I was a kid in the 1970s. I recall the high (at the time) gas prices. I recall my good income parents fretting constantly about inflation and taxes and the enormous effort they made to economize. They shopped groceries in bulk (we had a large family) and had a garden.
But looking back I think much of their economic consternation was a product of attitudes imprinted on them in their youth from the Depression and WWII rationing. I think that because I also recall my dad's coworkers - who would be in no better financial condition - owning lake houses and boats. I grew up "money poor" in an upper income household because my parents lived as if they would be impoverished at any moment. Now, this financial hypochondria did pay off in my parents retirement as they have always had the money to afford very good care
The financial attitudes of today held by most Americans are the polar opposite of those imprinted on the children of the Depression and WWII scarcity era. Ours is a society of "have it now, have it without consequences" opulence. Well, that is the attitude of the affluent upper half.
But consequences will come, right? The bills will come due, won't they? Or is the can that durable and the road so long the can kicking goes on forever?
My first mortgage in 1977 (UK) variable rate was 16%. Inflation was 22%, average wage settlements in unionised businesses was 14%, income tax base rate was 35%, then fairly narrow tax bands with 5% increments up to top rate 83%, reduced from 85% when a 15% supertax was introduced on unearned income to give top marginal rate of 98%. Corp tax rate was 60%.
This was post-war Socialist Britain with all key industries State-owned. The madness only ended after 1979 when Margaret Thatcher was PM and rolled back the Socialist State - incompletely as she left too much of welfarism intact.
Those who think a Socialised, centrally planned and controlled economy - which is what the Green Deal/Net Zero Carbon is - can be paid for by higher taxes and massive debt, are ignoring history.
If government policy supported the building of homes, intead of the financing of their purchase, what would be the consequence? I can appreciate there being luxury homes selling for luxury prices. I find it inexplicable that commodity homes sell for luxury prices. But that is where we find ourselves today
I laugh when I hear the "experts" say this time is different. Really? Home prices have doubled in some areas in the past two years! They have increased 25% in the past year in most places. My daughter can't figure out how any of her millennial friends afford a house where they live - entry level housing is $400,000. Since when did the median household earn $120,000?
We are witnessing the inevitable outcomes of government subsidized financialization of the economy - no one save the corporations will own anything because no one can afford to own anything. Ours has become a Rent-To-Never-Own economy.
The key relationship NOT clearly noted is house price to interest cost. Because high interest costs make mortgages more expensive, buyers can't afford as much in payments ... so those who sell, have to sell at lower prices. That nice house won't sell at $300k with 12% interest costs - maybe only $150k, with payments around $1,500 / month.
For most buyers, they buy as much house as the bank allows them. Those $72k yr/ $6k per month buyers can afford $1,500. They'll buy the best house they can find at $150k. If that house seller REALLY wants to sell his house, he'll have to lower the price until some buyer can afford it.
Current home owners, and especially recent home buyers, will be very very strongly against high or quick interest rate increases. But steady rate increases should cause a soft-landing plateau of most house prices - and hopefully also more house building (in low crime areas with good schools).
The Fed should have started 1/4 % increases last summer, and continue increasing each quarter until inflation goes down. Could easily be 8+ quarters, but that might be only a 2% increase in interest.
Since all production includes some energy costs, increases in energy costs result in all prices increasing, tho not equally. Still, all prices increasing also looks like inflation. The 70s also had two big oil-price shocks, with other prices also rising. Short term inelasticity of energy demand means a higher price only slowly reduces the amount used and paid for, as plans change.
I think there needs to be a caveat in this post that the markets are not currently predicting the ultra high interest rates which bring about the problems talked about in the post. Thus, there is some probability that we will see the dysfunction that occurred in the 1970s with extraordinarily high mortgage rates, but using the market as the best indicator of that occurring, we are presently at very little risk of a mortgage Armageddon in the US.
We should think and discuss using probabilities so we can better frame our problems and examine their likely outcomes and solutions.
If inflation drives up both wages and home prices then current homeowners make out like bandits, not current home buyers. They might make out OK, but people who bought when prices were 25-50% lower and interest (be it buying or refinancing into) rates below 4% get all those benefits without the costs. If current homeowners are making out to this extent with no risk then someone is going to be losing badly, and that is the holders of those mortgages. That is the real problem with 30 year fixed mortgages- which is a misnomer because they are only capped, not fixed, as almost none have a prepayment (ie refinance) penalty.
Arnold, you say "But the only reason for mortgage rates to hit 12 percent is if inflation is almost that high". No. You are ignoring what happened with Paul Volcker's new monetary policy in 1980-82. Interest rates rose sharply, much more than inflation. As I said in my yesterday's comment on Chile, the debt crisis of 1982 was entirely due to those sharp increases in interest rates. In 1978-1981, many Chileans contracted a large number of mortgage loans denominated in UF (the unit that takes account monthly of CPI changes-- it was copied from Colombia in the 1960s and it's still very much used for rents, loans and financial assets) and also in the U.S. dollar. In early 1982, interest rates in UF and dollars increased from 5 to 20% (actually, the mortgage premium implied both rates were at least 2-3 percentage points higher). Also, mortgage and other loans were not at fix rates but at floating rates which were adjusted at least every 6 months so servicing the stock of debt increased sharply by the end of 1982.
People should take long-term mortgage debts if they are denominated in some unit like UF and they can exit at any time their original contracts by refinancing or paying in advance without being subject to expensive penalties.
I'm pretty sure that the equilibrium, without price stickiness, would be for housing prices to fall to a level that people can afford. That's Econ 101 level - mortgages are a complement to housing, so an increase in the price of mortgages should reduce the price of housing.
Allowing for realistic price stickiness, I would expect nominal housing prices to fall slightly and trading volume to drop dramatically for perhaps five years while inflation does most of the work of bringing real housing prices down to a market-clearing price. That implies lots of layoffs in the highly-cyclical construction and housing finance businesses, which should reduce labor prices and somewhat counter the inflationary pressures (but also reduce housing demand).
Thank you for a lucid outline of financial innovations in mortgages, in response to inflation.
I'm reminded of the Chicago economics dictum: "Governments fail, use markets."
But financial innovation here looks like a series of fixes of fixes.
If complex financial innovations make mortgage markets much more opaque and uncertain for homebuyers, then there would be immense value in sound monetary and fiscal policies to achieve equilibrium at stable, low inflation.
There are solutions to all this so long as real rates do not go too high, another reason for the fed not to allow inflation to get so high (my friends and I are debating whether the Fed should have started tightening in July or September) that it then has to take drastic action to reduce it.
I was a kid in the 1970s. I recall the high (at the time) gas prices. I recall my good income parents fretting constantly about inflation and taxes and the enormous effort they made to economize. They shopped groceries in bulk (we had a large family) and had a garden.
But looking back I think much of their economic consternation was a product of attitudes imprinted on them in their youth from the Depression and WWII rationing. I think that because I also recall my dad's coworkers - who would be in no better financial condition - owning lake houses and boats. I grew up "money poor" in an upper income household because my parents lived as if they would be impoverished at any moment. Now, this financial hypochondria did pay off in my parents retirement as they have always had the money to afford very good care
The financial attitudes of today held by most Americans are the polar opposite of those imprinted on the children of the Depression and WWII scarcity era. Ours is a society of "have it now, have it without consequences" opulence. Well, that is the attitude of the affluent upper half.
But consequences will come, right? The bills will come due, won't they? Or is the can that durable and the road so long the can kicking goes on forever?
My first mortgage in 1977 (UK) variable rate was 16%. Inflation was 22%, average wage settlements in unionised businesses was 14%, income tax base rate was 35%, then fairly narrow tax bands with 5% increments up to top rate 83%, reduced from 85% when a 15% supertax was introduced on unearned income to give top marginal rate of 98%. Corp tax rate was 60%.
This was post-war Socialist Britain with all key industries State-owned. The madness only ended after 1979 when Margaret Thatcher was PM and rolled back the Socialist State - incompletely as she left too much of welfarism intact.
Those who think a Socialised, centrally planned and controlled economy - which is what the Green Deal/Net Zero Carbon is - can be paid for by higher taxes and massive debt, are ignoring history.
I am getting a strong sense of déjà vu.
If government policy supported the building of homes, intead of the financing of their purchase, what would be the consequence? I can appreciate there being luxury homes selling for luxury prices. I find it inexplicable that commodity homes sell for luxury prices. But that is where we find ourselves today
I laugh when I hear the "experts" say this time is different. Really? Home prices have doubled in some areas in the past two years! They have increased 25% in the past year in most places. My daughter can't figure out how any of her millennial friends afford a house where they live - entry level housing is $400,000. Since when did the median household earn $120,000?
We are witnessing the inevitable outcomes of government subsidized financialization of the economy - no one save the corporations will own anything because no one can afford to own anything. Ours has become a Rent-To-Never-Own economy.
The key relationship NOT clearly noted is house price to interest cost. Because high interest costs make mortgages more expensive, buyers can't afford as much in payments ... so those who sell, have to sell at lower prices. That nice house won't sell at $300k with 12% interest costs - maybe only $150k, with payments around $1,500 / month.
For most buyers, they buy as much house as the bank allows them. Those $72k yr/ $6k per month buyers can afford $1,500. They'll buy the best house they can find at $150k. If that house seller REALLY wants to sell his house, he'll have to lower the price until some buyer can afford it.
Current home owners, and especially recent home buyers, will be very very strongly against high or quick interest rate increases. But steady rate increases should cause a soft-landing plateau of most house prices - and hopefully also more house building (in low crime areas with good schools).
The Fed should have started 1/4 % increases last summer, and continue increasing each quarter until inflation goes down. Could easily be 8+ quarters, but that might be only a 2% increase in interest.
Since all production includes some energy costs, increases in energy costs result in all prices increasing, tho not equally. Still, all prices increasing also looks like inflation. The 70s also had two big oil-price shocks, with other prices also rising. Short term inelasticity of energy demand means a higher price only slowly reduces the amount used and paid for, as plans change.
I think there needs to be a caveat in this post that the markets are not currently predicting the ultra high interest rates which bring about the problems talked about in the post. Thus, there is some probability that we will see the dysfunction that occurred in the 1970s with extraordinarily high mortgage rates, but using the market as the best indicator of that occurring, we are presently at very little risk of a mortgage Armageddon in the US.
We should think and discuss using probabilities so we can better frame our problems and examine their likely outcomes and solutions.
If inflation drives up both wages and home prices then current homeowners make out like bandits, not current home buyers. They might make out OK, but people who bought when prices were 25-50% lower and interest (be it buying or refinancing into) rates below 4% get all those benefits without the costs. If current homeowners are making out to this extent with no risk then someone is going to be losing badly, and that is the holders of those mortgages. That is the real problem with 30 year fixed mortgages- which is a misnomer because they are only capped, not fixed, as almost none have a prepayment (ie refinance) penalty.
Arnold, you say "But the only reason for mortgage rates to hit 12 percent is if inflation is almost that high". No. You are ignoring what happened with Paul Volcker's new monetary policy in 1980-82. Interest rates rose sharply, much more than inflation. As I said in my yesterday's comment on Chile, the debt crisis of 1982 was entirely due to those sharp increases in interest rates. In 1978-1981, many Chileans contracted a large number of mortgage loans denominated in UF (the unit that takes account monthly of CPI changes-- it was copied from Colombia in the 1960s and it's still very much used for rents, loans and financial assets) and also in the U.S. dollar. In early 1982, interest rates in UF and dollars increased from 5 to 20% (actually, the mortgage premium implied both rates were at least 2-3 percentage points higher). Also, mortgage and other loans were not at fix rates but at floating rates which were adjusted at least every 6 months so servicing the stock of debt increased sharply by the end of 1982.
People should take long-term mortgage debts if they are denominated in some unit like UF and they can exit at any time their original contracts by refinancing or paying in advance without being subject to expensive penalties.
I'm pretty sure that the equilibrium, without price stickiness, would be for housing prices to fall to a level that people can afford. That's Econ 101 level - mortgages are a complement to housing, so an increase in the price of mortgages should reduce the price of housing.
Allowing for realistic price stickiness, I would expect nominal housing prices to fall slightly and trading volume to drop dramatically for perhaps five years while inflation does most of the work of bringing real housing prices down to a market-clearing price. That implies lots of layoffs in the highly-cyclical construction and housing finance businesses, which should reduce labor prices and somewhat counter the inflationary pressures (but also reduce housing demand).
Thank you for a lucid outline of financial innovations in mortgages, in response to inflation.
I'm reminded of the Chicago economics dictum: "Governments fail, use markets."
But financial innovation here looks like a series of fixes of fixes.
If complex financial innovations make mortgage markets much more opaque and uncertain for homebuyers, then there would be immense value in sound monetary and fiscal policies to achieve equilibrium at stable, low inflation.
How to fix government?
There are solutions to all this so long as real rates do not go too high, another reason for the fed not to allow inflation to get so high (my friends and I are debating whether the Fed should have started tightening in July or September) that it then has to take drastic action to reduce it.