Is the low interest rate environment causing a different kind of housing bubble? The tracking of the Effective Federal Funds Rate and 30-Year Conventional Mortgage.
Lower interest rates create added purchasing power. The lower the rate, the lower the monthly payment and the higher a home price people can afford. The math is fairly simple here. During the Wild West days of the mortgage market, teaser rates and other odd mortgages essentially provided the illusion of a low rate initially. That went away and the market contracted. What these loans also provided was easy access to low down payment options. Today that segment of the market is made up by FHA insured loans although these are expensive when you factor mortgage insurance premiums rising to make up for growing defaults. The Fed has essentially been a witness standing by when the first bubble hit and also, a pusher for the housing market as it is today by outright mortgage backed security purchases via the QE machinery. It is interesting to track the data over the last decade because you can see that the Fed is fully focused on the housing market. Is this low rate environment causing another housing bubble but of a different variety?
Fed Funds and 30-Year Mortgage Rates
There is a bit of story to the below chart. If we go back to the late 1990s and the early 2000s, the Fed pushed the Fed Funds rate to record low levels to combat the deflating and bursting technology bubble. But starting in 2005 the Fed realized real estate values were getting out of hand and the market was overheating (never publicly stating this of course). So they pushed rates back up but at that point the housing bubble momentum was already in full force. After the pop in 2007, it is interesting to see that the Fed pushed rates even lower than the previous cycle but also, went into other more aggressive measures by increasing their balance sheet to well over $3 trillion:
I think the chart tells two big stories here:
-1. The first 2000s housing bubble was largely led by the low rates and lax enforcement of crazy mortgages in the private market (i.e., subprime, option ARMs, Alt-A, etc). With all good bubbles, greed from every corner also added fuel to the flame.
-2. The recent move in home prices is definitely coming from the low rate environment caused by the Fed and the impact it is having on the 30-year fixed rate market. What is also causing this mania is the record low inventory on the market. Moratoriums and banks moving like molasses on foreclosures has caused a modern day purgatory for the housing market (works for their bottom line).
I think the second point is fascinating. If you look at the chart, the 30-year fixed rate mortgage stayed relatively stable throughout the first housing bubble. Even with the Fed funds rate going from 1 percent in 2004 to over 5 percent in 2007 the 30-year fixed rate mortgage stayed around 6 percent. The reason for this is that other products were leading the charge when it came to purchasing homes and 6 percent with bubble prices simply did not work.
Today, the big push in home prices is coming from the drop in interest rates from 6 percent to close to around 3.5 percent. This large push makes a big difference. Take a look at a scenario for a $500,000 home:
This is an important point here. A drop from 6 percent to 3.5 percent lowered the principal and interest payment by 25 percent. This is a big deal considering housing is the biggest monthly expense for most Americans. What is fascinating above though is look at how much more home a person can buy when rates drop. At 6 percent, a $500,000 loan will carry the same principal and interest payment as a 3.5 percent mortgage with a balance of $667,500 (a price increase of 33 percent).
What is interesting is that home prices in the US are still down by 26 percent yet home buyers today with a 30-year fixed rate mortgage have been given essentially 30 percent more leverage on the principal and interest side. Yet the issue with this kind of aggressive low rate approach is the Fed has caused banks to look elsewhere for higher yields. It also conditions a market to low rates. As we know for the last few years, investors have had a ferocious appetite when it comes to investment properties.
In California, roughly 30 percent of all purchases for the last few years have come from all-cash and investor buyers. That is incredibly high when historically this figure is closer to 10 percent. Not only is that the case, but you also had FHA insured buyers making up another 20 to 25 percent of all purchases. So you have the investor class coming in with all-cash and those barely scraping by for a down payment making up over half the market.
Is this a bubble? There is an interesting definition of this at Investopedia:
“Bubbles form in economies, securities, stock markets and business sectors because of a change in the way players conduct business. This can be a real change, as occurred in the bubble economy of Japan in the 1980s when banks were partially deregulated, or a paradigm shift, as happened during the dotcom boom in the late ’90s and early 2000s. During the boom people bought tech stocks at high prices, believing they could sell them at a higher price until confidence was lost and a large market correction, or crash, occurs. Bubbles in equities markets and economies cause resources to be transferred to areas of rapid growth. At the end of a bubble, resources are moved again, causing prices to deflate. Thus, there is little long-term return on those assets.â€
I think the bolded section is important to recognize here. What has occurred with this market is the Fed has shifted the financial sectors attention from lending to Americans or searching for more useful investment options to driving hot money into a market that is now raging up while overall household incomes are not improving in a way to match the massive jump in home prices. Plus, there is no historical evidence to show what the consequences will be of a Fed that is carrying a balance sheet of well over $3 trillion and is buying billions of dollars in MBS each month to keep the market at the current level.
What is certain is a large amount of money is now flooding into the housing market from investors and the yields they are chasing are not impressive. Many large investors are now pulling away. We are seeing aggressive flips in California once again and bidding wars are now going into their second year.
Look at a place like Pasadena that region wide has seen home prices increase by over 15 percent in one year and are now at multi-year highs:
What is interesting is rents are not necessarily keeping up:
Once again the CPI index will miss the inflation in the housing market since it tracks the owners’ equivalent of rent. Is this a bubble? Probably but a very different kind of one with big Wall Street money competing with local buyers stretching every last dollar they have to make that monthly payment on that Fed induced lower interest rate and a market so constrained on supply that investors are crowding into open houses like lemmings inching closer to the cliff.
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53 Responses to “Is the low interest rate environment causing a different kind of housing bubble? The tracking of the Effective Federal Funds Rate and 30-Year Conventional Mortgage.”
So Doc…what would cause interest rates to go back up? Will they stay perpetually low?
Why can’t people see this what’s in plain sight? The bubble has popped. Interest rates have skyrocketed in the past 30 days despite the Fed’s on-going MBS binge The move has already happened. We’ve seen the lows for mortgage rates. Rates will only trend up from here.
Looks like rates are starting to edge up now:
Home Loan Rates Near 4% Send Buyers Scurrying: Mortgages
http://www.bloomberg.com/news/2013-06-06/home-loan-rates-near-4-send-buyers-scurrying-mortgages.html
The great USA is now exponentially growing her debt by trillions every day.
There is no way Fed can raise rate, because a few basis point will cause problems for the gov’t to finance the debt!
There will be no way for gov’t to stop spending like drunkard. Both gop and dem will do the same and just keep raising the debt ceiling.
We are near the end game when something blows up or the great bond bull market is over and pop.
Fed will keep on printing until the end and finally there will be a war as usual
When the interest rates go up, home prices will go down, as it always had, economics 101. Therefore, we have a real estate bubble now because we know that next year when the interest rates go up, home prices will go down, below what you pay form them now, during the bubble. Hold fast, don’t buy now. Also the stock market will go down as will. Pimco says to go to cash now. Risk off.
Be careful, Uncle B. Some folks on here would state that the Fed will keep rates low for a long time to come as if a) they have a crystal ball and b) the Fed operates in a vacuum, omnipotent to all global and macro movements outside of their purview.
My gut tells me that the Fed has been running from fire to fire and has been a day late and a dollar short on each. Either that or they are the best mind-benders the world has even known. Or maybe both.
At the end of the day, all you can rely on is what makes common sense. Flipper shacks in ghetto neighborhoods of LA selling at $300 K and above prices in today’s dollars doesn’t make sense.
@Uncle Ben wrote: “When the interest rates go up, home prices will go down…”
This is 100% correct.
I find it perplexing when people say “when interest rates go down it’s a great time to buy”. When interest rates go down, selling prices go up, but the monthly mortgage payment does not change.
There is a very brief window when interest rates go down where there may be a bargain to be had but wait long enough and the selling prices move up as does the monthly payment back to the levels before. This process is called “normalization”. Many realtors, journalists and real estate pundits are oblivious to this concept.
There is also a brief window when interest rates go up where homes become more difficult to buy. But what happens is when interest rates go up home selling prices will eventually come down so that the monthly payment normalizes back to the previous payment level.
Real estate prices work just like bond prices. The selling prices and interest rates of both items move in opposite directions.
Like you said, basic Economics 101.
It is a shame folks have to buy in this housing environment. I bought when interest rates were high and houses were ‘cheap’ in the mid 80’s. $200k for the upscale houses in so cal with 14% interest rates. Rates had nowhere to go but down and as a result, housing prices had nowhere to go but up. Over the years, you could always refi to lower mortgage rates as your house went up in value. Those were the days. None of that is possible today. Higher mortgage rates or lower housing values, a homeowner today is screwed.
http://www.smallworks.ca/index.html
101 cont. – when the prices of homes get too fr*%cking crazy, niche builders start making smaller homes. The link goes to a Vancouver builder’s site.
Or, further, go to youtube and type ‘tiny home’ in the search field and you will see folks downsizing their living arrangements to 500, 400, 300, 100 square feet, etc.
Expect the interest rates to go up and down in waves. Fed is working in cycles to systematically soften the blow to its member banks and large investment entities from the major losses resulting from the real estate / financial bust.
Most people here believe in a black and white view of fundamentals and economics, but it’s not so much that they are necessarily wrong, but Fed/market manipulation has broken down the black and white into tiny pixels, and made it look gray. The Fed will play the push/pull game until the banks are somewhat clear of all that inventory (and barring any other debt issues from over-leveraging). This will result in small boom/bust cycles, but overall stagnant home prices. If you want to own a home, wait till the next trough, but don’t wait forever thinking this will end soon. It won’t.
ed, ur comment is the smartest one I’ve seen so far. Right on the spot man!
I agree. Buy what you can afford in the next lull, to assume that this game will ever be fair for the middle class is delusional. I got a great deal toward the end of 2012 (except for my sky high property taxes) and I am an amateur at this, it’s important not to over think things while also considering your own mortality. What do you want now and what are you willing to pay for it? You could drop dead tomorrow.
Who is assuming the playing field will ever be fair for anyone? I haven’t noticed any statements to that point on this blog or its comments forum. That said, raising the issue of an unlevel playing field is part of the rebalancing process.
“What do you want now and what are you willing to pay for it? You could drop dead tomorrow.”
That doesn’t make good sense. The likelihood of dropping dead tomorrow is less than being around for a while to come. Patience and prudence pays off over the long term.
Yeah, take out a 30-year loan in a crumbling job market with the fundamentals of the economy in the toilet, just because you want a future that doesn’t even exist… That is the American way, all right, ignore reality, and just do whatever makes you feel good in the moment. The longer this delusion goes on, the worse things get, but no one ever stops… Turn off your mind, relax, and float downstream…
Has it occurred to you that throughout much of history there was a thing called a debtors’ prison, and that it could happen again? Do you have any idea how unstable and wicked the world governments of today are? Money has never been free and never will be free despite the jiggery-pokery of recent decades. The chickens WILL come home to roost, one way or another.
Ditto
http://seekingalpha.com/article/1479281-yields-of-10-market-insanity-leads-to-huge-opportunity
treasury spikes from the last few years. (see first chart)
Hang on guys interest have already started going up. All it takes is the bond market expecting the fed to taper off its MBS purchases. Rates have risen from 3.3% to 3.8% in the last month. This is only a taste of what will happen to mortgage rates once this all comes to an end. Not sure when this will happen, but it cannot go on forever.
@gte343z, the average 30 year mortgage rate finished at 4.2% today. The 30 year has gone up 90 basis points, i.e. added 0.9%, in about a month. This is why mortgage loan applications have plunged in the last week.
This is a bubble deflator as the summer months are historically the busiest for home sales. If the 30 year mortgage rate gets to 5% by early July you will hear the NAR and many real estate agents crying in their beer.
They already are, I know several lenders whom have halved their staffs, the Mortgage refinance numbers this weekl will be abysmal, next month worse….the fed with low rates is actually killing any hope for forward movement in the economy, they have caused a great schism of yield seeking to wind itself into a tight ball, a bear flag…it will end bad…1.5 years I give it and SHTF…
If you have a chance read the Federal Reserve’s Advisory Board meeting minutes from May 17th. Pretty insightful information on how they view the economy and housing especially.
http://www.federalreserve.gov/aboutthefed/fac-20130517.pdf
Oh boy. The part about FHA having to be the lender for regular homeowners was enlightening. I mean it all makes sense that banks aren’t lending and the market is being investment driven. It is scary in the sense to know that lots of property will be owned by funds, instead of people who want to live there or even small investors who want a rental or two.
That was already the case with mortgage backed securities many years ago…
What is up with the chart on page 8 of the pdf? It is so NOT what I would have expected.
Some of the big boys agree with DHB:
http://www.marketwatch.com/story/doomsday-poll-87-risk-of-stock-crash-by-year-end-2013-06-05
Page 2 is especially telling.
I really like Paul Farrell’s articles. Been following them for awhile now.
Usually I comment here to throw some cold water on our bubble-popping boosterism. We all want prices to go back down, but I think our desire tends to color our predictions a bit too much and leads us err in our estimates of short to medium term price moves.
That said, this time I’m just here to vent.
I’ve been watching prices in Moorpark, CA for about 10 years now. During the height of the bubble it seemed that many of the most excessively priced monstrosities were shilled by a particular realtor. In one of life’s rare instances of fair play this guy dropped off the face of the earth and I hadn’t seen his name darken the listings since about 2008. Now as prices zoom back to 2005-2006 levels, the stake appears to have worked its way out of his heart and he’s crawled back from the crypt to hype properties at $150K more than comps of a year ago.
Even though I knew I’d missed the market bottom I’d continued to look for opportunities in this area. With bubble era realtor shills crawling out from under their rocks to convince every prospective seller to pump asking prices to the stratosphere, though, it’s just game over. I’m out until bubble 2.0 (or is it 3.0?) pops.
Heck yeah – the realtors have blood on their hands. I wonder how many of ’em took all that extra cash they made scamming 2005-06, and dumped it in the equities markets during the crash?
‘Used house salesmen’ has a bit classier ring to it.
Rates rising fast:
http://money.cnn.com/2013/06/06/real_estate/mortgage-rates/index.html
Pass the butter for the popcorn, this is getting interesting.
I am a SCAL native and just entered into a “contract” for a small farm in the Roanoke VA area. Monday I got a Wells Fargo offer on a 300k loan for 2.75 7/1 Arm or 4.0 on 30 yr fixed. We took the 2.75 as we are planning to sell our SCAL home within that time frame.
With regards to a bubble, it is Money and Banking 100 that people should be looking at. When we have a stable economy — and there is a aggregated demand shock, w/o any change in Fed Policy, you would expect interest rates to rise. What we need right now is a demand shock to the economy to get the unemployed back to work. It is hard to distinguish what is happening now- an increase in inflation expections or an increse in aggregate demand. The latter would effectively increase the demand for houses driving house prices higher to more than offset the increase in interest rates. I am betting on the latter.
Good luck DougS, a rural place has always been a dream of mine.
“Unless the Fed does the housing market a favor by talking mortgage rates back down, it will be telling to see whether more IPOs get out of the gate as the fundamentals for the rental play come into question.”
Investers are starting to flee at this very moment.
http://www.nakedcapitalism.com/2013/06/mortgage-rate-increases-starting-to-bite.html
It’s a roller coaster. Hang on for the ride.
I hate the FED and I hate SOCA. I’m talking BIG hate. I’ve lived and worked here for years and still can’t afford a decent place, and I blame the assholes at the FED and the douchebag flippers. I sincerely wish that ALL of these people would die of cancer, and very soon.
As much as I hate to admit it, I fell EXACTLY the same way you do. Except rather than wishing cancer – which, though awful, is a natural thing that most of the population gets if they live long enough – I say bullets to each and everyone of their greedy bankster brains. And on a related note let’s exhume that renowned proto-liberal Woodrow Wilson’s corpse and do the same to him for thinking a central bank would be such a swell idea. “The Founders warned about what? oh, nonsense! I know much better” he said! Ironically, I give the Wall Street hugger Reagan a pass – I honestly think he was too dumb to know what he was doing would lead to the horrors we currently face.
The FED is testing the waters with interest rates rising. It sure cracked 4% in a hurry. Gives you an idea how artificial the FED subsidized rates are. Too many unknown manipulated variables in this market. One big wind could blow over this house of cards.
http://www.westsideremeltdown.blogspot.com
http://www.santamonicameltdownthe90402.blogspot.com
When the interest rates go up, economy goes up, inflation goes up, housing prices go up.
Although mortgage affordability may in fact go down due to higher mortgage payment other parameters tend of offset it. If you look at 50 year chart of interest rates vs. housing prices there is no correlation.
What is “economy goes up”?
Wouldn’t this make more sense if it read from back to front? Even so, it’s still too simplistic to make a helpful point.
Up.. the opposite of down.. meaningful growth.
there is definitely a correlation between economic expansion and interest rates.
That’s wrong and nothing but wishful thinking on your part. History and common sense show otherwise, at least regarding asset (home) prices. Incomes are currently stagnant and will remain so due to global wage arbitrage, among other demographic reasons. If interest rates go up, there is less money left to go to principal portion, therefore the prices go down so that the monthly payment stays where it HAS to stay to continue to affordable when wages are stagnant or falling.
which part is wrong and wishful thinking?
the fact that interest rates historically did not have much to do with housing prices? It’s just a fact. Pull up charts over last 50 years.
By the way, incomes have been stagnant for the lower and lower middle class. The top 25% have been doing just fine.
On a separate line of thinking 50% of the deal in my area (Brentwood) is all-cash, interest rates are largely irrelevant to these buyers.
Big Wall Street money disagree’s with your assessment.
“Also this week, Stephen Schwarzman, co-founder and chairman of Blackstone Group, addressed the topic of rising interest rates at a Morgan Stanley Financials Conference. The private euity giant has also dabbled in the market, buying 25,000 single-family homes and converting them into rentals.
“If the interest rates were to go up a lot really quickly that should affect the value of real estate,” Schwarzman said. “If you just stay in a very slow growth environment and interest rates double or triple, of course, that would affect values.”
I agree it’s a totally different bubble just from the buyers. Your posts have spotlighted the problem of investor buying and all cash buying. There just has not been the true jobs recovery to create a pool of organic buyers. The market not fully clearing also left the hurdle higher for new entrants than it should be. New family formation is starting with higher debt (or not forming at all) therefore they need a lower entry point. Propping up the market freezes them out and no new jobs freezes out new buyers picking up the 10$/hr jobs the recovery is creating. I’d argue this is a bubble because nothing is organic with this restart to the housing market.
Good luck trying to pin down the fair present value of ANY asset class when the discounting mechanism is broken to smithereens. This is the new normal, brought to you by the wizards behind the fiat curtain ….. the world’s central banks !
cash out refi’s are heating up, lenders will allow cash out of up to $500,000 of your equity now. cash out refi + raising values = bubble/crash
I’ve noticed that ads on TV for reverse mortgages are now back with a vengeance. Have not seen them since 2007.
This is an aside but I think it is tangential to future of California. Please scroll the jobs database published in today’s LA Times for the salaries of the employees of the LA Department of Water and Power and you will see why the public sector in California will destroy the state. Remember that these people will retire and the taxpayers will have to keep paying them for life based on these salaries. To pique your interest a roofer makes over a $100,000 a year.
Have fun.
http://salaries.latimes.com/dwp/?name=&classification=Senior+Roofer&year=2012&min_amount=&max_amount=
There’s a lot of this type of BS going on in SoCal and at some point the dam is going to break. Somebody has to pay for these programs and the average Joe is increasingly paying a higher proportion of his standard of living so that others can maintain their lifestyle. This is really apparent in places like Los Angeles. Lets just hope the rebalance doesn’t get ugly.
By the way, I work in Florida as a U. professor, four university degrees including PhD, speak three languages fluently and make $74,000 with over 35 years experience and NO defined retirement plan other than employer yearly contribution of around 3% of gross salary.
Fulani,
I guess you don’t work for a public university. I imagine they get a pension. Still, $76,000 is good money in Florida, right? I teach at an elementary school in an LA barrio, and I make $76,000 a year. It’s six and 1/2 hours of high-intensity work every day. Your degrees and languages got you your position, and my credential and language (Spanish) earned me mine. I’ll bet your teaching load isn’t too stressful. I think that’s the trade-off. Now, the HVAC/trades guys who are omnipresent at my school (it’s 90 years old) don’t really have much pep in their step (lots of looking in their truck toolboxes drinking Big Gulps), but I don’t think they get summers off, either. I’d be surprised if LAUSD paid them $100,000 a year, but they probably do get a sweet pension. I think the unexposed funding/entitlement problems at LADWP, LAUSD, and your university may be in the administration. How many people at these institutions make big $$$ but don’t teach, roof, or repair?
I have been following some of the flips here in LA and noticed this one today on Curson.
http://www.trulia.com/property/3120952465-2107-S-Curson-Ave-Los-Angeles-CA-90016
price history
03/29/2013 Sold view details $385,000
12/23/2011 Sold view details $566,653
08/17/2001 Sold view details $155,000
Can anyone figure out this price history? I get that it sold for $155K in 2001 but then sold for $566K 2 yrs ago and then sold (foreclosure?) for $385K 3 months ago? and now on the market for $649K? insane!
155 to 649 in 12 years. That’s like a 12.7% annual return. At that rate, the home would be ‘worth’ $1.5M by 2020. Go Vancouver!
They should teach banking and real estate dynamics as part of a requirement for graduating both high school and college.
It’s really not fair. Investors get it at rock bottom, but regular people cannot.
I look at that house and I think it is still just a box house worth $100K (lipstick on a pig).
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