In recent years, both short and long term interest rates have plunged to near, or at, all-time record lows, partly due to the manipulation of the U.S. Bond Market. Since the Credit Crisis (www.thecreditcrisis.net) officially began back in the Summer of 2007, asset prices have both crashed and boomed over the past six (6) years because of, or in spite of, the sluggish U.S. economy.
For U.S. economists, financial analysts, investors, bankers and Central Bankers, one of the biggest fears since 2007 or 2008 was that the USA may end up somewhat like Japan back in the 1990s, when their stock, bond, and real estate “bubbles” all popped. Sadly for the Japanese, the past few decades have been very asset deflationary as asset values have plummeted to values at a fraction of the market peaks in the late ‘80s or early ‘90s, in spite of their incredibly low interest rate policies, which were somewhat akin to the USA’s ongoing “Quantitative Easing” policies.
Asset Values may either Rise, Fall, or be Stagnant
From various regional market peaks across the USA, many homes or commercial properties reached their all-time market value highs anywhere between 2006 and 2008, depending upon their region. After “Stated Income”, “100% Loans”, “EZ or No Doc Loans”, and very low adjustable rate mortgage loans (starting rates beginning in the 1% range) started to disappear following the start of the Credit Crisis, then home values began to drastically fall in value.
From my perspective, the number #1 reason why home values either rise or fall, is related to the ease and availability of capital or loans to either help one buy or sell their homes. When money is “easy” and more readily accessible, then there are typically more buyers for real estate. An increased demand for a home or any other type of asset or consumer goods product typically leads to an increase in prices. Conversely, a decreased demand for an asset class or a consumer goods product historically has led to a decreased value or sales price for this same asset or product.
When too little money chases too few goods, then asset prices may begin to fall across the board regionally, nationally, or world-wide. Additionally, when access to capital begins to get more challenging by way of higher interest rates, tougher underwriting guidelines, fewer liquid or solvent equity investors or lenders, and / or more difficult regional, state, or national regulations, then home prices tend to fall as we have seen during several different “Boom and Bust” housing cycles over the past few decades.
QE to the “Rescue”?
Over the past few years, our financial and governmental leaders have attempted a wide variety of alleged “bailouts” in order to better stimulate the financial and housing markets. QE (or “Quantitative Easing”), once again, may be effectively akin to “creating money out of thin air in order to buy up more stocks, bonds, mortgages, and other assets.” Prime examples of the impact of QE policies in recent years, for better or worse, include the 15,000+ Dow Jones index values as well as annual home price value increases of double digits over the past year or two in various regions nationally (i.e., Las Vegas, Phoenix, Los Angeles, etc.)
The downside of QE policies has been related to rampant inflation for consumer goods like food and gasoline. When our financial leaders flood the markets with trillions of dollars each year, then the overall value of the U.S. Dollar may rapidly decline. Many nations around the world have been so concerned about the USA’s inflationary QE policies that they have begun to use other forms of currency besides the U.S. Dollar. This decreased demand for the Dollar from abroad has led, in turn, to even further falling Dollar values.
QE and the Stock and Bond Markets
Shortly after Federal Reserve Chairman made public statements on May 22nd that the Fed may begin “tapering” (or reducing) their QE methods in the near term, then U.S. stock prices plunged and bond prices increased quite a bit due to investor concerns. Since many investors know and understand how important QE policies have been to increased stock and real estate prices in recent years, then their same investor concerns adversely impacted stock and bond values in the short term.
Fed Chairman Bernanke also made similar “tapering” statements about potentially easing up QE policies, or buying fewer assets like stocks, bonds, and mortgages, on June 19th and on July 10th. Yet, the financial markets strengthened, strangely, after the July 10th comments at an economic conference, and the Dow Jones sits near all-time record highs once again on the day that I am writing this article (mid-July 2013).
In the 2nd quarter of this year, the $5 trillion dollar U.S. bond market dropped about 2% partly related to Chairman Bernanke’s “tapering” comments. This was the worst bond market drop since the “Bond Market Massacre” back in 1994 after the Fed shockingly raised short term rates a number of times back when interest rates were near thirty (30) year lows at the time.
The worsening bond prices then, in turn, led to higher 10 year Treasury Yields. Thirty (30) year mortgage rates are tied to the directions of the 10 Year Treasury Yields, so mortgage rates began to increase rapidly in recent months. In fact, mortgage rates spiked the most in a two (2) month time span than ever before.
Additionally, thirty (30) year fixed mortgage rates increased to their highest levels or rates since July 2011. While today’s interest rates are still near historically low levels, the 30 year fixed mortgage rate recently increased from a national average of 3.93% to 4.46% within the span of just one (1) week. According to a Freddie Mac report, this was the largest one (1) week increase since as far back as 1987.
Mortgage Rate Directions & the Housing Market
Not every home buyer or investor over the past few years has been an all cash buyer (individual or institutional). A very high percentage of home buyers have been owner occupied buyers in need of highly leveraged FHA loans (96%+ LTVs). The thirty (30) year fixed mortgage rate has increased as much as 40% from their near record low rates at 3.25% over the past twelve (12) months which, in turn, has led to higher FHA, and other loan types, costs.
The Fed may still be purchasing upwards of $85 billion of mortgage backed securities and Treasury Bonds each and every single month. Without their same consistent level of capital investments, then bond and rate yields may only worsen. Is a 5% thirty (30) year fixed mortgage rate more likely prior to the end of 2013 as suggested by some economists and financial analysts? Or, will we possibly reach 6% to 7% mortgage rates which have been more common in recent decades?
Regardless, increased mortgage rates make it more challenging for buyers to qualify. If a potential client may qualify for a $400,000 mortgage loan at a 3.25% interest rate, then that same borrower may only qualify for a new mortgage $100,000 less if the future interest rates hit closer to 5%. With fewer mortgage borrowers able to qualify for larger loan amounts due to higher mortgage rates, then home price appreciation levels may begin to “taper” off, ironically.
As compared with past financial time periods such as the early 1980s when the U.S. Prime Rate hit as high as 21.5%, today’s mortgage rates are still incredibly cheap. Banks need to ease up somewhat on their underwriting guidelines as well, so that more borrowers may qualify for more loans. When the capital markets ease up more and more hopefully, then we may see more stability in the financial and real estate markets.
A more solid U.S. Economy is needed more than another “bailout”
The American economy needs to strengthen more without magical and mythical “bailout” programs which seem to increase the U.S. debt numbers, weaken the U.S. Dollar, and cause rapidly increasing inflation numbers which hurts gasoline, food, and other consumer goods prices while helping certain asset classes like real estate in both the short and / or long term.
If the national job market numbers improve more in the near term, then the potential tapering of QE money may not adversely impact our economy as badly as some economists perceive. Yet, stock, bond, and real estate prices continue to improve fairly consistently in 2013 in spite of a sluggish job market and economy.
One of the main questions to ask ourselves related to this same “QE and Asset Prices” topic may be as follows: “How long will the boom in asset prices continue to last?” Only time will tell. Since my “Crystal Ball” continues to be in the shop, I will not even venture to guess the answer partly since there is no historical time precedent to compare with here in the USA, as we have never relied so heavily on these glorified forms of “bailouts” to better stimulate our financial markets.
Author: Rick Tobin
Rick Tobin has a diversified background in both the Real Estate and Securities fields for the past 25+ years. He has held seven (7) different Real Estate and Securities brokerage licenses to date.
Rick has an extensive background in the financing of residential and commercial properties around the U.S with debt, equity, and mezzanine money. His funding sources have included banks, life insurance companies, REITs (Real Estate Investment Trusts), Equity Funds, and foreign money sources.
You can visit Rick Tobin at RealLoans.com.