fixed. However, housing itself represents a huge chunk (almost 18%) of the economy, and that sector is now dependent on super-low rates, too. Basically, the entire economy is addicted to low rates and the Fed knows it.

Several pundits expect the Fed to find excuses as to why 2023 is not a good time to raise rates and kick the can down the road yet again. So, we will either see a continuation of a Japan-like situation for a very long time with continued low rates, slow growth, and massive government intervention…or inflation will set in and the Fed will lose control of rates, as investors simply demand higher yields.

Either way, I would not expect the Fed to actually raise rates itself in 2023.

KRISTIN’S TAKE: Nobody has a crystal ball, and if rates do start to edge up, it would take some time for them to get into the 5%+ range. We are also seeing a bit of a reprieve on the buying frenzy. More houses are having price reductions, not as many multiple offers, etc. I am just not sure if it is because everyone hit vacation mode, but if you’re a buyer who got priced out earlier this year, it might be time to start looking again.

Fed Rate Cuts Don’t Mean Mortgage Rate Cuts!

NOTE: We will be moving to one post a week (on Wednesday’s) until further notice since we are under lockdown here in Contra Costa County and I can’t go out and explore!

My friend Jay Vorhees at JVM Lending has an interesting take on the latest interest rate cuts by the Fed. Even since he’s written this, the Fed has made yet another cut (because of the government’s response to coronavirus killing the stock market in addition to the Saudi’s dropping the barrel prices), so I’ll try my best to tie the two together at the bottom and make sense of all this:

We were asked a variance of this question over and over yesterday: “I heard that the Fed cut the rate by 1/2 percent; can I lower my mortgage rate by 1/2 percent?” We would respond by explaining that the “Fed Funds Rate” often does not correlate to mortgage rates for a variety of reasons. I touch on this often because the confusion surfaces every time the Fed cuts rates.

When the Fed makes a rate cut, it is to the short-term “Fed Funds Rate,” which does not always impact long-term mortgage rates in the way that most consumers might expect. I blogged about this as recently as August, but here is a brief summary of why mortgage rates not only don’t always correlate to Fed rate cuts, but often go up after the Fed cuts rates:

The “markets” anticipated the rate cut and already adjusted for it. Traders and investors analyze polls, data, and Fed comments to very effectively anticipate changes and the Fed Funds Rate and the markets often adjust long before the rate cuts take place. As a result, very little happens when the Fed Funds Rate is actually cut (or increased).

Short-term rates don’t always affect long-term rates. The Fed is only reducing the Fed Funds Rate, or the rate banks charge each other for overnight loans. This is a very short-term rate and short-term rates don’t always affect long-term (mortgage) rates.

Many factors influence long-term rates besides the Fed, and below are just a few. These factors include economic data; inflation signals; geopolitical crises; and the demand for mortgage bonds. SO WHAT DID RATES DO AFTER THE FED CUT RATES? Rates were about the same after the rate cut as they were the day before.

One day later – in a shocking and surprise weekend move, the Fed cut the Fed Funds Rate to 0% on Monday. See above as to why it might not move mortgage rates. But, the Fed also committed to $500 billion of treasury bond purchases and $200 billion of mortgage-backed security purchases.

This renewed “Quantitative Easing” did push rates down slightly but that didn’t last, as the market is all over the place yesterday and probably today and extremely volatile.

MORTGAGE RATES BARELY MOVE; CAPACITY ISSUES

Despite the massive Fed intervention, mortgage rates barely moved. The reason is capacity.

There are $11 trillion in outstanding mortgages – give or take. The industry is capable of funding about $2 to $3 trillion per year – at most.

When borrowers with $5 trillion worth of mortgages want to refinance over the course of a few months, the industry simply can’t handle the volume.

And – as a result, rates remain on the higher side and are still over 1/2 a percent higher than where they were 10 days ago. The Feds’ rate cut is actually getting a lot of criticism because it will do so little to stimulate economic activity (travel, major events, supply chain issues) offset by the coronavirus concerns. It also leaves the Fed nowhere to go if things get worse. We are in uncharted waters; welcome to the new normal. At the end of the day when this settles, rates will still be low and we may see a listing and buying spree due to the sheltering in place.

Stay safe and healthy my friends!

The Fed lost control over interest rates – so now what?

My friend Jay Vorhees of JVM Lending had a great blog recently about The Fed and interest rates. Here is the article below, with my two cents included:

Rates are at an eight-month low right now – about 1/2 percent lower than they were at their peak in October. I should add though that they still remain about 1/2 percent higher than they were last year at this time. So, did the Fed finally achieve its stated goal of pushing up rates?

Not in the way anybody expected.

According to former Senate Banking Committee Chairman Phil Gramm, the Fed now has less control over interest rates than at any other time in its 105-year history. I won’t go into all the details, but it has to do with its massive bond holdings (almost $4 trillion) and the excess reserves in the banking system. You can read more about it here.

The Fed can influence rates in the short term with its actual policies and statements, but the markets now seem to have much more say in the matter than the Fed. We are watching this currently, as the Fed’s short-term rate increases are not resulting in long-term rate increases like we have seen in the past.

What this means is a repeat of what I have been saying repeatedly over the last several years – nobody really has any idea of what will happen with rates (or anything else for that matter – remember Mr. Trump’s election?). A slowing world economy could continue to bring rates down, or a resurgence in bank lending (according to the article referenced above) could spark an inflationary spiral that will send rates through the roof.

Suffice it to say that we will see a lot more volatility in both the stock and bond markets for a long time to come. What is really scary though is what will happen when everyone figures out that there is no way that the world can ever pay back the $250 trillion in worldwide debt that has built up over the last ten years. When that happens, today’s environment will seem like very calm sailing.

Lastly – despite the uncertainty, many pundits are now predicting low (and even declining) rates throughout 2019.

Great stuff from Jay, right? So, here are my thoughts: The Fed came up with four rate hikes last year, and now the mortgage rates are lower than expected as stock market sways are leading people to bonds. What that means for the real estate market, especially locally is that more buyers maybe taking advantage of getting in now. I am starting to see the market pick back up, but this year it didn’t happen on January 3rd, didn’t really see it until the weekend after January 7th when the kids returned to school from their holiday break. January has been interesting the last few years, as buyers have been out, but sellers want to wait until March and they often loose that burst of lots of buyers and no inventory. At any rate, nobody has a crystal ball and I believe we will be on a wild ride as the stock market will have more volatility (as it is suppose to).

Why bank statements are so important!

Our friend Jay Vorhees at JVM Lending has shared another important blog recently: why bank statements are so important for borrowing and financing for a home. You’ll want to read on to see what Jay says, especially if you’re in the market for a new home. You’ll find a copy of the (slightly re-formatted) blog copied below:

STRONG BORROWER DENIED FINANCING – WHY?

We once had a borrower who qualified for financing in every way (income, assets, credit, etc.) but she was denied financing. The reason? She had five unexplainable overdraft charges on her bank statements that indicated she could not manage cash.

Every borrower has to provide bank statements for every account used for “cash to close” (down payment and closing costs). There are no exceptions because lenders have to ensure that down payment funds were not recently borrowed or obtained through illicit means.

“Borrowed” down payment funds are not considered “seasoned” and they create debt ratio issues b/c they need to be paid back. In any case, lenders are required to go through every bank statement with a fine-toothed comb to look for every irregularity. Irregularities include overdraft charges, unusually large deposits, and unexplained regular monthly deposits or withdrawals, among other things.

Unusually large deposits have to be paper-trailed and explained or they are assumed to be borrowed funds (and they can’t be used for a down payment/closing costs funds). And unexplained regular monthly deposits and withdrawals often indicate the existence of undisclosed side businesses, support payments or other liabilities.

In any case, borrowers often get frustrated when we ask them to explain so many things that are buried in their bank statements. But, we have to ask because bank statements tell lenders so much more than meets the eye.

This is, in fact, often one of the most time-consuming aspects of the loan approval process.

On a related note, Jay discusses something at the footnote of this blog: rates have climbed recently after a stretch of stability. President Trump’s comments about the Fed raising rates too quickly were the primary cause, but, according to the Wall Street Journal, the Fed may now be more likely to raise rates than it was prior to the President’s comments. This is because it will want to prove its independence from political pressure. How ironic!

What can bring down house prices and rates?

What could bring house prices and rates down? According to my friend Jay Vorhees at JVM Lending, it could be something called “monetary tightening,” or an experiment conducted by The Fed to infuse the economy with cash. Basically, what Jay is getting at, is that you’ll never know exactly when to buy or sell (or when a market dictates that decision), and that assuming you know the market intimately trying to time the market may be a mistake. Read on for more from our slightly-edited version of Jay’s blog:

Dude Sells Too Soon!

I was at a graduation party yesterday and the host told me how his law partner sold his Silicon Valley home two years ago because he was convinced the market had peaked.

It hadn’t. The poor guy’s former home has gone up another 20% since he sold, and so has his rent. The host made the further point that people should never try to time a market they are not intimately familiar with.

I like to remind everyone that nobody should ever try to time a market, no matter how much they know, because there are so many variables they have no control over – especially when those variables involve the Fed.

Elephant in Room: Monetary Tightening

There is a huge elephant in the room that nobody is talking about: Massive Monetary Tightening via Higher Rates and Quantitative Tightening.

After the meltdown, the Fed engaged in a massive experiment known as Quantitative Easing, where the Fed bought trillions of dollars of government bonds and mortgage-backed securities. These bond purchases increased the money supply by flooding financial institutions with cash in an effort to increase lending and liquidity. The Fed also lowered the rates to unprecedently low levels.

The low rates and huge capital infusion pushed up asset prices, particularly with respect to stocks, bonds and real estate. This is what usually happens when the Fed increases the money supply, and this is partially why we see such high asset prices now. Many people believe high prices are just a function of too much demand chasing too little supply, but that is not always the case.

Excess demand is often driven by excess capital in an economy; people want to park their capital somewhere, as opposed to letting it sit in bank accounts, so they buy assets. In any case, the Fed created about $4 trillion of new money up through 2016, and in 2017 they reversed the policy! They are now not only pushing up rates but also selling bonds with the intention of vacuuming about $2 trillion out of the economy.

This will likely have an adverse effect on asset and housing prices at some point. Do I think real estate prices will tank? No. I still like real estate because the fundamentals are so strong in many areas. But, I don’t think we’ll continue to see such strong appreciation, and now might be a good time for Silicon Valley lawyers to sell their homes.

Fed Could Reverse Again

Nobody is more aware of this than the Fed, and they are watching closely. If Fed policymakers see the economy showing excessive signs of softening, they could very likely change course again – and lower rates. Again, nobody knows what will happen because we have never seen anything like this before! We are in the midst of one giant experiment, and we all get to be the lab rats.

Why rates went down after 4th Fed increase?

My friend Jay Vorhees at JVM Lending wrote another interesting end-of-year blog recently, regarding rates. Despite the Fed increasing rates for the 4th time in 2017, they are still down. Why is that, and how does it affect you?

In Jay’s blog, he notes that 30-year fixed rates have fallen 1/4 percent over the last year even though the Fed has done four increases. On that note, he asks why the Fed’s rate increases don’t push up mortgage rates?

In response, Jay gives two main reasons:

Short-term rates don’t always affect long-term rates
Many factors (besides the Fed) influence rates

Inflation, geopolitical strife, economic news and demand for credit and bank loans are the other main factors named by Jay. Most of those are very relevant in today’s societal and political climate. Basically, the Fed helps influence rates, but isn’t the sole influencer – if investors are pushed out of stocks or bonds into the other, due to war, a poor week on the stock market, etc., rates will change just as rapidly.

So, what does this mean for you? Rates are going to continue to fluctuate. They are still low, so if you are considering buying, it might be a good time to get off the fence and make a move in 2018!

How rate increases affect your payments

We’ve seen rates increase since Donald Trump won the election. Now, the Fed is saying they’ll do three rate hikes instead of the expected two in 2017. This caused rates to bump up about half a percent. What do interest rate increases mean in regards to a buyer’s payment and the overall market?

According to The Wall Street Journal, if we adjust for inflation since 2006, housing prices are actually 16 percent below their 2006 peaks in most areas. Many economists are saying the demand for housing remains as strong as ever and that recent rate increases will have a minimal effect.

However, people usually make home purchases based on payment. So as interest rates increase, somebody thinking of purchasing should know a 1/2 percent increase in rates for a $500,000 loan, increases the payment about $140-$150 (and even less after “tax benefits”).

Should buyers and borrowers wait to see if rates fall before moving forward with transactions? Jay Voorhees of JVM Lending says absolutely not. Borrowers can easily take advantage of no-cost refi’s if rates fall.

And, as Gary Shilling wrote in a Forbes column on Dec. 6, he thinks the markets massively overreacted to Trump’s election. He points out that the root causes of weak economic growth (that have kept rates low) will remain. He also says that Trump’s proposed tax cuts and stimulus programs will be watered down by Congress; the expectations of an economic boom are overblown.

What do you believe? Are you bullish or bearish? This election reinforced the notion that nobody has a crystal ball and sitting on the fence waiting for one outcome or another may be the worst thing you can do.