Current interest rates, housing & the US economy

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Dog_Papa
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Current interest rates, housing & the US economy

Post by Dog_Papa » Sun Jul 07, 2013 7:38 pm

In business school, I was taught interest rates had component parts. A real rate of return, a figure for inflation and a part to pay taxes on the interest bondholders rec'd. At the time the 30 yr Treasury was paying about 7.5%. It all made sense, 3% real rate of return, 2-3% for inflation and 2-3% to pay the tax due. It seems that rates today are now so low, there's not enough to cover these components. I watch documentaries, where pundits will say, we just keep kicking the can down the road, and that we will have to face reality at some point in time in the future. In other words, current rates do not reflect real rates of interest, and rates are being held artificially low.

I now have started to agree. We're now 5 yrs into this so-called financial crisis and it now seems like the new norm. I just wonder if such low rates can be sustained, for an indefinite period of time. When rates begin to reflect reality, real estate prices will have to take a big hit. I don't see anyway around that. Also people saving for retirement, are getting the short end of the stick. That I also see being a problem down the road. There's no place to get a decent return on the bond portion of people's asset allocation.

If this was going to be short term, that's one thing. But, it looks like rates need to be kept down for a long time. I would not invest money, at such low rates of return, that we have today. I just think we need to get back to interest rates, that are based on market forces. As opposed to artificially low rates. And the longer we put this off, the worse the problem will be. Anyone else seeing it this way.....in terms of interest rates and their component parts?
Last edited by Dog_Papa on Sun Aug 18, 2013 3:32 pm, edited 1 time in total.

RenoJay
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Re: Current interest rates, housing & the US economy

Post by RenoJay » Sun Jul 07, 2013 7:45 pm

I think there are quite a few of us on this board who are avoiding bonds and bond funds currently, but the rest of the argument seems too speculative for me. For instance, your assumption that rising rates will kill housing depends a lot on when rates rise, by how much and how quickly. There have been lots of periods in history where rates rose and housing prices either rose or at least stayed flat.

ourbrooks
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Re: Current interest rates, housing & the US economy

Post by ourbrooks » Sun Jul 07, 2013 9:36 pm

Actually, for long periods of time, perhaps, the majority of time, the first of the three components, the real return, has been zero for bonds. People tend not to remember, but from 1935 to 1980, real returns were near zero or negative. During most of that time, there was no intentional government policy of holding real rates down; it was market forces that held them down.

Since 1980, real returns on bonds have been mostly positive, up until recently, and investors and retirees have been enjoying the free ride of high returns and low volatility from bond investments, but now, the new normal is over and the old normal is back.

If your primary goal is to maximize returns, bonds have never been as good an investment as stocks. Bonds are to dampen volatility and, as long as they have a real return near zero or above and sometimes move in the opposite direction as stocks, they're a better choice for this purpose than cash.

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Ged
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Re: Current interest rates, housing & the US economy

Post by Ged » Sun Jul 07, 2013 9:49 pm

Over most of my life home mortgage rates have been significantly higher than they are today. I don't see housing prices being greatly affected by a moderate increase in interest rates, especially as that increase is likely to be due to an improving economy.

billyt
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Re: Current interest rates, housing & the US economy

Post by billyt » Mon Jul 08, 2013 6:07 am

Most people buy as much house as they can 'afford'. In other words, they go for the highest monthly payment the bank will qualify them for. A month ago someone who could qualify for $100,000 mortgage had payments of $457.46 at the rate of 3.65%. Today the rate is 4.65% and for a payment of $465.46 the same person can qualify for only about $88700, or 11% less. All else being equal, this should put downward pressure on housing prices.

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Re: Current interest rates, housing & the US economy

Post by richard » Mon Jul 08, 2013 7:00 am

Dog_Papa wrote:In business school, I was taught interest rates had component parts. A real rate of return, a figure for inflation and a part to pay taxes due on the interest bondholders rec'd. At the time the 30 yr Treasury was paying about 7.5%. It all made sense, 3% real rate of return, 2-3% for inflation and 2-3% to pay the tax due.

The predominant theory is that longer-term interest rates reflect expectations of future short rates plus a risk premium.

Inflation is very low and inflation expectations are very low.

Many treasury investors are institutions that don't pay taxes.

Beware of using common sense to explain the economy. Many have been led astray by investing based on their common sense understanding of economics.
Dog_Papa wrote:In other words, current rates do not reflect real rates of interest, and rates are being held artificially low.

The economy is slow, unemployment is high, there is substantial idle capacity and inflation is low. Where would you expect interest rates to be?

It's not easy to find a coherent model that explains how the Fed can artificially keep rates low without inflation. A slow economy does a better job of explaining current interest rates and inflation, although Fed action certainly matters.
Dog_Papa wrote:Also people saving for retirement,
are getting the short end of the stick. That I also see being a problem down the road. There's no place to get a decent return on the bond portion of people's asset allocation.

Standard advice is to have a diversified portfolio with both stocks and bonds. You have to look at the whole portfolio, not just one part. The polices that are keeping rates low appear to be helping stocks. TSM is up 16% this year.

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shokwaverider
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Re: Current interest rates, housing & the US economy

Post by shokwaverider » Mon Jul 08, 2013 9:21 am

Dog_Papa wrote:When rates begin to reflect reality, real estate prices will have to take a big hit. I don't see anyway around that. Also people saving for retirement,
are getting the short end of the stick.


I think it may have the reverse effect on housing, at least initially. When and "if" our financial leaders decide to come back to interest rate reality, people will "rush" in to beat the rate rise. house prices will spike, then come back to a normal 3 - 5% per year increase.

As far as us old retirees and those saving to be old (or FIRED) retirees are concerned, do you really think anyone cares? All they want is for us to spend what we have, take more out of our 401k(s) and pay taxes. They seem (IMHO) to be more concerned about pandering to the Wall Street and the MegaCorps.

I agree that interest rates are artificially low at the moment, but we are not the only ones. Look at Canada, typically the Canadians do a better overall job at keeping their economy stable through good and tight times than the USA, all be it at the expense of higher Taxes. But remember they only have ~30m folk up there over almost as much real estate, most paying taxes, as opposed to our ~350m. The money to run the place has to come from somewhere, plus they have a good healthcare system to fund, that (by the way) works for everyone.

NOLA
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Re: Current interest rates, housing & the US economy

Post by NOLA » Mon Jul 08, 2013 10:02 am

billyt wrote:Most people buy as much house as they can 'afford'. In other words, they go for the highest monthly payment the bank will qualify them for. A month ago someone who could qualify for $100,000 mortgage had payments of $457.46 at the rate of 3.65%. Today the rate is 4.65% and for a payment of $465.46 the same person can qualify for only about $88700, or 11% less. All else being equal, this should put downward pressure on housing prices.


I'm far from an expert on economics etc, but I think your explanation is too "simple". When the interest rates go up, that probably means that less people are unemployed and more can afford to buy houses. So I feel that there are way too many factors to consider.

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Dog_Papa
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Re: Current interest rates, housing & the US economy

Post by Dog_Papa » Sun Jul 14, 2013 8:41 pm

I think it may have the reverse effect on housing, at least initially. When and "if" our financial leaders decide to come back to interest rate reality, people will "rush" in to beat the rate rise. house prices will spike, then come back to a normal 3 - 5% per year increase.

I can see a spike as a possibility. However, the idea that house prices only go up is now gone. There is now a trend towards smaller, more affordable housing, in FL anyway. Families have been smaller for many years now. So, that was a change that needed to take place. Housing prices had also gone up, year after year, and decade after decade (70s, 80s, 90s), that was a trend that also needed to change. Wages did not increase, like the cost of housing did. Yes, eventually the housing market will recover. So, at that point a 3-5% rate of increase would be expected. Due to the effect of inflation.
Last edited by Dog_Papa on Sun Jul 14, 2013 9:20 pm, edited 1 time in total.

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momar
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Re: Current interest rates, housing & the US economy

Post by momar » Sun Jul 14, 2013 8:44 pm

billyt wrote:Most people buy as much house as they can 'afford'. In other words, they go for the highest monthly payment the bank will qualify them for. A month ago someone who could qualify for $100,000 mortgage had payments of $457.46 at the rate of 3.65%. Today the rate is 4.65% and for a payment of $465.46 the same person can qualify for only about $88700, or 11% less. All else being equal, this should put downward pressure on housing prices.

All else is never equal and it tends to dominate.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep

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