July 12, 2013, 7:44 a.m. EDT
The looming threat to the housing recovery
Have the financial markets been taking too many painkillers?
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By Brett Arends
A while back, a very good friend of mine
had an operation on his arm. In the aftermath, the doctors gave him some Vicodin
to deal with the pain. When I next saw him, his arm was in a sling. I asked him
how he was doing.
He was in a terrific mood. “I’m as high as a kite,” he
said and started laughing. I’ve never seen him so happy.
Reuters
I don’t mean to be Mr. Gloom, but I sometimes wonder if
investors are in a similar state of unreality. For the past few years, a massive
dose of free money, thanks to zero-percent interest
rates and “quantitative easing,” has sparked a similar sense of
euphoria in many financial markets. One shouldn’t overdo analogies, but free
money and Vicodin have one thing in common.
They wear off.
Federal Reserve Chairman Ben
Bernanke lifted markets with remarks hinting that the era of free
money may go on longer than some had feared. Last month, he sent markets into a
tailspin just by looking forward to the day when the era of free money would
come to an end — when the Fed would start “tapering” off its purchases of
government bonds and, indeed, when short-term interest rates would rise.
Yet commentators on TV are making sarcastic remarks
about last month’s “taper tantrum.” But it is all a matter of degrees. Sooner or
later, this is going to end. The Vicodin will wear off.
Consider the U.S. real estate market.
It has been going through a dramatic two-year recovery
since hitting rock bottom in 2011. According to the National
Association of Realtors, the median new home sold for $208,000 in May
— a gain of 11% in a year and 21% over two years. Median prices are now back to
their highest level since before Lehman Brothers collapsed.
“The market’s been going crazy,” says Svenja Gudell,
senior economist at Zillow.com, the real estate site. Normal rates of growth
ought to be closer to 3% a year, she says.
Naturally, this is coming out of the biggest housing
crash since the Depression.
Yet a key factor in the real estate recovery was the
collapse in mortgage rates, which made it much, much cheaper to buy a home. It
is surely no coincidence that the housing market finally took off in the second
half of 2011 — just after the summer budget showdown in Congress,
quantitative easing by the Fed, and debt deflation fears sent rates plummeting
to historic lows. According to Bankrate.com, average rates on a new 30-year loan
fell from 4.5% in May, 2011, all the way down to 3.4% last fall.
IMF chief economist on global markets, China
Paul Vigna and IMF chief economist Olivier Blanchard
discuss the state of the global economy, and Dan Fitzgerald looks at the
interest rate challenges facing banks.
Yet even though the stock market is now shrugging off
the taper tantrum, the bond and mortgage markets aren’t. According to Bankrate,
in May, before Bernanke spoke, you could get a 30-year mortgage for 3.6%. Now it
will cost you 4.6%.
In January, an American family who wanted to buy a
median home would have paid $170,600, according to the National Association of
Realtors. (There are seasonal factors making winter purchases cheaper). Assume
they borrowed 80% of the price at prevailing mortgage rates then, which
according to the Fed were 3.4%, they would have faced an annual interest cost of
about $4,600.
Today, a family hoping to buy a median home will pay
$208,000, and 4.6% interest. Annual interest on an 80% mortgage: $7,600.
In other words, the effective cost of buying the median
home in the U.S., when measured in terms of the actual cost of the mortgage per
month or year, has risen by more than 50% in just a few months.
And this, if markets are to be believed, is just the
beginning. I tend to follow baseball
legend Casey Stengel’s advice, and avoid forecasting anything, especially the
future. However, in this circumstance, some speculations are unavoidable.
Historically, long-term Treasury bonds have typically
yielded at least 2% above inflation. The bond market today is forecasting
inflation over the next 10 years of about 2%, so in a normal environment —
without financial Vicodin — you might expect the 10-year Treasury to yield about
4%.
In those circumstances, 30-year mortgages would probably
cost well over 5%, possibly approaching 6%.
At 6%, that family buying a median home today would
saddle themselves with an annual interest cost of nearly $10,000, more than
twice what it was at the start of the year and about twice what it was a year
ago.
It is alarming to think how much of our economic
recovery, halting as it is, is simply the product of financial engineering and
artificially low interest rates. What will happen when those rates go back to
normal, and the Vicodin wears off?
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