Low Mortgage Rates -
Prosperity & Diminishing Benefit
Quantitative Easing, QE, in its various forms, is an
activity that drips monetary policy directives into the economy and builds
potency like medicine in your body. See Definition Below. When you take a pill, you want immediate
results; however, medicine does not work that way. That is why antibiotics are taken over 5 -6
days to build potency and eliminate its target.
Get impatient and take too much medicine and there are
consequences. With respect to QE, these
consequences occur as risk profiles change and rates rise, creating an
optimistic mentality in the economy. If
the correct dose of monetary policy is applied, the scenario plays out well for
all; however, if too much is applied, a point of diminishing return can occur,
slowing the economy to the next recession and or depression. You need just enough medicine to cure the
patient and not create a terminal event.
The issue is there are no directions, the weight of the patient is
unknown, and the illness being treated is not clear. Odds are with an overdose at some point in the next 5 years.
The US economy is still absorbing QE 1–3. This level of stimulus is historic. The normal result of a QE 1 is some level of
inflation once the economy recovers.
With QE 1-3, inflation is a given at some point. It is a matter of when
and how much. There is no data to
correlate the outcome of the current level of stimulus in the economy from QE
1-3. It will cause home prices to rise,
inputs to home construction to rise, and equity markets to rise. People feel better about life in general when
their stock portfolio rises and their homes are more valuable. As a result of this “happy…happy” time,
everyone loses sight of 2008 and buys stock at highs, new homes, vacations,
cars etc. which creates the expansion cycle.
In my opinion, we are about to experience one of the best periods we
will ever see in the Real Estate Industry.
If QE 1-3 was the correct dose of medicine, this will all play out
nicely with little disruption or dislocation.
We will know in a few years as the full effect of QE 1-3 is absorbed by
the US economy.
History
proves there is a point of diminishing return of lower mortgage rates for
Consumers and the Real Estate Industry.
Every 7-8 years everyone – Mortgage Borrowers, Realtors, and
General Business – cheers the decline in the rates needed to stimulate the
economy out of a slump. This stimulus is
necessary and generally short-lived.
The backlash of low rates is normally tighter credit for
borrowers and home builders. The lower
rate environment excludes many participants in two important segments of the
Real Estate Industry. Why does this
happen? In an economic slump, there is a
flight to safety and some builders and consumers get caught off guard and
experience various levels of financial hardship. Banks and Secondary Markets all take the same
path and tighten credit to protect their balance sheets until a recovery is on
the horizon.
While rates remain low, there is a corresponding tighter
credit policy. Banks retain their risk adverse posture until there is
visibility on a better risk return profile.
Builders and Developers have to seek private money or borrower
construction perms to fund projects, thus constraining inventory. Once banks can earn an acceptable return for
risk at higher rates, they will open the gates to their coffers and housing
will take off.
Banks and Secondary Markets think a lot like a
consumer. If you were offered .25% for
your $5,000 in savings, you are probably indifferent between stashing the money
under your mattress or depositing it into your savings account. In an economic decline, trust is lacking and
the mattress looks good. If you are
offered 5% at the bank, you are probably willing to take additional risk for
the return and do not want to forgo the interest for the safety of your
mattress. As a result, you put your
money to work in the bank’s capital structure.
The same logic is used at Banks.
If rates are low, they prefer to mitigate risk and put it in safe
instruments like Treasuries or other instruments with low risk. When yields are higher, they assume more risk
and put their deposits to work which provides the capital to expand the economy
further – especially the Real Estate Industry.
The same holds true for consumers. They will accept higher risk as they feel
better about the economy and their income prospects. Even though rates are higher, consumers tend
to buy homes when they are confident. The
same holds true for the stock market.
Most consumers never buy during a correction and tend to buy when highs
are reached and euphoria exists in the market.
The current low rates are not stimulating new home buyers; however, as
rates rise credit will moderate which stimulates new home purchases from the new
entrants to the housing market. At the
same time, Bank’s will adjust their posture and fund builders and developers which
will create a surge in inventory.
Economic slumps given time will generally seek an
equilibrium in the free market; however, the government usually does not have
time to allow a natural solution to occur.
This is what occurred in “The Great Recession”. As a result of necessity or political
pressure, our government engaged in monetary policy initiatives to stimulate
the economy.
Everyone should want rates to normalize and seek their
natural higher level based on current economic data points. It will be great for Consumers, the Mortgage
Industry, Real Estate Sales Industry, and Builders / Developers.
Cal Haupt
Chairman and CEO
Southeast Mortgage of Georgia, Inc.
www.southeastmortgage.com
Quantitative easing
(QE) is an unconventional monetary
policy used by central
banks to stimulate the economy when standard monetary
policy has become ineffective. A central
bank implements quantitative easing by buying specified amounts of financial
assets from commercial banks
and other private institutions, thus raising the prices of those financial
assets and lowering their yield,
while simultaneously increasing the monetary
base. This is
distinguished from the more usual policy of buying or selling short-term government
bonds in order to keep interbank interest rates
at a specified target value.
