Cheap Mortgages: No Boost to Housing The drop in interest rates reflects deflation, not an opportunity. In India, Real Estate inflation has been managed through a cosy nexus between Developer-Dealer.It will be stupid to expect the link to continue for long, as over-supply and unsold inventories force Realtors to cut price or go bust. Key Shorts remain DLF, Unitech, HDFC and GIC Housing.
The US Should be The Big Example Here
ONE OF THE SILVER LININGS in the clouds that hang heavy over the global financial markets is steep drop in U.S. Treasury yields, which has pulled down long-term mortgage rates in their wake.
This isn't first financial crisis to have had this salutary side-effect. But unlike previous such episodes, this drop in mortgage rates is unlikely to give a similar boost to housing. And that goes a long way towards explaining the debt-deflation predicament in which we now find ourselves.
As Monday's Wall Street Journal pointed out on Page One ("Mortgage Rates Decline"), the (mostly) unexpected plunge in Treasury note yields in reaction to the deflationary downdraft from the European sovereign credit crisis has lowered the 30-year mortgage rate for Americans to under 5%, to 4.86% to be exact.
This isn't the first time that a financial crisis originating far from U.S. shores worked to the benefit of U.S. home borrowers. Back in the fall of 1998, the near-collapse of the Long-Term Capital Management hedge fund following the emerging-market debt crisis that culminated in Russia's debt default sent Treasury yields and mortgage rates sprawling.
Global investors flocked to the safety of U.S. government securities, which drove up their prices and pushed down their yields. Back in 1998, however, there was a significant difference: the government-sponsored enterprises Fannie Mae (ticker: FNM) and Freddie Mac (FRE) were considered nearly on par with Uncle Sam as quality credits. Events a decade later would force the federal government to put the mortgage giants into conservancy.
In 1998, Fannie and Freddie revved up their mortgage-making machines. The GSEs sharply boosted their then-coveted debt securities borrowings. That provided them with the wherewithal to step up their purchases of mortgages.
Meantime, Fannie and Freddie also ramped up their issuance of mortgage-backed securities, which, like their direct debt obligations, were sought after for their triple-A credit quality stemming from their implicit federal backing. And, in an ironic twist, Fannie and Freddie also became active purchasers of those same mortgage-backed securities.
That's because the yield spread between Fannie and Freddie directly issued debt and their MBS widened as a result of the volatility in the debt market. Fannie and Freddie took advantage to expand their balance sheet and boost their earnings.
In the process, the rate on the 30-year fixed rate mortgage fell to a then-record low of 6.56% in September 1998. "The strong economy, combined with a low-interest-rate environment, helped to push MBS issuance to a new high, as both mortgage originations and refinancings reached record levels," the Bond Market Association commented at the time. Indeed, MBS volume doubled in 1998 to over $700 billion.
In other words, mortgage money was plentiful and cheap in no small part because of Fannie and Freddie. All of which spurred home buying and building as well as consumer spending. The American consumer thus was the direct beneficiary of the flight of capital from the risky emerging debt markets to the safety of the U.S. mortgage market. And the party would play on for nearly another decade.
Much has changed since. While capital is coming to America again -- witness the strength of the dollar and the Treasury market -- U.S. homebuyers do not seem willing or able to take advantage of it.
According to the Mortgage Bankers Association, mortgage applications to buy new homes fell 27% in the latest week to the lowest level since the trade group began keeping in track in 1997 -- even with an average 30-year fixed-rate mortgage at just 4.83%, the lowest since last November.
Refinancing volume did perk up by 14.5% as opportunistic borrowers sought to take advantage of the low rates -- perhaps to splurge but more likely to pay off other, higher-cost debt.
The sharp drop-off in purchase applications is almost certainly the result of the end of the tax credit of up to $8,000 for first-time and certain other home buyers on April 30. The largesse from Uncle Sam gave a 7.6% boost to existing-home sales last month and will likely to be felt in the May and June data. (Under the rules for the tax credit, buyers had to sign contracts by April 30 and close by June 30 to qualify. Home resales are counted at closings.)
The tax credits most likely only affected the timing, not the total, of home purchases, accelerating them to meet the deadline. And with the lapse of the subsidy, there already are signs that housing sales and prices are dropping ("Housing Begins to Fade Without a Spur")
One unintended consequence of the improved home resale market resulting from the tax credit and lower mortgage rates has been a surge in the number of houses for sale.
Inventories of unsold homes jumped 11.4% in April, to over 4 million units, almost all single-family homes. That strongly suggests that prospective sellers, who had held back while the market was weak, are returning now that market conditions apparently have improved.
It's unlikely that near-record-low mortgage rates can overcome this supply coming onto the market, which will be augmented by record foreclosures as lenders try to catch up with their backlog of bad loans.
Ultimately, the disparate responses to lower mortgage rates demonstrate how it really is different this time.
In 1998, during an asset inflation, borrowers leapt at the offer of cheaper financing. Rising asset prices plus cheaper costs of liabilities equaled rising wealth.
During a debt deflation, however, asset prices fall while the value of the associated liability remains fixed, resulting in reduced wealth. Expectations of lower asset prices elicit more sales, which puts more downward pressure on prices. Lower borrowing costs can't offset that squeeze.
So, one cheer for the drop in mortgage rates. They are the result of the deflation that is deepening.
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Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.
Nothing in this article is, or should be construed as, investment advice.
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