There seems to be this mentality that low interest rates come with no consequences. While one sector of the economy may benefit from this, primarily the housing and financial system, there are other net losers. This is also coming at a tremendous cost. Our public debt is growing at a fast clip and we are likely to breach another debt limit shortly. While some are narrowly focused on activity in their own markets they fail to answer the broader questions. Will this trend be sustainable? Are we simply seeing the pent up demand rushing in thanks to constrained inventory coupled with historically low rates? Throw in the typical summer seasonal selling heat and it is a recipe for a boom. I want to look at a longer-term perspective since the cheerleading articles are now out in mass (of course they rarely discuss which high paying job sectors are going to boost real wealth for families overall). What is the cost of the low interest rate?
Low interest rate drag
I’m not the only one noticing the downside of low interest rates. The data shows that we are now pushing costs in other areas of the economy:
Source: JP Morgan
So net US household interest income is pushing record lows. This is actual money coming out of the pockets of American consumers. One negative aspect being discussed is that this low rate delays retirement for many Americans. Inability to retire with smaller job selection might be a reason for the persistently high unemployment rate for younger Americans (a key future home buying group). Since many older Americans shift to fixed income products as they age, a low rate in effective slashes income (i.e., bonds, CDs, etc). I doubt many retirees are going to be flipping houses as a secondary source of income to Social Security although investments in real estate suggest a chasing of yield.
When we look at savings rates they are abysmally low in the US. So this is a key reason why FHA insured loans have been a big mover of the current housing market. Like many readers, I have heard of many first time buyers getting loans or gifts from family members to subsidize their first home purchase. Yet this isn’t new money being created but equity simply being shifted around. As the chart above demonstrates, the cost of low interest rates has other impacts in the broader economy.
Has housing really recovered?
Nationwide housing prices do look to have reached a bottom and sales are up. Yet this bottom is largely due to low interest rates allowing households with stagnant incomes to purchase more home (higher price) and the slow methodical leaking out of inventory from banks. Yet is this really translating to a better overall economy?
California sales have taken off in 2012. In many markets bidding wars are back. Rarely do we ever see a deep analysis of household incomes and their debt-to-income ratios. Some think just because the government is backing every loan that somehow things are all rosy. FHA insured loans are seeing a growing rate of defaults. Keep in mind this is a due diligence loan with a very low down payment. That is, lenders are examining the total income and debt profile and yet people are still facing problems. Let us not even discuss the 11 million nationwide home owners that are underwater.
Let us however examine the key metric of the economy with looking at job growth. Since California benefitted the most from the bubble and took one of the largest hits, let us see how the two sectors linked to housing are doing today:
Construction employment is down 40 percent from the peak and FIRE sector employment is down 17 percent. You notice a recent trough but certainly no resurgent boom. These are typically better paying jobs, at least those in the FIRE sector. California still has a headline unemployment rate of 10.8 percent and an underemployment rate of 20 percent. These rates are incredibly high and play into the annualbudget deficit issues we face.
The expanding public debt
The rate that public debt is increasing is historical:
The debt limit was increased from $15.194 trillion to $16.394 trillion on January 30, 2012. At latest count we already are up to $15.908 trillion (an increase of over $714 billion just this year alone). At the moment as a safety bet, the US can still attract capital at low rates. But for how long?
The psychology behind recent buying involves the following:
-Low rates have pushed leverage up even with stagnant incomes
-Rental parity in many markets exists (in some US places it is cheaper to buy than rent)
-Low inventory. If I’m looking to buy and most do not follow the micro and macro housing trends, they simply ask their real estate agent what is out there. Limited inventory in better markets causing bidding wars.
The problem of course is that this is not being pushed by underlying stronger economic fundamentals. As many readers have pointed out, the issues at hand include:
-Globalization of employment and push for lower wages for competition (i.e., Europe, US, etc).
-Younger less affluent future buyers. How much can they really afford and do they want to buy?
-Bifurcated nature of economy (wealth inequality at record levels)
On the last item, I think this is where we get the many e-mails and stories of “I remember a few decades ago when I was able to buy with my blue collar job.” In many cases, these people live in equity trapped houses but still find themselves living in a high cost area. Many will sell but the new buyers are more likely your high income or dual-income household looking for the California property ladder race in a prime location. Interestingly enough the only stabilizing force was artificially shutting down the inventory pipeline and forcefully lowering interest rates to historical lows.
Based on the bidding war stories you would think that boom times are just around the corner. Sales have picked up but put into perspective we are returning to more normal volume:
The big question is longer term. Here is an interesting psychological twist since some seem so narrowly focused in their own tiny niche market because they bought or somehow have a bias to their area. Back in 2006 in the early days of the blog the California unemployment rate was 4.8 percent. Tax revenues were flush. Home sales and prices were hot. So I completely understood the argument from some bulls at that time regarding their notion that housing would continue to boom (plus, the real global economy was flush with credit, stock markets were soaring, and more importantly unemployment was very low). Even then, it was easy to take the other side of the fence perspective. Today with unemployment in California up to 10.8 percent and with 20 percent underemployment and state budget deficits for years to come, this bidding war mentality that you will be priced out is hard to understand. Rates are so low, that even a further drop will do very little in purchasing power. We are already having spillover costs as you can see from the first interest income chart above. Ultimately some people want to believe that they bought or sold at tipping points in markets. Yet that would presume we somehow have an open market right now.
It’s ironic that we first went from some denying shadow inventory, to then acknowledging it was there but not an issue, to now having banks essentially leaking out this inventory to control price. This is not a market by any standards. I’ve noticed more talk recently of cutting or lowering the mortgage interest deduction by politicians. Do you think that will have an impact on say a market like California?
- The dog days of summer – Americans are losing consumption power because of lower rates at the expense of subsidizing more housing. The psychology of today’s boom. (doctorhousingbubble.com)