{"id":626,"date":"2011-10-17T20:50:00","date_gmt":"2011-10-18T00:50:00","guid":{"rendered":"http:\/\/rentpost.com\/blog\/?p=626"},"modified":"2023-05-29T20:25:49","modified_gmt":"2023-05-30T00:25:49","slug":"curb-your-capitalism-the-federal-open-market-calamity-and-dis-interest-rates","status":"publish","type":"post","link":"https:\/\/rentpost.com\/blog\/realestate-news\/curb-your-capitalism-the-federal-open-market-calamity-and-dis-interest-rates\/","title":{"rendered":"Curb Your Capitalism\u2026 The Federal Open Market Calamity and dis-Interest Rates"},"content":{"rendered":"

\"\"<\/a>As short-term political motivation sullies the sanctity of central banking, presumptuous open market meddling, unrestrained by the boundaries of logic, makes a ticking time bomb of Federal Funds. It\u2019s time we meditate on circumstance, accounting for the rational and the hardly so. Let\u2019s see: inflation without spending? A stagnant, yet expanded money supply? At what point did capitalism become so irrational? What brought life to our economic paradox? The distant thunder of a self-imposed inflationary storm demands anticipation; it will not subside with neglect, and survival is a blessing left only for the aware, but it is the keen that will thrive. Stay informed, and stay ahead.<\/p>\n

<\/p>\n

Interested in buying a home? Starting a business? Great, now is the time, but remember, financing structure means everything<\/em>, and no matter the appeal of financial opportunity, don\u2019t be dollar shy of tedious attention to the origin of money. Don\u2019t be fooled by the money supply\u2019s patchwork facelift.<\/p>\n

To ye eager borrowers, fix your interest rate for the life of the loan, even if it means settling for higher-than-advertised rates.<\/p>\n

To the do-it-yourself, asset managers: fixed-income debt securities (and preferred stock!) will <\/em>quickly corrupt portfolio value, and if liquidity is a must, fixed income is a must-go.<\/p>\n

Skeptics could dismiss these words as an attempt at virtual attention, as no economic prediction justifies proactive portfolio re-assessment (sigh)<\/em>. To this I say: comfort yourself in the warmth of explanatory blog posts and news feeds, but do not justify apathy by paralyzing over analysis. Without a doubt, U.S. economic forthcomings are riddled with macro-mystery. Nevertheless, SOARING interest rates are a certainty in the coming years. I do not write for the sake of exploring a prediction; my purpose is to warn and advise against potential catastrophe.<\/p>\n

Your orders are simple: Buy now, and lock it up.<\/span><\/em> The curious real estate predicament occupying economic brainwaves has an upside. Historically low prices and mortgage interest rates flood the market with opportunity for both bargain-scavengers and property virgins (who can buy). The shortage of qualified buyers makes for a pressure free environment those elite consumers, still able to purchase real assets; however, prices only tell half the story. For too long, housing prices were the standard measure of affordability. Funny, even in the wild post-Clinton years of the 0% down payment, buyers focused on the home price, rather than the mortgage terms. The structure of a loan dictates affordability, not the price, especially<\/em>, when down payments are inconsequential.\u00a0 Enough already! Interest rates direct real estate traffic; how about this example:<\/p>\n

Two friends, Tip and Bop each buy a home, Tip for $500,000 and Bop for$300,000. Tip has an excellent credit score and initially puts 10% down, but immediately borrows back the down payment in the form of a home equity loan, resulting in an effective loan rate of 4.1% on the full $500,000. Bop waits a few months later than Tip, and because of climbing interest rates, little collateral, and a mediocre credit score, Bop winds up with a 8% fixed interest rate on a $300,000 loan. Despite a significant price difference in the homes, Tip pays $2,415 monthly (for a $500k home), and Bop pays $2,201 monthly (for a $300k home). Both effectively spent $0 day 1, but Tip buys (nearly) twice the home for a mere $200 more per month. If Tip purchased Bop\u2019s home, his monthly payment would have been $1,449\/mo \u2013 a 35% discount. Think of it another way: In order for Bop to lower his monthly payment to $1,449 with the same financing structure, he would need to negotiate the sales price from $300,000 down to $200,000.<\/p>\n

So, I must ask: why do declining prices appeal to buyers more than declining interest rates? Obviously, this does not apply to those purchasing with cash, but you get the point.<\/p>\n

The average price of U.S. homes has dropped 20% since its 2006 peak.\u00a0 While the 30-year fixed rate dropped from a 2006 climax of 6.88% down to 3.95%. So now, look at the $500,000 home in 2006, with a 6.88% interest rate, the monthly payment was $3,286. Let\u2019s Factor in the effect of a 20% decrease in price to $400,000; that takes the monthly payment down to $2,629 ($2,293\/mo if interest only) . Instead let\u2019s look at the effect of a 3.95% interest rate on a $500,000 home. With the new interest rate, the monthly payment is $2,372 ($1,645\/mo if interest only). Now, we can observe the impact of a decreasing interest rate compared to decreasing prices. I give this example only to show the impact of interest rates, and how delicate your financing structure is to the affordability of your purchase. So, now you might be able to anticipate the effects of increasing interest rates in your financing agreement. Just take a look at the charts below, summarizing this paragraph.<\/p>\n

As you can see, the change in interest rate has a much higher effect on the monthly cost than the change in price.<\/p>\n\n\n\n\n\n
Interest + Principle<\/em><\/td>\n2006 Price ($500k)<\/strong><\/td>\n2011 Price ($400k)<\/strong><\/td>\n<\/tr>\n
2006 Rate @ 6.88%<\/strong><\/td>\n$3,286\/mo<\/td>\n$2,629\/mo (20% decrease from 2006 cost)<\/td>\n<\/tr>\n
2011 Rate @3.95%<\/strong><\/td>\n$2,372\/mo(28% decrease from 2006 cost)<\/td>\n$1,898\/mo (42% decrease from 2006 cost) <\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n\n\n\n\n\n
Interest Only<\/em><\/td>\n2006 Price ($500k)<\/strong><\/td>\n2011 Price ($400k)<\/strong><\/td>\n<\/tr>\n
2006 Rate @ 6.88%<\/strong><\/td>\n$2,867\/mo<\/td>\n$2,293\/mo (20% decrease from 2006 cost)<\/td>\n<\/tr>\n
2011 Rate @3.95%<\/strong><\/td>\n$1,645\/mo (42.6% decrease from 2006 cost)<\/td>\n$1,316\/mo (54.1% decrease from 2006 cost)<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

The same $500,000 home in 2006 may be purchased now at $400,000 with interest rates down to 3.95%, taking the monthly payment down to $1,898.15<\/p>\n

Now, why does this matter? Even though prices may continue to drop, interest rates have already bottomed out<\/em>. The Federal Reserve has already exhausted its ability to create liquidity in this economy, and the Federal Reserve\u2019s target Federal Funds rate essentially dictates what the 30 year fixed mortgage rate will amount to. The current Fed. Funds target rate is 0-0.25% – nothing! <\/em>Since we know the Fed. Open Market Committee has almost no more room to force rates down; we may readily acknowledge the bottom of Mortgage Interest Rates. Why is this true? Well here is the extremely abridged version: Fed. Funds rate is driven down when the Fed. Reserve puts money into the economy by purchasing Fed. Agency Securities in exchange for cash. The additional cash creates a surplus over member bank reserves, which the member banks then loan out in the short term to lock in some profit from the otherwise stagnant funds. The Federal Funds Rate is the rate banks may borrow overnight from one another to meet reserve requirements, so banks borrow money from others, issue loans with the added $$ (while not dipping below reserve requirements), resell those loans in the secondary loan market at a profit (in this case, usually Fannie Mae and Freddie Mac), and repay the loan the next day.<\/p>\n

So what do we know? The rate at which banks access the funds used to supply mortgages cannot go any lower, so you cannot expect your mortgage rates to go any lower. Now, combine that with the added knowledge that interest rates have a greater effect on the cost of owning a home than do the prices of the home. What do you get? In all likelihood, the effective cost to homebuyers will never be lower than right now, even if prices continue to drop. Waiting for prices to bottom out will cost you money every month for the next thirty years, in the form of higher interest rates. Buyers must strike with low rates; forget the fear of price fluctuation. Take the time to understand how mortgage rates come to be, and learn the variables of influence.<\/p>\n

You may have realized inflation persists, despite the fact Americans are less able to make purchases. Doesn\u2019t make sense, huh. Normally, if there are fewer buyers, prices drop (deflation). However, we\u2019re much too unique to conform so easily. The average American spends 12% of her disposable income on energy (oil\u2026<\/em>), and the oil market is dictated by OPEC, since American\u2019s have a relatively inelastic demand for oil (meaning the price can increase without demand going down very much). American\u2019s also spend 12% of disposable income on food. For a while, oil prices stayed high because of increased foreign demand (Japan, India for example), but even after that demand decreased, the prices stayed up because the decrease in value in real estate, turned investor speculation toward commodities, and the strongest commodity at the time: oil and oil futures. So, commodity speculation kept oil prices high, and American trade (food for oil) kept food prices high, as well as speculation in agro-commodities.\u00a0 So what we have are two products American\u2019s cannot part with, food and oil, both maintaining high prices, despite a shortage in American buying power. Americans are paying more money for the same products, while earning less.<\/p>\n

\"\"<\/a>The federal reserve sought to combat the disastrous conflict by cutting the Federal Funds Target Rate as low as possible, attempting to increase the purchasing power of a dollar (by making it cheaper to acquire), and thereby encouraging spending and money circulation. Nevertheless, inflation still outpaced Federal Reserve efforts, and interest rates are still low. It is only a matter of time before America can start taking advantage of the low cost of borrowed money, and borrow we will! Because our cost of living is still increasing, America will rely on borrowed money to regain the purchasing power it once had, meaning the demand for borrowed money will be enormous, and once banks manage to make the surplus of cash available to the public, borrowing activities will take off like a slingshot.<\/p>\n

So what does this mean to you? Well, when lending goes crazy. First, the heightened demand for borrowed money will cause the price of borrowed money to increase (the interest rates), and because America must also compensate for a devalued dollar, the demand for borrowed funds will, by necessity, be exaggerated. Normally, the Federal Reserve would be able to limit dramatic jumps in market interest rates; HOWEVER, the Federal reserve will not be able to taper off this great liquidity surge because it has already purchased Federal Funds to its max extent. This means the U.S. government is, for all intensive purposes, the only player in the Fed. Funds market, and the interest on Agency securities will not be attractive when investment money will be able to achieve much higher interest rates and return in other market sectors. Agency securities just wont have enough bang for the buck, so the Federal Reserve will not be likely to sell the securities back in an effort to take money out of the money supply.\u00a0 Interest rates will be free to soar without limitation, and the effects will be catastrophic. Fixed income securities of today will become worthless, as the interest rates will not be attractive. Variable rate loans will bankrupt the borrowers, as loan interest payments will become prohibitively expensive. But don\u2019t be fooled by the apparent paradise of spending and money circulation that will proceed the time of despair; American\u2019s will spend their way into crises, as everything will be based off of debt. And demand, when unchecked, will rise until the world\u2019s greatest ponzi scheme self-implodes. You don\u2019t have to be a part of it! Secure yourself from now, lock in your rates, and don\u2019t worry so much about the potential of lower prices. (yes, I know this doesn\u2019t apply to all cash purchases).<\/p>\n

If you\u2019re interested in and capable of buying a home, do it now, but protect yourself from the inflationary storm on the horizon. Protect your dollar (I could get into how, but I\u2019ve already said enough), and position yourself for success, no matter what we name our economic turmoil. In America\u2019s history, never have the evil stars been so aligned. Interestingly enough, America\u2019s only hope is to stay in a recessed, stagnant economy until the dollar sufficiently deflates, so the proceeding borrowing frenzy will not be overly exaggerated, in an effort to compensate for a de-valued dollar.<\/p>\n

Remember the theme of this message \u2013 interest rates have bottomed out, and the inevitable climb will come fast, meaning\u2026 NO FLOATING RATES! Forget they exist; I understand them from lender and re-purchaser perspective, but don\u2019t let the short-term appeal make you a prisoner in your own home.\u00a0 Thirty-year loans are better than fifteens, especially for those with extra cash to purchase fixed-income investment securities after interest rates climb. You might find AAA preferred stock paying 7-9% annual interest later on, which will net out a positive portfolio cash flow, accommodating for the mortgage payment.<\/p>\n

As a final note \u2013you may wonder why this threat, if present, would not be recognized by those in charge of the country\u2019s economic well-being \u2013 those far more qualified than I. Simple: politics baby! Remember, political motivations are always in the short term; Presidents need to gain re-election, so when America wants economic recovery, and elected officials are expected to deliver. Congress oversees the Federal Reserve, and congress lusts over the time when spending increases, and money seemingly surrounds us all. Most elected officials will be out of office by the time the easy money makes life hard on America. Just keep that in mind. Now, to conclude. Remember\u2026.<\/p>\n

Be careful!!! The Federal Reserve has exhausted its open market tools of money-control. Do not<\/em> underestimate the dangers of a money supply in anarchy. Today\u2019s opportunists could become the prey of tomorrows housing market. In short, market interest rates can hardly avoid an upward blast.<\/p>\n

\"\"<\/a><\/p>\n

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As short-term political motivation sullies the sanctity of central banking, presumptuous open market meddling, unrestrained by the boundaries of logic, makes a ticking time bomb of Federal Funds. It\u2019s time we meditate on circumstance, accounting for the rational and the hardly so. Let\u2019s see: inflation without spending? A stagnant, yet expanded money supply? At what […]<\/p>\n","protected":false},"author":42,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":false,"jetpack_social_options":{"image_generator_settings":{"template":"highway","enabled":false},"version":2}},"categories":[5,6],"tags":[108,115,116,119,244,247,283,284,285,306,310,461,470,613,621,714,815,1126],"class_list":["post-626","post","type-post","status-publish","format-standard","hentry","category-realestate-news","category-opinions","tag-borrowing","tag-buy","tag-buy-now","tag-buying-home","tag-economic","tag-economy","tag-federal-funds","tag-federal-funds-rate","tag-federal-reserve","tag-fixed-rate","tag-floating-rates","tag-inflation","tag-interest-rates","tag-mortgage","tag-mortgage-rates","tag-politics","tag-real-estate","tag-time"],"jetpack_publicize_connections":[],"aioseo_notices":[],"jetpack_sharing_enabled":true,"jetpack_featured_media_url":"","jetpack_shortlink":"https:\/\/wp.me\/p4cqZp-a6","_links":{"self":[{"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/posts\/626","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/users\/42"}],"replies":[{"embeddable":true,"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/comments?post=626"}],"version-history":[{"count":1,"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/posts\/626\/revisions"}],"predecessor-version":[{"id":5273,"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/posts\/626\/revisions\/5273"}],"wp:attachment":[{"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/media?parent=626"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/categories?post=626"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/rentpost.com\/blog\/wp-json\/wp\/v2\/tags?post=626"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}