Finally, a constructive piece on the mortgage market

Now here’s an interesting thing: Mike Mandel, on his blog, has managed to avoid

the housing mania which seems to have overtaken much of the rest of the blogosphere,

myself included. No talk about credit crunches, no talk about housing-led recessions,

no doom-mongering in general.

And now he’s written an eminently sensible and well-balanced cover

story for Business Week on the new era of cheap credit. Yes, there are some

risks involved, but let’s not lose track of the big picture, he says: the benefits

are even greater.

The low cost of capital is probably going to last "five to seven years,"

says Samuel Zell, who as chairman of real estate firm Equity Office Properties

Trust (EOP ) watched bidders wield cheap debt in a fight over his company.

(Blackstone Group, with a $39 billion bid, won out on Feb. 7.) James W. Paulsen,

chief investment strategist at Wells Capital Management (WFC ), sees an even

longer horizon: "This could be a prolonged cycle where the cost of capital

is low [for] 10 or 20 years."

It is, indeed, a low, low, low-rate world.

Easy money is creating all sorts of economic benefits. Corporations are making

capital investments again—and with their borrowing costs so low, profits

are still zooming. Private equity firms are using loads of cheap debt to buy

companies at jaw-dropping prices. Even the housing market, which boomed for

five years on cheap money, hasn’t fallen apart. It’s gliding to a soft landing

rather than a hard crash, allowing consumers to keep spending. "We are

in this era where financial innovation and product structuring, particularly

in the debt markets, has been very stimulative," says Henry H. McVey,

chief U.S. investment strategist at Morgan Stanley (MS ). Zell puts the state

of rates in similar terms: "I think that’s going to be a growth accelerant

around the world."

There’s even a sidebar

specifically on the property market, and that, too, is balanced and constructive

– to the point where, almost uniquely for a mainstream publication, something

nice is said about the CDS market!

So this is the much-feared "housing bust"? Bust Lite is more like

it. Existing-home prices are as high as they were a year ago, while sales

have receded only to 2003 levels. The only extreme decline is in construction:

Builders are trying to get rid of the houses they’ve already built before

they put up more. The overhang of unsold homes could be back to normal by

around midyear…

Low rates are still keeping a floor under housing. Thirty-year mortgage rates

are no higher than in June, 2004, even though the Fed has since pushed up

the federal funds rate by 4.25 percentage points. It’s the same in Britain,

where long-term rates have actually fallen since 2004 despite short-term rate

hikes by the Bank of England. No surprise: After a brief lull, Britain’s housing

market is booming again…

Credit default swaps, which let people bet for or against a bond or loan’s

creditworthiness, have also improved transparency. If investors bet heavily

against an issuer’s securities, its lending costs are driven up. "This

pushes out the marginal lenders," says Whalen. That creates a healthier

market—and ultimately, lower rates.

So when the likes of Dan Gross

and Nouriel Roubini

tell you that the sky is falling, just remember that low interest rates

are a good thing – and that people who think they can time the market

are nearly always wrong.

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8 Responses to Finally, a constructive piece on the mortgage market

  1. brad setser says:

    low interest rates are a good thing if you want to borrow money, but only if the price of the thing you want to buy hasn’t been bid up … the int. costs on half a mil at 10% are the same as the int. costs on a million at 5% … (and then yuou have to come up with a wee bit more principal)

    low interest rates, by contrast, are a good thing if you are looking to sell something as well — as it increases the price others are willing to pay …

    that said, I had a very different take on mandel’s article than you. It seemed to attribute low interest rates to almost exclusively to financial innovation. perhaps true. but the biggest change in US and european financial markets over the past few years (And a spur to a low of the innovation) was the enormous upsurge in inflows from official institutions in the emerging world. most would say those inflows have reduced int. rates by about 100 bp. That didn’t even get a mention. and it no doubt is the dominant factor explaining low rates.

    the story mandel wants to spin is innovation in the US and europe lower rates, and the rubes out in the emerging world still have unsophisticated financial systems that cannot intermediate effectively, so they lend their funds out to the world …

    which sort of misses a lot of things — the government restrictions on Chinese banks that keep the banks from lending, heavily sterilization and above all massive intervention that prevents the financial system in emerging markets from intermediating the money their citizens and int. investors alike want to hold in local currency assets.

    a low rates story that doesn’t mention central bank reserves or petrodollars strikes me analytically incomplete.

  2. Lord says:

    Are low rates really a good thing? Low rates really tell us there is not much worth investing in and rather than saving we should spend. That doesn’t make for promising future.

  3. Felix says:

    I’m not sure I agree with you, Brad. How much do central bank inflows reduce interest rates? No one knows, and I think you’re stretching a little with your “most would say” — “most”, I think, wouldn’t have a clue.

    In any case, my point wasn’t that Mandel’s story was “analytically complete”. Just that it was constructive, as opposed to sky-is-falling. Which makes for a refreshing change.

  4. muzza says:

    Felix, you’re back tracking. When you describe an article as “eminently sensible and well balanced” you are a lot closer to calling it “analytically complete” than anything else.

    I read Mandel’s story and see someone who kinda sorta understands some of the issues creating and fostering global liquidity, pays some lip service to the odd credit bust-up or two, but has fallen for the prognostications of those who would have us believe this can last for years!

    He – and you – clearly love the wholly unsubstantiated wishful thinking of Zell and Paulsen. Come on, if Gravedancer Zell were to say anything negative right now, do u think Blackstone would be so keen to buy his EOP?

    And the last line is just a riot: “Whatever shocks are ahead,” says del Missier, “the markets are better positioned to deal with them than they’ve ever been.”

    Based on what? We hear this in every single cycle, Felix. Such exuberance might not yet be irrational. But there’s little foundation for it.

  5. Felix says:

    Based, muzza, on the fact that the risk is being held by those who want it, and that there’s so much liquidity that shocks need to be much bigger than ever before they cause any systemic problems.

    And maybe the reason you hear this every single cycle is because it’s true every single cycle. The markets have, over time, become better and better at responding to shocks.

  6. muzza says:

    There is a rather large amount of room for pain between the bipolar “no risk vs systemic risk” that seems to infuse your posts.

    My point is simply that there is very little that’s fair, balanced or well founded in the kind of pseudo hubristic crap predicting “this’ll last for years” and “we’re so much better than before”.

    People can hold all the risk they want; doesn’t change the fact that they can still lose money.

  7. Felix says:

    Well, duh. That’s what risk means. If you can’t lose money, you’re not holding risk. My point is that low interest rates mean that risk is cheaper than ever, which is a good thing, because it helps drive the economy. (Surely you’re with me so far: higher interest rates put the brakes on an expanding economy.) What we want is more, cheaper risk — so long as that risk doesn’t end up causing something like inflation (bad), or systemic collapse (very bad). That’s why I’m concentrating so much on systemic risk — because if systemic risk is low, then increased risk in general is good. Of course I’m not saying that there’s no risk: I’m saying that there’s lots of it, and hooray for that.

  8. Felix,

    My thanks for providing a bit of a palliative for Roubini’s understandable but somewhat overdone calls for Doom. I’m in secured consumer finance and my basic feeling is that we’ve seen an increase in stress and some pressure on credit quality, but nothing of the sort of systemic crisis that Nouriel is calling for. I myself chalk a lot of the apparent increase in stability to the rapid advances in securitization technology.

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