patrick.net

tatupu70:

Thank you for the reply. I would not absolve consumers, companies, banks, etc of blame. There is plenty of blame to go around.

For your Best Buy analogy: No they are not responsible for the people maxing out their credit card by offering TV's. The low rate on the credit card which was the effect of the Federal Reserve artificially suppressing interest rates had more to do with it; which is the crux of this conversation.

Presumably, a free market would have noticed that the American economy had been hollowed out due to nefarious policies and given that buyer a more appropriate (higher) APR. If credit wasn't cheap, the buyer would have had to buy the TV from accounts receivable. Thus we would not have a population so deeply in debt and a crushing recession. This is the thought experiment laid out in the thread.

And it is not my theory - just thought up. There is general agreement that artificially low rates were a big contributor to the current bust:

http://www.time.com/time/specials/packages/article/0,28804,1877351_1877350_1877331,00.html
http://online.wsj.com/article/SB123414310280561945.html
http://www.law.gmu.edu/news/2009/zywicki_consumer_behaviors
http://mises.org/story/3252

The cause and effect of low interest rates on speculation has been know for many years. Here is a broadside put out by the Century Club in 1892 titled "Cheap Money Experiments In Past and Present Times":

http://tinyurl.com/kpm2dd

There is no general agreement as to whether there was a tulip bubble in 1630. The South Sea bubble was caused by a low interest equity swap for high interest public debt.

This has been Ron Paul's argument all along.

The Fed's manipulation is actually more damaging in my opinion since it is continuously chasing its own tail, thus creating these wild swings.

A good example that an economics professor I read once used the concept of a spring. If a spring is just left hanging from a close line, it will bounce around lightly as minor forces cause it to contract and expand. However, if you attempt to control the oscillation by adding compression or tension, the spring will move more wildly. That is how I see the Fed.
The market is supposed to move freely based on what interest rates the system can currently absorb. Greenspan raised interest rates towards the end of the dot com bubble to stave off inflation that was actually pretty non-existent. And then when the dot com bubble exploded (as it would have anyway without any help from Greenspan), in a panic, he lowered rates to low levels and created a secondary bubble. Now that unwinding is happening and we have dropped rates to zero yet again. But all this is doing is dragging out this malaise for much longer than it otherwise would have.

Personally, I would rather see the market over and under correct itself without Fed intervention since those swings would be much smaller in my humble opinion.

Air tight arguments and all, but the only way to stop this crap is for people to not buy (borrow) in. What could the Fed do? It cannot FORCE people to borrow (although Obama and crew are trying mightily).

So the entire theory on which the Federal Reserve is based, is that they are GROWNUPS.

That they will "take away the punchbowl" just when the party is getting exciting to prevent kabooms.

However they have never filled this role in actuality since their inception.

Keynes argued that during the boom times you have to "store nuts for the winter" and that the role of central bankers and ecoomic policy should be to tax & regulate enough during booms that when the inevitable occurs you can smooth it out with your war-chest you've saved up. Again this is never done, they let things run with razor-thin reserves and no savings, they even deride a "savings glut" as being counter to maximizing growth.

If I were a risk manager who had repeatedly failed to manage any of the risks under my perview I'd be fired. It's astounding the persuasive power of these BS artists that they still have jobs.

Tatupo70, the bubble surely wasn't limited to those few cities that you mentioned. Oregon felt it from hick town Prineville all the way through Portland and up I-5 through Vancouver and up past Seattle. Friends in Dakota Dunes, South Dakota experienced it as did friends in North Branch, Minnesota, as well as relatives in St. Petersburg, Florida and Grafton, Mass.

Here's a thought process we had in 1999 while looking for our first house. We couldn't save faster than housing prices were inflating in Portland at the time. We jumped in, bought too much mortgage, spouse got laid off in the tech bust, blah, blah, blah, sold at the peak and now watching our little down payment CD collect a whopping 3.2% interest.

People determine what they can afford by what the monthly payment is, that goes for homes, cars, boats, jet skis, plasma TV's etc. Increase the rate and all of a sudden that car, etc doesn't look so inexpensive.

Jack the interest rates on CD's and I bet you'll see folks save for that car, etc and even the rainy day.

Tatupo70,

The low interest rates shifted the supply/demand curve. When monthly payments drop, more people are willing to pay the lower price. When monthly payments go up, less people are willing to buy, so there is less demand. It started with low interest rates. From there human emotion and private and corporate greed/stupidity gave more fuel to the fire. But it could not have happened with 12% mortgage rates. Low rates were the spark.

Clearly I'm in the minority at this site--I knew that before I posted, but help me out. I've still not seen one argument explaining why low rates cause excess risk taking or asset bubbles.

Here are two charts: interest rates vs. mo./year and housing prices vs. year

The last few years are obviously not the first time in history that the US has enjoyed low interest rates. And it is also not the first time the US has encountered a housing bubble. And like I expected--low interest rates don't correlate with housing bubbles. The data just doesn't back that theory (eg 1970's bubble)

http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
http://mortgage-x.com/general/indexes/prime.asp

My take--for what it's worth--is that Wall St. greed is almost exclusively to blame for this mess. There was a very good article posted here some time ago explaining credit default swaps and how mortgages were packaged to supposedly lower the risk. Basically, the idiots on Wall St. created an artificial market for these mortgages--they bought as many mortgages as lenders could write without understanding the risk. So, everyone played the game. Realtors, mortgage brokers, ratings agencies, etc. all went along because they knew that AIG would buy the crap. As long as they got paid, noone asked any questions.

And Reniam--you're right. It is widely believed that low rates caused this mess. I just happen to disagree.

Tatupu70, you are mostly right, IMHO. There were many factors that played into it but the baseline factor was low interest rates. Check out the video "Money, Banking and the Federal Reserve." Well worth the 40 minutes.

http://www.youtube.com/watch?v=iYZM58dulPE

Lots of greed and ignorance played into this bubble. Some simply it blame it on the Community Reinvestment Act of the 70's which encouraged lending to minorities. Some blame FHA. Check out the Seattle Bubble for much more details re: FHA

http://seattlebubble.com/blog/2009/09/21/whats-behind-rising-fha-defaults/

Many believed RE only went up and that it was a great investment, thanks NAR.

Some blame too much subprime lending. Though in Oregon we are getting hurt by too many Alt-A loans going bad, ie, interest only, negative amortization, Option ARM, etc by folks with GOOD credit.

Some blame people who used their home as an ATM to live an unsustainable lifestyle.

MBS trading fueled the push to lend to anyone with a pulse thus all the false documentation loans, ie liar loans.

Without the low rates and the easy credit none of this was possible.

How could this have happened otherwise?

I will look into the 70's housing bubble, thanks for the link.

tatupu70 says

I’ve still not seen one argument explaining why low rates cause excess risk taking or asset bubbles.

Low rates -> bigger loans -> asset bubble

Very interesting charts, Tatupu70. I'm sure someone can explain this better but low prime rates do not always equate to low mortgage rates. I can remember a few times that the Fed's lowered the prime rate in the past few years and mortgage rates actually went up...go figure.

I see trends during the late 70's boom and late 80's boom. Rates were trending down when the booms started and then were higher as the boom ended. Note that our current boom has ended even though prime rates and mortgage rates are at historic lows.

It would be interesting to look at the overall economy at those two times also. What was the mentality? Was it similar to today's where everyone is trying to keep up with the Jones' but at McMansion sizes? Were the neighbors in the 70's marveling at the new young couple that just moved in who had two brand new upper end vehicles, vacationed every winter in Cabo, had the $1,000 stroller and never seems to fret about retirement?!?!?

Once you guys get this all figured out can you tell us in Oregon why we always trail the country during these recessions and bubbles. Our housing peak was Aug 2007, almost a 12 month difference from the rest of the country. Our foreclosure rate spiked later, too.

interest rate would be same as broad index ( dow jones) returns over time.If not for FED , why would anybody loan be money when they can invest in stock index. The risk level in house is similar to stock index which was proven by the recent housing crash. i would say somewhere around 7%

Lets face it. We are sheep to be fleeced by the Fed forever, or until their power over the people is taken away by the people. They are nothing but a private cartel of ponzi schemers whose sole role is to profit from the control of the money supply, interest rates, and most importantly - lending itself.

After all, any group that profits by leveraging other peoples money out at fractional reserve ratios of as little as 10% can loan - as a total system over time - up to 10 times the face value of that same money. That means interest rates of 5% actually yield (to the banking system as a whole) up to 50% per annum. And that’s not even taking into account the increase in money supply every year. (Actually, that’s a large part of the mechanics of increasing the money supply - as it effectively creates money out of nothing but thin air!)

The international banking cartel (including the Fed) is the largest criminal organization in the world. Bubbles? They use them to make even more obscene profits. When one bursts, they just blow up another… dotcom, tech, gold, oil, housing, stock market, gold, commodities… oil …. on and on. They make money on the way up and on the way down. It may appear they made a mistake with the real estate bubble, but look how they engineered their way out of that one: Goldman Sachs cronies to the rescue! Bush/Obama doesn’t matter, that’s just the face card they are showing while they hide aces up their sleeves, waiting for the next big pot to build up.

People are just like sheep, lining up for their next mortgage, stock portfolio, or IRA, all the while they are tagged by the shearer. 95% of the wealth is in the hands of less than 3% of the people. Are they really deserving or have they just figured out a way to cannibalize the rest of us and have us accept it as status quo? There is NO hope until many more like Ron Paul raise their heads in the political arena. Until that time, we will be fleeced over and over by the mighty Fed and their cronies.

You know Rogerer, just a few years ago I would be laughing at your post thinking 'what a goofball', now it just makes me wonder about relocating to another country. But where could I go to avoid this? It seems to be all a sham. And with the cost of higher education getting out of hand, my retirement, aka 401K hoax, in limbo, we are really considering a move...but where? I worry about my kiddos future.

I just finished reading a book called "The Origins of the Federal Reserve System" by James Livingston. I can't really recommend it because it's very academic and doesn't really get to the point most of the time.

But I did understand from it that the Fed was created largely to protect the very wealthy capitalists of the time from their biggest fear: deflation. With deflation, the book explains, the working man wins as long as he still has a job. Prices fall, so his salary is worth more.

But deflation means that factory owners lose. Falling prices wipe out profit margins very fast, and capital tied up as factories that cannot make a profit also plummets in value. Society becomes more equal. Capitalists become ordinary people. A nightmare!

And, horror of horrors, banks made using those factories as collateral and those loans fail to get repaid in full. Then as people get nervous about the banks, there are runs on the banks and no one to lend to the banks to tide them over.

So what happens in essence is that over-investment or poor business ideas get very badly punished, and it takes a long time for anyone to get up enough guts to lend again.

The Fed was supposed to prevent all of that, and keep the very rich owners in control no matter how bad or irrational their investments are. That sounds quite a lot like the housing bubble.

I can agree that we need something like the Fed to lend during the panics and get things running again when no one else has the guts to lend. But I think they should do it at high interest rates, so that the businesses need a really profitable and well thought out plan to get a loan.

If you haven't already, read The Creature from Jekyll Island which talks more about the creation of the Fed, how it had been tried to be installed (and failed) for decades by the "money trusts", and was finally successful during the Wilson administration after a secret meeting between the bankers (JP Morgan and others) and a small group of government co-conspirators. It was a highly guarded secretive meeting (similar to the Bilderberg meetings today) which resulted in a piece of legislation (the Federal Reserve Act). Later the same year on Wilson's watch, the Income Tax Amendment was also passed - which was the other half of the scam.

The institutionalization of a private cartel of bankers in charge of money creation was a direct abrogation of the Constitutional decree that gave only the Congress the power to coin money (U.S. Constitution - Article 1 Section 8). In a scam not unlike today's "credit default swaps" (which are designed to circumvent Federal insurance regulations), the Federal Reserve System (not actually Federal, but PRIVATE and having NO reserves) was put in place in an elaborate scheme whereby the U.S. government swaps debt notes with the Fed for "Federal Reserve Notes" - neither having any real value. since they are both created from nothing. Of course, in this mutual exchange of worthless paper, it is the U.S. Treasury (i.e. taxpayers) that have to pay interest to the Fed for borrowing money which they create out of thin air. It's a crazy smoke and mirrors game whereby debt is collateralized and turned into an asset by the Fed, which proceeds to use that debt as collateral for up to 10 times more debt using today's fractional reserve lending. The practice is nothing more than a legalized ponzi scheme. This is LITERALLY true (see below).

Bernard Madeoff is small potatoes compared to the banking system headed by the Fed. Someone once said that if all the loans of American dollars were to be paid off, all money would simply evaporate before the debts were ever paid in full. That's because there is far more debt in the system than there is money! This is one of the secrets the Fed does not want you to know, since it would reveal the hoax of the entire financial system.

But don't take it from me. See quotes concerning the Fed by ex-presidents, congressmen, famous authors and inventors, economists, etc. by scrolling down to the section entitled "Federal Reserve quotes" on this page about Woodrow Wilson and the Fed. Then continue to educate yourselves on the Federal Reserve System. There is much that is available on the internet. It is one of the most eye-popping disillusionments you will ever have - like taking the red pill in "The Matrix". Welcome to the Real World!

Tatupu70 said:
I guess I just don’t see how low rates “make it possible for people to borrow way too much money” People can borrow too much money regardless of the interest rate–all it takes is someone who is willling to loan it to you. Low rates do allow you to borrow a larger sum for the same monthly payment, but that doesn’t make you any more likely to default. It just means that you are paying less interest.

Aside from the "greater picture" view of the Fed, the housing bubble was in fact created by a combination of a) low interest rates b) under-regulated lending practices and c) the obfuscatory monetization of mortgage debt instruments by Wall Street.

One thing lacking in your view that a low rate "doesn't make you any more likely to default" is that because the low rates helped push up demand, housing prices rose excessively, hence the bubble that created imaginary "value". Since low rates enabled people to borrow more for less money, they directly contributed to the likelihood of default after the inevitable collapse of the artificial valuation". Regardless of the borrowers creditworthiness at the time of the loan, when bubbles collapse, a domino effect ensues. Peoples' financial positions - whether in real estate, stock markets, or jobs - deteriorates.

There are more and more foreclosures happening every day on fully qualified loans made to able buyers at the time. But whether they were speculative gamblers or nesters, their circumstances including their abilities to pay, have now changed dramatically for the worse. This due in large part to the low interest rates. Some borrowers, by the way, are defaulting completely out of choice, as an alternative to taking an even greater loss by paying effectively high rates for a declining asset valuation. That same $5,700/month payment on a million dollar loan at 5.5% effectively becomes a 13.4% loan on a now $500,000 "asset" with a $500,000 negative equity.

I agree entirely with Patrick in his views on the real estate market bubble. While low interest rates were not the sole cause, they were a major contributing factor.

Rogerer--

I agree that low rates will cause an uptick in demand and subsequently prices for houses. The magnitude of this uptick is not well defined, because demand is made up of many factors--interest rates are only a part of it. But, this increased demand and prices wouldn't be "excessive" as you state it. Or an "artificial valuation" With lower rates, there is a new equilibrium point on the supply and demand curves and prices rise. The true value of the house has risen. Not a bubble. Nothing excessive. Just how free markets work. When/if rates rise back to "normal" levels, housing prices should go back down as well--at least in inflation adjusted terms. Prices go up and down over time--nothing artificial about that.

The foreclosures on fully qualified loans were most likely people getting laid off from their jobs, I imagine. This has nothing to do with low rates. During recessions, people lose jobs and houses go into foreclosure. It's unfortunate, but it's how the world works.

Finally--I see low rates-->bigger loans. I just can't make the connection to bubble.

fyi--good article here. from todays links
http://business.theatlantic.com/2009/09/a_grand_unified_theory_of_the_financial_crash.php?ref=patrick.net

House valuations were excessive for one thing because income levels in this country (one of the major determinants in the demand curve) did not keep pace with the level of inflation seen in housing during the boom years.

The law of demand dictates that an individual will buy more of a given commodity when the prices are lower, and purchase less if/when prices rise. This fundamental was forced on its ear during the boom years thanks to loose lending and phantom wealth - but especially artificially low interest rates, which is what really kicked off the hysteria. That's all anyone could talk about during those years. So I guess you could add popular suggestion/propaganda to the list.

Let's see:

tatupu70 joined one day ago and immediately starts sounding like a REIC (Real Estate Industrial Complex) insider with a severe case of denial of responsibility. Would it be impolite to point that out?

I would not waste any time on tatupu70 until said poster starts showing some sense.

Trolls are a waste of time. Just point out where they are wrong, repeat points as necessary and move on.

It's not impolite to say you think someone is trolling. Impolite means calling people "asshole" or "libtard". It's the lack of good will that shuts down real conversation.

But I think tatupu70 is actually sincere, and I have another point that might help him see that artificially low interest rates lead to bubbles:

Low rates lead to bigger loans, which leads to higher prices. That much is clear to him. But then those price increases are used as collateral for more lending!

Say interest rates fall by half, so I get twice the loan I would have. I double my bid on a house. I buy it. Now the bank calls that extra 100% in price "equity" when it is not really there. The bank then lends out that extra "equity" as money to the next guy, letting him borrow more, and he bids up the price on another house. More equity!

Round and round it goes with vast amounts of "equity" being creating from nothing. THAT is a bubble.

Tatupu70- Here might be another way to explain why artificially low mortgage interest causes a bubble.

This is only MY life example. In 2000, I noticed that we were in a housing price bubble. At that time I was renting in a small duplex to save enough money so that I could put down a large downpayment. Several years before, I was upside down on my house during another post bubble, and the only reason I kept the house, is that I had at least 20% down on the house. Why did I use a conventional loan? Because I hate to pay interest , it only increases the REAL house cost and it steals any speculative and inflationary equity that my house accumulates over time. That is when its time to sell in a normal market, I can still have a profit afetr paying Realtors another 6% for doing nothing.

Back to my point. One of the most difficult things for most people to do is to DOWNSIZE their living standard at that same time they can afford a higher standard of living. Why do this? To save on the total cost of the hosuer and not have to worry about being upside down on my mortgage ---like most house owners over the past 5 years.

Now to the point! I told my wife that the best way to save for our new house was to save 100% of the difference between what we were paying for rent and what the normal PITI would be for the same house.

At this time, I have no moral hazard. I am just a prudent saver waiting to accumlate enough cash to put as a downpayment on a house. I would rather have some equity in the house than use other peoples money and a lot of promises. At that time, we were forced to cut back on everything includng food budget jsut to save. But I noticed that Realtors were in a frenzy. Like sharkes in bloody water. I knew people who had NO MONEY, NO SAVINGS and they were looking for a house to buy. Multiply this times millions and you see---we had more buyers than houses. the buyers had no money, but the goverment felt it would help the economy to sell new houses to the homeless even though they couldnt pay. House prices were increasing so everyone can be a millionaire. So I discussed this with a few educated prosepective house buyers. I told them, that all the greed with no money down and extremely low interest only caused the prices to go up. Local houses built before World War I that were in disrepair and had more termites than nails were selling for $400,000. They couldnt give this junk away in the middle 1990's. Some of the selleers were smart and kept the PROFIT and rented. Others got greedy and started flipping. I have always had a good household budget. I thought it was ironic that people who could not save a dime---literally--as in NOT ONE DIME. Were acting like millionares. I knew a part time car wash cleaner who was paid less than minimum wage bragging about all of his "investments". he was getting cash back at closing on houses that he never moved into or paid any money for. He would start advertising them for sale before the house closed.

It was killing me, because the house prices were skyrocketing exponentially. Realtors would tell me NOW IS THE BEST TIME TO BUY---YOU WILL NEVER OWN A HOUSE---YOU ARE A LOSER IF YOU DON'T BUY TODAY.

Then it happened---our personal crisis. We were paying high rent and saving the difference for our future "house downpayment". The owner of our duplex sold to a flipper. The FLIPPER WAS A MORON---I mean a real one. IQ was low 60's. His job was to clean up old houses so they could be sold. He made minimum wages. When the sale closed ---he announced I AM YOUR NEW LANDLORD. I never saw thew man before in my life. I will be raising your rent effective tomorrow! He increased our rent 150%. He said---laughing thats what you get YUPPIES for not buying now. We paid the higher rent---and watched. I noticed that withing days I was getting letters to him from loan companies---toi my address---why because he lied on the county tax form and said it was owner-occupied to get a property tax exemption.

We had to sacrifice more. We sold personal belongings, anything, to get the money we needed to savbe for a downpayment, but houses prices were going up faster than we could save. WHY? because people were NOT BUYING HOUSES. Houses were only a pretext to get the almost zero interest mortgage with no money down. We had millions of almost broke underclass almost overnight refinancing houses when they could not afford to pay monthly house payments.

Our new landlord who would shove his finger in my face and laugh---because he was an idiot and thought he was earning his "wealth". He was "smarter' than I because he had money. First he refied the duplex and showed off his brand new $100,000 custom VIPER convertible. He than showed off his wifes new Mercedes convertible. Expensive toys----but he couldnt make the payments if he ever stopped flipping houses at ever higher prices.

I tried to warn him---that it was dangerous now---because the market was filled with flippers and no one was available to buy. He tried to sell to us. I said NO we are stupid Yuppies.

Bottom line. He found a sucker in the Bay Area who thought it was a "low" price. So I had fun. When they walked through and asked me what I paid for rent in a low whisper ---I lied and told them it was the old rent amount. I am only a stupid renter, saving my money.

A few months later the duplex closed and we and the next door neighbor gave 30 days notice.

We moved to a larger duplex and lower rent.

What happened to Mr. Bigshot landlord. My security deposit check bounced twice. Mr Bigshot with the red Viper. I met him IN HIS BANK and made I made a stink for him WRITING BAD CHECKS when HE HAD NO MONEY JUST BIG CARS. I told him I would have him arrested for fraud. He left, and came back with my CASH---he was very embarrassed. I laughed.

I rana background check on him and learned that he bought SIX PROPERTIES and one well known business in only six months. He also had a custom house built. By the end of the year ---he lost all houses to foreclosure and I added fuel to the banking fires when I told them he was a greedy cheat. He has over $100,000 of IRS tax liens and thousands of state tax liens on him. He is destitute and living in a trailer. His business was taken back and all his fancy cars were repossessed. I on the other hand have enough cash to buy a house outright. But I don't. Here is the reason. The personal misery and savings that I had to experience , the beans, rice, ramen noodles, clothes from the Goodwill---old cars was MISERY. So I learned the value of a dollar. IF YOU WERE IN MY SHOES---and YOU were also honest----you will find it is very difficult to throw your money away on lies and promises from Realtors and other housing cheerleaders.

Its a fact---REALTORS ONLY WANT TO SELL TO first time home buyers who are naive. THEY HATE people who know the score---why? Because they have to be very careful when they lie. Its easier to find a sucker with no money down and lie to closing than it is to deal with a person who refuses to be lied to, BECAUSE THE HAVE LEARNED ABOUT THE LIES THE HARD WAY. THEY PAID FOR THEM.

So, yes when INTEREST RATES DROP, "so-called affordability" in terms of MONTHLY payments go up. When interest rates increase , house prices go DOWN. Why? Because house prices are based on income when the buyers use a long term mortgage. If there were no mortgages houses would probably sell what they are worth or they would not build them. Very few people who buy houses to live in, pay cash.

Notice how house prices go up as mortgage interest rates go down and/or increase the terms of the loan and /or the government provides a tax incentive and /or interest deduction for mortagges? Why are mortgages so special?

If you ever have a family member get sick---and learn that your health insurance does not cover the costs of care---WHERE WILL YOU GET THE MONEY. I get mine by saving, not refinancing a house. It takes a lot of pressure of living.

Did you know that some man agers will use a house to enslave employees? I have. In the past, If I had an excellent worker and could not afford to give them a raise, I will encourage them TO BUY A HOUSE. It makes them feel important---and makes them loyal to me---for helping them buy it. I am not a philanthropist--its just business. An employee is more likely to stay with my company, if they have so much debt they cant afford to look for a different job. I don't take advantage of them, other than to assure they dont start looking for a job with another firm. Beware if your boss tries to "help you" buy a house. A house is a long term commitment and you can't sell them in two days. My area takes years to sell.

Justme--

I'm laughing that you think I'm part of the REIC (that's the first time I've seen that acronym, but I like it). I thought I was pretty clear that I think the vast majority of the bubble was caused by mortage brokers, realtors, and Wall St. flunkies. Where I disagree with most of the other posters here is that low interest rates were a major cause. And I find it funny that I'm one of the few people here who has posted data to back up their points. Whereas you accuse me of being an insider, and without sense. If you think I am wrong--by all means, show me why. But please have some logical reasoning and/or data to back up your arguments. Otherwise, I agree with you--I'd advise you to move on too.

Patrick-- Intersting example, but if I followed it correctly, I have a couple of comments. If interest rates fall by half, I don't think you'll get twice the loan. It's not a linear relationship. But the real problem in that scenario is you're forgetting about the appraisal. Just because you qualify for twice as much loan, doesn't make the house worth twice as much. And that's one of the key pieces that was missing during the bubble. Appraisals came in for whatever number they had to meet to keep the deal on. And banks didn't care because they didn't understand the risk. So, I'd argue that it wasn't the low rates--it was the banks/Wall St. underestimating risk and realtors and appraisers looking the other way...

tatupu70 says

... banks didn’t care because they didn’t understand the risk. So, I’d argue that it wasn’t the low rates–it was the banks/Wall St. underestimating risk and realtors and appraisers looking the other way…

Banks didn't care because they would either immediately sell the loans, or because they, like the market at large, were greedy and wanted to profit from the boom. They did understand the risks, but were seduced by high margins and huge capacity.

tatupu70 says

Rogerer–
I agree that low rates will cause an uptick in demand and subsequently prices for houses. The magnitude of this uptick is not well defined, because demand is made up of many factors–interest rates are only a part of it. But, this increased demand and prices wouldn’t be “excessive” as you state it. Or an “artificial valuation” With lower rates, there is a new equilibrium point on the supply and demand curves and prices rise. The true value of the house has risen. Not a bubble. Nothing excessive. Just how free markets work. When/if rates rise back to “normal” levels, housing prices should go back down as well–at least in inflation adjusted terms. Prices go up and down over time–nothing artificial about that.
The foreclosures on fully qualified loans were most likely people getting laid off from their jobs, I imagine. This has nothing to do with low rates. During recessions, people lose jobs and houses go into foreclosure. It’s unfortunate, but it’s how the world works.
Finally–I see low rates–>bigger loans. I just can’t make the connection to bubble.

It is somewhat ironic that in your quote above, you are arguing that there is no connection between interest rates and a bubble, yet you at the same time admit that housing prices will go back down when interest rates rise to normal levels. Hmmm...

Any time prices rise by 8 to10 times the average annual rate of inflation, when supply is actually outpacing historical demand, then there exists what can justifiably be called "excessive" demand. This leads inevitably to excessively high valuations. You choose to see this as "just how free markets work" but fail to see that when housing prices outpace other basic commodity values by such a disproportionate degree, that by definition is "excessive". That is, it has "exceeded" both the usual % appreciation in the historical sense and also exceeded valuation compared to other markets and economic indicators.

One thing Patrick has brought out clearly and consistently on this site is that house valuations are necessarily and unsustainably "excessive" when they move far beyond the normal cost to own / cost to rent ratios AND far beyond the normal mortgage/income ratios.

As to my use of the word "artificial", I would say that is true in the sense that is was both by design and through interference of influences outside the natural workings of a truly "free market". The arbitrary setting of ridiculously low interest rates is NOT a natural phenomenon occurring in the free market. The Fed has a long history of market manipulation, usually for the purposes of "curbing inflation" or "avoiding a recession" and has now lowered rates to levels even lower than those that helped trigger the boom. How can you not agree that these rates are artificial? And artificial rates lead to artificial demand which produces artificial valuations. The whole cycle is artificial!

Your resistance to what virtually all other commentators agree to seems to be based entirely on historical data in which you see no direct correlation between low rates and a bubble. The missing pieces in this puzzle could be that in all other cases of low rates, there did not exist the following factors:

1. There was never previously such a huge disparity between the prime rate and the mortgage rates - giving lenders an added incentive to go over the edge with new loans (and simultaneously decreasing the risk factor on paper due to the huge margins involved.)

2. Interest rates had never been lowered so significantly and suddenly.

3. Interest rates had not been lowered at a time when the overall economy was doing so well. Greenspan justified this by saying he feared a recession after 911. (He has since admitted this was a mistake "in hindsight".)

This is just a situation where historical data does not have direct relevance to current conditions.

I don’t think tatupu70 is being a troll. He has a difference of opinion.

I do think though at this point he is arguing just to argue. Almost all have said that low interest rates were ONE OF the many confluent streams involved in making this bubble. There have been plenty of references already provided but he is still putting the onus on others to “prove me wrong”. Even one of his provided references states: “instead, they skyrocketed by 86% due to Alan Greenspan’s irrational lowering of interest rates to 1%...”

It’s fine if you wish to see suppressed interest rates as having minimal effect. That is certainly your prerogative. But please don’t claim you “still [have] not seen one argument explaining why low rates cause excess risk taking or asset bubbles”. Read the references provided to you already. Find the speech given by Senator Elihu Root in opposition to the Banking and Currency Bill. It should take you days to read and contemplate them. In other words, do some of your own research.

reniam--

Fair enough. How about we agree to disagree. You're right that we are going round and round and saying the same things now. I hope I'm not being a troll--I enjoy a civil discussion and disagreement.

Tatupu70,

Ok, I will indulge you just ONCE on this topic. Greenspan himself finally admitted to the following, per Wikipedia.

"Greenspan admitted that the housing bubble was “fundamentally engendered by the decline in real long-term interest rates”,[41] though he also claims that long-term interest rates are beyond the control of central banks because "the market value of global long-term securities is approaching $100 trillion" and thus these and other asset markets are large enough that they "now swamp the resources of central banks."[42]

In addition, there is any number of well-known economists that said the same thing, or made even stronger connections between rates and bubbles. Follow the links people have posted above.

Now, your data about the Prime Rate is not very relevant. It has little to do with mortgage rates, or the fact that LOTS of money was pushed into (low rate) mortgages because the short term interest rate was even lower and there was no other SAFE place (irony alert) for the money to go. Weak lending standards are sometime a function of the demand for loans to buy, again caused by low short-term yields!

Now, do you think the admission by Greenspan himself is wrong? Show me some reputable economists that agree with you, and refer to their arguments. They are going to be hard to find.

My question is, where did you get the idea that interest rates do not matter to bubbles? There just is not any credible evidence for your thesis.

Don't make me cut and paste a quote from Alan Greenspan again. I really don't like the guy at all.

More on Greenspan's primary role in creating the bubble: Greenspan the Goat

One thing tatupu70 has not used (surprisingly) as an argument is that interest rates are currently lower than they were during the boom, yet prices are continuing to fall, and therefore would suggest that it was the combination of other factors which was primarily responsible. This would actually be a great argument, if it wasn't for the fact that we are now IN a recession, which again differs from the environment present during the boom.

The Fed has already signaled that it will raise rates again dramatically and significantly when it determines we are out of recession and and it must then respond to inflationary pressures. What will happen to real estate values then? Just another reason to justify Patrick's many arguments against buying real estate in this market.

Interest rates have a long noticed direct effect on house prices.

For the typical Joe HowMuchaMonth who just wants to know how much house he can get for $1,500/mo:

At 6%, it is a $250,000 house

At a a 3.5% teaser rate , it is a $330,000 house.

Unfortunately, due to the aggregate of Joes, it is the same house.

investor90 says

If you just look at a mortgage loan from the perspective of prudent Risk Management loan principles, I would speculate that mortgages should be around 12-13% interest per year.

In a way that's what it is.

When lenders collect 5% interest on a mortgage inflated 2.4 times they indeed collect 12% interest. And that's what they do when they pass all risks to government guarantors/bail outs.

It's very simple calc. Since the lenders do not invest any real money (they just create them while creating a mortgage), it does not matter to them if they lend $360K or $150K.

Let's assume you buy a $450K house using a traditional 30y 20% down mortgage.

You put down $90K and take a $360K mortgage. Your annual interest is $18K. However, the real value (what it would be without various ways prices are artificially pumped up) of the house is $187.5K.

Would it be a free market you would take $150K mortgage with 12% interest rate. Your interest payment and lenders interest would be the same: 18K/year. The lender collects the same as in our current 5% interest world. Obviously the lender invests the same amount of work in creating $360K out of thin air as $150K. And it takes the same risk - namely zero risk, since the risk is passed away.

The differences are:
1. You pay an inflated down payment of $100K (instead of $37.5K) on house worth 187.5K. By doing this you subsidize the whole housing industry.

2. You pay inflated commissions, fees and taxes, subsidizing all kind of parasites.

3. You will pay much higher principal over the lifetime of the mortgage (with the same effects).

4. Those who would otherwise buy homes with cash as well as those who may be able and interested in quickly paying off their mortgages are strongly discourage from doing this. Indeed, why would anyone spend $500K of cash on a property worth less than $200K.

But worst of all, this has devastating effects on the overall economy. It causes overbuilding of oversize houses, in areas often not appropriate for residence. It causes huge unnecessary financial investments. It supports very low standards of American residential construction. It causes waist of energy. etc, etc, etc.

On top of all this it is subsidized by debt we all assume (not only those miserable home-debtors).

>>Unfortunately, due to the aggregate of Joes, it is the same house.

LOL, and therein lies a major problem.

So important question is what is probability of housing market conditions to return to Free Market, seeing current Fed behavior doesn't look likely..

michaelsch says

investor90 says

If you just look at a mortgage loan from the perspective of prudent Risk Management loan principles, I would speculate that mortgages should be around 12-13% interest per year.

In a way that’s what it is.
When lenders collect 5% interest on a mortgage inflated 2.4 times they indeed collect 12% interest.

Not sure of the logic of this since they are selling a spread between the cost to borrow - say 1% and the cost to loan - say 6%. That's a 5% margin on the loan amount. The fact that your virtual interest rate is 12% based on the perceived intrinsic value of the home is irrelevant. What is relevant is the increased risk of reduction of asset value. When the asset value declines and the loan is then sold (to govt or otherwise) then the NEW purchaser of the debt has a virtual 12% interest rate. But by that time the originator has already lost his shorts.

Would it be a free market you would take $150K mortgage with 12% interest rate. Your interest payment and lenders interest would be the same: 18K/year. The lender collects the same as in our current 5% interest world. Obviously the lender invests the same amount of work in creating $360K out of thin air as $150K. And it takes the same risk - namely zero risk, since the risk is passed away.

The lender is taking on much more risk on the 360k/5% mortgage since his margins are lower and his risk of equity erosion is higher. It is never zero risk, unless the originator immediately sells the mortgage on the secondary market at a profit.

4. Those who would otherwise buy homes with cash as well as those who may be able and interested in quickly paying off their mortgages are strongly discourage from doing this. Indeed, why would anyone spend $500K of cash on a property worth less than $200K.

This can actually be WORSE for the high mortgaged investor since he has reverse leverage working against him as prices decline, i.e. he can lose far more than his initial investment when it goes under water. His main advantage is he can walk away and stick it to the bank, whereas the outright purchaser is stuck with the loss.

OK--several posters have written since my last post, so I feel I must at least answer them. I think most understand my feelings that Headset is correct, but that in no way does he describe a "bubble". He describes a free market economy. Think of oil prices. One day they are $40, then a few years later they are $80. It's the same oil. But market conditions have changed--namely supply and demand. Same as housing prices change with changes in mortgage rates. Lower rates create more qualified buyers, therefore more demand, therefore higher prices. Not a bubble.

Now--Rogerer's last post was interesting. The end at least. The beginning is the same arguments that I don't agree with. The disparity between prime rate and interest rates could create some unusual conditions. I'll have to think about that one. Oh--and I thought I had made the argument that interest rates are still historically low. Thanks for having my back. You made my point though--the bubble burst during a period of low rates. Because of mortgage defaults--not because of rising mortgage rates.

Justme--you state that the prime rate has little to do with mortgages. But this topic is concerning the Fed and interest rates--you realize that the Fed doesn't set mortgage rates, right? The Greenspan quote is interesting. I will do some research to see the context in which it was made. Here's one for you. From Wiki-- "Robert Shiller does compare interest rates and overall U.S. home prices over the period 1890–2004 and concludes that interest rates do not explain historic trends for the country.[22]" Another one "Some believe that mortgage standards became lax because of a moral hazard, where each link in the mortgage chain collected profits while believing it was passing on risk.[70] Mortgage denial rates for conventional home purchase loans, reported under the Home Mortgage Disclosure Act, have dropped noticeably, from 29 percent in 1998, to 14 percent in 2002 and 2003."

I'll try to state my contention a different way. Imagine that you are a broker/Wall St. investor/bank or whoever is making the loans. Even if I gave you a supply of free money--ie 0% interest rate--would you loan it to someone that you knew wasn't going to pay you back? Of course not. So the only way these guys would make these loans is if they didn't understand the risk involved. Or if they were only concerned with next quarters financials and not 2-3 years down the road when the shit hit the fan...

tatupu70 says

Lower rates create more qualified buyers, therefore more demand, therefore higher prices. Not a bubble.

It was not just the low rates, but the accompanying low lending standards that shifted the demand. Note "shifted the demand." as in not just an "increase" in demand, but a shift of the demand curve itself. If that is not a bubble, what would be?

Now you may have a point about interest rates themselves not increasing prices, but only if credit itself is tightened up. When very few people qualify for a loan at a going 4%, it will have less of an effect than when all mirror foggers qualify when the rate is 6%.

Bottom line: Lax lending at low rates shifted the demand curve for houses far enough to push prices well above the level supportable by current earnings (wages of the owners or rents from the houses), i.e., a bubble. Remove the easy credit and the demand curve shifts back to reflect demand based on current earnings.

What makes a cake a cake? Is it the flour? The sugar, the frosting? Or is it the process of baking everything together that makes it a cake? We can argue, but at least we can all call it a cake!

Well, most of us, that is. Tatupu70 cannot even agree that what looks like a cake is actually a cake. He is basically saying that bubbles are not bubbles because they are the result of natural free market forces at work. As I've said previously, there is nothing natural or free market about outright manipulation of interest rates. He may however, be right in the purist sense that low interest rates ALONE do not necessarily produce a bubble. I'm at the point where I can agree with that, since it clearly requires other things like availability of credit, etc. We should all stop arguing that point with him, since no one can prove him wrong.

However, to say that no bubble exists is ludicrous, whether it is a housing bubble or an oil bubble. Anyone can see - at least after the fact when prices come down - that we get financial bubbles. The question is: what causes the bubbles? It certainly is not the normal supply and demand cycle as Tatupu suggests. Actual physical demand for oil at $149/barrel was not significantly higher than it was at $40 or now again at $80.

Speculative demand is a different story. But this gets right back to how we are all being played by the powers that be in these bubbles. Those with the power of money - whether it be the Fed, the World Bank, market makers, Goldman Sachs, hEdge fund managers, or anyone else with a financial edge can influence the markets quite severely by seeding it. All it takes is a momentary push out of balance and a trend gets started which can feed on itself.

This kind of thing has been going on since there have been markets. It's just that now, in the age of instant electronic communication, things can happen much more quickly and more severely. That's what we're seeing in the last decade. Is it a coincidence that virtually ALL of the major bubbles of the last 30 years have occurred since the wide spread use of the internet? (1 exception was the crash of '87, but that also is known to have been caused by computer trading programs). Most of the others have happened in the last dozen years since the internet. Markets have become extremely liquid in this era, contributing to an exaggeration of every bull or bear trend. More players, IRAs, 401Ks, all add to liquidity and demand. And all are highly intertwined with electronic information systems. This sets up the conditions for a bubble, needing only the added ingredient of speculation in the mix.

This is where the big players have a major edge since they control the money. They now just have a bigger pool in which to make bigger waves. But these are not the natural waves of free market capitalism. These are market manipulations, pure and simple, instigated by those with colossal assets and seemingly infinite leverage. The Fed is the prime example as discussed in my first 2 posts above. But there are others. I'm starting to see that Goldman Sachs seems to have their greasy fingers in just about every pie (and cake too).

Does it strike anyone else that the most sensible and intelligent independent investors, by and large, are losing their shirts in ALL of todays markets? I'm speaking of the average Joe taxpayer/home buyer/401k holder. He is constantly lured into the notion that he can profit by buying into the latest bubble. The money controllers see to it that he has a stake in the game, whether voluntarily purchasing that new home, or involuntarily participating in a bailout of those that manufactured - and already profited from - the bubble. It's all part of the boom/bust cycle, and this has been going on for a very long time, even before the Fed. The winners are always those who can best manipulate the system, the ones with the power and the money. And they make money both on the way up and on the way down, since they know exactly what's coming. So lets see... who gained the most from the current housing market boom and bust? If we can answer that question, we may not need to debate the ingredients of cake any longer.

He describes a free market economy. Think of oil prices. One day they are $40, then a few years later they are $80. It’s the same oil. But market conditions have changed–namely supply and demand.

In this case, at least, demand had decreased. It was speculation/trading that drove that particular commodity into the stratosphere. It's distortions like this and other X factors that preclude any notions of a free market economy.

You all need to put on some tinfoil hats. Thats right I said you all need to PUT ON some tin foil hats.

in the 21st century western world there is basically nothing to spark the human ambition in a sincere way. We have medicine, food, shelter, water, and energy. We have effortless sexuality no matter where you sit on the fence (asexual, mysogionist, breeder, homosexual, voyer,etc)

All of the subsidies that can be built in, have been built in for just about anyone to live any life they choose regardless of race, color, or creed. And gone past the concept of subsidy. Things like public education, national defense, etc are becoming part of a Jungian shared conciousesness.

That is the worst thing that can happen for the types of people whose personality can only be fed from activism. They have worked themselves out of a job. The only thing sparking thier plugs is to send the economy on a roller coaster ride to get the reactions and profits that can be taken from the friction. Otherwise we'd all just drink 1 gallon of fresh water from the tap every day. 3 glasses of good wine. 3000 calaries of the best food this world has ever seen. Two asprins and call each other in the morning on our cell phones.

Housing is the 4th rail of politics. There is no 5th rail. Get used to manipulation, now and forever.

Rogerer,

That was an excellent post.

>>Tatupu70 cannot even agree that what looks like a cake is actually a cake.

It is a problem that Tatupu70 wants to engage in sophistry rather than talk straight.

>>He may however, be right in the purist sense that low interest rates ALONE do not necessarily produce a bubble.

He was not explicit enough to make it clear that this is what he meant. He did say:

>> Low rates in and of themselves don’t cause a bubble.

He did not claim explicitly that interest rates are NOT a factor, but he did try to argue with data that the correlation between (prime) rates and housing inflation was low, which I took (and I think reasonably) as an argument that interest rates are an irrelevant factor.

Here's what I would say:

Low interest rates are a NECESSARY condition for a financial bubble to form, but not a SUFFICIENT condition. Other factors, such as low lending standards, also have to be present.

But if taken to the extreme, I bet I could ignite one hell of a housing bubble if I was in a position to force mortgage interest to ZERO, and grant loans based on the borrowers ability to pay off the principal.

Rogerer says

michaelsch says

investor90 says

If you just look at a mortgage loan from the perspective of prudent Risk Management loan principles, I would speculate that mortgages should be around 12-13% interest per year.

In a way that’s what it is.

When lenders collect 5% interest on a mortgage inflated 2.4 times they indeed collect 12% interest.

Not sure of the logic of this since they are selling a spread between the cost to borrow - say 1% and the cost to loan - say 6%. That’s a 5% margin on the loan amount. The fact that your virtual interest rate is 12% based on the perceived intrinsic value of the home is irrelevant. What is relevant is the increased risk of reduction of asset value. When the asset value declines and the loan is then sold (to govt or otherwise) then the NEW purchaser of the debt has a virtual 12% interest rate. But by that time the originator has already lost his shorts.

Would it be a free market you would take $150K mortgage with 12% interest rate. Your interest payment and lenders interest would be the same: 18K/year. The lender collects the same as in our current 5% interest world. Obviously the lender invests the same amount of work in creating $360K out of thin air as $150K. And it takes the same risk - namely zero risk, since the risk is passed away.

The lender is taking on much more risk on the 360k/5% mortgage since his margins are lower and his risk of equity erosion is higher. It is never zero risk, unless the originator immediately sells the mortgage on the secondary market at a profit.

In fact most of the "conforming" loans, and (I carefully described a "conforming" loan) are sold very quickly. Mostly to FMA or FMC (i.e. the taxpayer) others - to naive foreign "investors". Those that banks kept are now sold to the Fed. Please don't tell me this wasn't in initial plans of the lenders. Nobody ever made a BAD loan not counting on future bailout.
The cost to borrow is irrelevant as well. In most cases mortgages are considered as valid reserves. (At least in case they are kept by FMA etc., the reserve requirements were never applicable in their case.) The lender only needs to borrow for a very short time and not more than 10% of the amount of the mortgage and even this was never enforced even in case of private lenders. So, again, mortgage money is created out of thin air, it's not borrowed.
That's why the total amount of the mortgage DOES NOT matter. The only thing important to the lender is the total interest it may collect.

4. Those who would otherwise buy homes with cash as well as those who may be able and interested in quickly paying off their mortgages are strongly discourage from doing this. Indeed, why would anyone spend $500K of cash on a property worth less than $200K.

This can actually be WORSE for the high mortgaged investor since he has reverse leverage working against him as prices decline, i.e. he can lose far more than his initial investment when it goes under water. His main advantage is he can walk away and stick it to the bank, whereas the outright purchaser is stuck with the loss.

So... How is it WORSE for the high mortgaged investor? The most he can lose is his down-payment (plus fees and taxes). As long as the losses are higher he just walks away. The bank does not lose much since the mortgage is bailed out. The only loser is the taxpayer and the overall society.