There is a simple solution to the current Political Thesis and all the Evils that attend to Bush-ism.
2%.
That is the rise in long-term interest rates sufficient to cause a housing crash and an economic meltdown.
The current "recovery" is based on housing, on real estate, on construction. We are becoming extravagantly over-housed, compared to our forefathers. The upwardly-mobile are buying themselves 4,000 square foot McMansions in both cities and suburbs, while the wealthy buy themselves second homes and (somewhat smaller) starter homes for their kids.
All this is based on leverage. It’s based on leveraging past gains in real estate, on doubling-down on asset values. It’s also based on free money bought at low prices.
The current 30-year bond rate is 6.49%, but a lot of people have even-lower rates. If you get an Adjustable Rate Mortgage (ARM), your rate could be pegged to something like one-year money rates. If you have an interest-only note, you’re not paying principal at all and your monthly "nut" is lower.
But if you have these instruments you are betting on rising or at least stable house prices, as well as low and stable interest rates.
Rising rates pop real estate bubbles.
Do some math. If you have a 6% note on $100,000 you pay $6,000 for your money the first year, or #500/month. If you have an 8% note on $100,000 you pay $8,000 for your money the first year, $667 per month.
Trouble is, nothing costs $100,000 anymore. We’re now talking of house prices averaging $300,000 in many markets — higher in some, lower in others. That 6% note costs $18,000 per year, and the 8% note costs $24,000.
That’s just the interest cost. Add in taxes and a bit of equity, it goes up. What you’re betting is that while you pay that $18,000, say for three years, the asset becomes worth $400,000. This has been true in some markets — it actually underestimates the gains in many.
But what happens if asset values decline? They must if interest rates rise 2%. The $18,000 that once carried a $300,000 note now carries only a fraction of that amount. If you’re on an ARM when this happens, you’re now paying $24,000 for an asset whose value has gone down.
Multiply this by millions and millions and millions of homes and you see where we’re going.
How close are we to this precipice?
Supposedly, not very close.
But the pain is already evident. Foreclosure rates are rising. (That means more supply of houses on the market, more pressure on prices.) The longer people hold their mortgages, in the present market, the faster foreclosures rise, according to Bankrate.com:
Half of the mortgages out there are three years old or less. Which
means that half of mortgages have yet to enter the peak years for
delinquency and foreclosure.
Delinquency rates on ARMs usually are a couple of percentage points
higher than delinquency rates on fixed-rate mortgages. That difference
almost disappeared after the refinancing boom of 2003, when millions
of people got low-rate ARMs. But delinquencies — especially those
for ARMs — began to march higher in the last half of 2005, two
years after the end of the refi boom.
Right on schedule.
Now what happens if inflation rises, as it must with continually-rising oil and gas prices? At first, people hunker-down. They don’t buy homes as often. The age of mortgages rise. Delinquencies go up.
Interest rates are also a function of inflation. If inflation is 3% and you’re holding someone’s 6% mortgage you’ve got a positive yield. If inflation is 6% and you’re holding the same mortgage you’re barely breaking even.
The only thing holding rates down so far is the fact that Arab (Dubai) traders are still taking dollars (in the form of loans) for oil, and Chinese traders are still taking dollars (in the form of loans) for VCRs.
How long can this continue? How long can it continue while the U.S. dollar continues to fall, not against the Euro and the Yen, but against Third World currencies like the Peso, the Korean Won, or (most importantly) the barrel of oil?
Not as long as forecasters think.
Oh, and crashes are never forecast. (Except by folks like me.)
