Thursday, August 12, 2010

Mortgage Rates Fall Again

30 year mortgage rates fell to a new all time record low this week at 4.44%.  The following chart shows where rates stand today in a historical perspective:

The best time to purchase a home is when interest rates are high and the money to borrow is expensive.


Because when interest rates fall, homes become affordable to additional buyers.  Additional buyers create additional demand.  An example of this would be in 1982 in the chart above.

The worst time to purchase a home is when they are at all time record low interest rates.


Because when interest rates rise, less buyers can afford the mortgage payments at the current prices.  Prices would then have to fall to make the payments possible.

Interest rates should have begun to rise sharply after 2008, but you can see on the chart the moment the government stepped in and nationalized the mortgage industry.

This has delayed the bottoming process for housing.  Instead of a sharp fall in prices bringing homes back to affordable prices, we now must wait for the government to exit the market.

Then interest rates will rise and home prices will collapse.  At this point real estate will become an excellent buy.

Wednesday, August 11, 2010

Laurence Kotlikoff

Fed Prints - Stocks Plunge

Events are happening rapidly now as we move through the second half of the year.  Some were surprised by the Federal Reserve's announcement yesterday of additional Quantitative Easing (printing money to buy assets), and others were even more surprised by the stock market's reaction: Falling yesterday after the news, and plunging again today after it had time to digest it.

First let's talk about what exactly the Fed did, and then we can focus on the reaction.

For the first time in history the Federal Reserve has now said it plans not on interest rate focus, but on the size of its balance sheet, meaning how many assets they own.  (And how much they print to buy those assets)

Due to its recent purchase of $1.25 trillion in mortgages over the past 18 months, the Federal Reserve now holds a tremendous amount of real estate loans.

When homeowners make payments on these loans, they make payments on both principle and interest.  The principle paid every month reduces the size of the total loan.  (After 30 years the loan is paid off completely)

When the homeowner pays down principle on his mortgage, it simultaneously reduces the size of the assets on the Federal Reserve's balance sheet.

Estimates from Bank of American and Morgan Stanley have come up with estimates of $200 to $340 billion of principle that would have been paid off through 2011.

The Fed's announcement yesterday was that every month, as this principle is paid down, they will print that same amount of money and purchase additional assets. (At this point they have only announced the purchase of government bonds)

They want to keep their balance sheet targeted at $2 trillion.  This can be seen in the chart below in the red line:

The reason stocks sold off on the news is because the market is beginning to understand that lower interest rates are not going to fix the problem the economy currently faces.

The issue with our economy right now is final demand for goods and services.  The American consumer is not willing to either go into debt or purchase goods with cash.

This is due to lack of income growth and severe unemployment.  That is the structural problem we currently face.

In the past when money was force fed into the economy consumers were eager to borrow and spend.  They purchased new homes, televisions, appliances, and cars.  This caused massive optimism and new hiring in the small business world, which thus reinforced the growth.

It is obvious, however, that this economic model is unsustainable.  The credit bubble that was created by artificially injecting free money into the economy over the previous 20 years blew up in the fall of 2008 and has not been restored.

We now find ourselves in uncharted territory.  The economy desperately wants to heal itself with a recession and paying down debt, and our leaders desperately want to force feed additional debt and printed money into the system.

Ultimately it will be an unstoppable force colliding with an immovable object and the outcome I fear will be terrifying.

Monday, August 9, 2010

Japan: America's Lost Decade

Good video helping explain the debate on whether the United States is about to enter a decade long Japanese style deflation.

The Largest Bubble In History

Over the past 13 weeks retail investors (401ks and IRA's) have pulled their money from stock market mutual funds and piled into bond funds.

This comes at a time when bond prices are more expensive than any time in history, and we are seeing a record supply of new bonds coming onto the market via Federal Government deficits.  A bubble can be spotted if it contains three common characteristics:

1. Record Prices
2. Record Supply
3. Public rushing in

The following graph shows the inflow of retail (the public) money into stocks during the last two years of the greatest stock market bubble in history: 1998-2000.

The right side of the graph shows the money retail investors have moved into bonds and out of stocks over the past two years. 2008-Present.  The size of the bubble has now surpassed the stock market bubble, which is staggering.

While bubbles are easy to spot, it is far more difficult to know when they will pop.  Many times they burst without a specific catalyst such as the stock market peak in March of 2000, or the real estate top in February of 2006.