Participants Will Emerge... as Fed Withdraws From Mortgage Securities?

I love to read quotes by Fed Officials... Here is one I just read here on Bloomberg:

“Our capital markets are deep enough that I’m not as worried about the ability to be able to fund those mortgages,” he told an audience Tuesday at a commercial real estate conference in New York. “Price will change, and I think market participants will step up as the price changes.”

So Mr. Rosengren, why has it taken 8 years for you to think markets are deep enough to not be worried about the ability to fund mortgages?  And what rate / price change will be necessary for them to do so?  And when do you think this will be possible?

The thing is, you and your comrades over at the Fed should have allowed this adjustment to start happening 5 or 6 years ago.  Instead you have artificially propped up mortgages, holding unrealistically low rates for far to long now, so long in fact that you have allowed the creation of bubble housing prices in at least a dozen, maybe as many as 20 markets in the US.  These are not irrelevant markets, they are huge metropolitan areas where prices have already surpassed the bubble peaks of just a decade ago.  This time, YOU are the MBS market!  YOU have allowed / created the bubble and NOW you state you are confidant the "market" will pick up the slack at "adjusted prices"...

Well Mr. Rosengren, what is that price?  My guess is the highest quality mortgages in non-bubble market cities would need to yield north of 6.5% in TODAY'S interest rate environment to bring back private investors with bubble markets. Less then true AAA mortgages will need to be north of 8% for the same.

Now, lets fast forward to 2019 when YOU bubble creating Fed officials have managed to back interest rates to "normal", say long bond 6%+ and short end 2%+ where do you think mortgages need to be then to bring in participants, cause my dear Mr. Rosengren they will not be in the market before then.  How many people will have serious mortgage servicing issues then, with average auto loans at $38,000+ with 7 year terms, average college debts $100k with lifetime payoff terms, and an increasing number of mortgages going under water as the bubble you created starts to correct as interest rates jack up?  How many folks will purchase those $1 million dollar houses at 7% or 8%?

You are in a catch 22 sir.  I suggest you go very slowly and steadily now as you suggest and push congress to stop sitting on the sidelines about Fannie / Freddie and find a way to provide serious liquidity to the mortgage industry as you wonderful Fed officials start to retreat from the market.

OH, but maybe I am wrong... Maybe those "bubble" prices are actually reflecting the global loss of purchasing power of all "major currencies" as the money printing machines across the globe find the wealthiest people parking it in hard assets because bricks and mortar will not vanish like the purchasing power of soon to be highly irrelevant fiat currencies. The most reckless policies in human history, from the ponzi-scheme government debts, over extended private citizens to the reckless money printing of central banks all come crashing down...

Are Americans Already Paying Dearly for Brexit?

I was reading an article today about "Shoe-Leather Costs", a somewhat esoteric paper related to money demand when I realized that of all of the formulas and assumptions related to interest rates, inflation, income and behavior related to how money is used, nothing addressed debt or more specifically, the cost of debt born by society at large.

This is starting to bug me as for some unknown reason, the more literature and articles I read about monetary policy and economic growth and inflation etc, not finding the cost of debt factored into the myriad of formulas out there trying to analyze economic realities leads me to believe the theories are broken.  Economists focus on interest rates that determine the "cost of money" in the financial sector and "interest" paid to savers but not to the larger and more impactful number, "debt costs", in their figures. In fact, contrary to one's intuition, economist and financial folks cheer when consumer debt is growing at a "healthy clip". 

Well excuse me, but at what point do these folks begin to understand, that nearly all wealth degradation and a huge amount of income stagnation over the last 40 years can be directly attributed to the ballooning of consumer and public sector debt. If the average American household now holds some $15k in credit card debt (not to mention Auto $28k, Student $50k, Mortgage $170k) with an average annual interest rate of $15% this means the average household is paying nearly $200 per month in interest on credit card debt alone.  Now, what is the average interest earned on savings? How about less then 1/2 of one percent, or if you are lucky and have enough money to sock away, 1%.

Just imagine if old values of saving money and buying a modest home while borrowing as little as possible at the lowest interest rate possible, still held.  What if the average household would have socked away $3000 in 1976 (the value of 15k 2016 dollars) and added the equivalent of $200 a month (about $50 in 1976) to this amount each month and continued to do so at an inflation adjust rate till today when they would be putting in $200 a month and the interest earned on their original $3000 kept up with inflation (yes interest rates on savings accounts were nearly 7% in 1976 while inflation was around 6%).  Where would this household be today?  I did some crude math, adjusting the interest and contributions every 5 years for inflation and interest rates and found they would have somewhere around $185,000 in the bank.  This compares to an average net worth (not including mortgages) of about $45k for Americans age 55-64. 

Mind you, I only did this fun little exercise on this lazy hot Saturday afternoon in Washington based on the $15k in credit card debt and the lost "savings" due to interest payments.  Why don't you have fun doing the math for auto loans and student debt, which is ballooned astronomically, and why?  Because the parents of the children reaching college age HAVE NO MONEY cause they paid it all out in interest their entire working lives!  (NOTE: Average overall household interest costs totals over $6500/year.)

I could go on, but all this discussion misses the title and point of my writing today.  For whatever reason (easy manipulation of the numbers over a 20 year or so period until 2014 when the ICE Benchmark Administration (IBA) took over the Administration of LIBOR?), many American lending institutions switched Mortgage loan interest from using US interest rates, ie One year treasury or more recently one year constant maturity rates or CMT as a base rate, to using London Inter-Bank Offer Rates or LIBOR plus their customary 2.25% or whatever. 

This little move means that millions of American mortgages are tied to in interest rate set in London, the capital of a nation that just voted to exit the European Union which could, though has not thus far, create volatility and instability in London rates.  Why is this important?  Well, the one year LIBOR rate now stands at 1.52% vs .85% one year ago.  Meanwhile the one year CMT or Constant Maturity Rate in the US is about .58%, the 11th District Cost of Funds rate is about .68% and the European Interbank Offer Rate is -.05% (yep that's negative).  So Americans unlucky enough to have the LIBOR rate are going to see base mortgage rates that nearly double last years rate at this time, and average 1% more then comparable US mortgage lending rates.

The change in LIBOR alone, given the historical average of 15% of outstanding mortgages being adjustable rate would result in Americans paying out about $600 million more per month or $7.2 billion per year in additional mortgage interest.  If they have credit cards and student loans also based on LIBOR this number will be significantly higher.  So you have a kind of global financial tax that the Fed can do nothing about.

So why is LIBOR so heavily used in the US today?  My guess is during the go-go days of using mortgages as the underlying "asset" for the myriad of financial "products" that were used to gamble with, the money borrowed to play was global in nature.  Hedge funds, Insurance companies, Private Equity, Financial institutions etc. from Europe, London, Hong Kong, the US and every "off shore" domicile imaginable all played with money borrowed and lent at international interest rates so why not base the underlying asset's interest rates on the same global lending rate paid by the gamblers... and so now you have it.