What The Recent Surge In Rates Means For Your Home Purchasing Power

Contrary to what one may have read in the financial tabloids, a houseing market does not recover thanks to Fed-subsidzed REO-to-Rent loans used by the biggest private equity firms to buy up distressed property on the margin, by foreign oligrachs buying Manhattan triplexes sight unseen just to park ‘tax-evaded’ cash courtesy of the NAR’s anti money-launderingexemption, and by foreclosure stuffing from the big banks desperate to subsidze the market higher before the sell into it. The recovery comes from the average consumer, who has disposable income and savings (in a hypothetical scenario of course) and who can buy houses based on a given monthly budget – a budget which must provide a better deal to own than to rent.
The problem with such a budget is that first and foremost its purchasing power is dependent on interest rates, and in an economy in which leverage is everything, rising rates mean a collapse in purchasing powerHere is a glimpse of what has happened to the mortgage rates in the past month alone: from Bloomberg’s Jody Shenn:
Wells Fargo & Co., the largest U.S. mortgage lender, is offering 30-year fixed-rate loans at 4.5 percent, according to its website, up from 4.13 percent on June 18 and 3.88 percent on May 22, when comments by Bernanke to lawmakers and the release of the minutes of the last Fed meeting caused bonds to plummet. Freddie Mac’s survey, which is lagging behind the bond slump because it reflects originator responses through yesterday, showed average rates falling to 3.93 percent this week.
So in one month, the average 30 year fixed rate mortgage has jumped by over 60 basis points. What does this mean for net purchasing power? Well, as the chart below shows, assuming a $2000/month budget to be spent on amortizing a mortgage (or otherwise spent for rent), it means that suddenly instead of being able to afford a $425K house, the average consumer can buy a $395K house.
This means that, all else equal, housing just sustained a 7% drop in the average equlibrium price based on what buyers can afford.
But assuming the current selloff in rates continues, things are going to get much worse: we may be seeing 5%, 5.5% even 6% and higher mortgages in the immediate future.
It also means that a buyer who could previously afford a $506K house with a $2,000 monthly budget at an interest rate of 2.5% will be able to afford only $316K if and when the average 30 Year fixed hits 6.5%: a 40% drop in affordability based on just a 4% increase in interest rates!
And this is bullish for the economy?
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Imminent US real estate market crash

Imminent US real estate market crash

  1. Lumber is near term low, which usually tracks with homebuilders.  Very simple to understand, lumber is still primary material to build houses.  Housing recovery built on faith
  2. Institutional players entered market such as BlackRock and JPMorgan (and many others) now exiting.  Smart money getting out of stocks and real estate These new investor buyers have been artificially inflating the market in many areas.
  3. Fed policy – Fed will stop buying mortgage securities  This will drive the cost of financing through the roof.
  4. Demographic shift, baby boomers retiring and new generation not buying more houses.
  5. Lack of foreign support – Due to a global tax witch hunt, and a European banking crisis, foreigners who previously supported US market will support to lesser extent
  6. Job crisis – while unemployment figures officially claim we have a job recovery, companies are laying off workers in record amounts.  Unemployed people don’t buy houses.  Workers who are laid off may have to sell their house.
  7. Bond market collapse – For those retirees who keep their money in bonds, with the pending bond market crash they will have less money to pay for their houses.

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Fed much more upbeat about outlook

WASHINGTON (MarketWatch) — The Federal Reserve on Wednesday signaled greater optimism about the economic outlook, forecasting that the unemployment rate could fall to 6.5% by 2014, one year sooner than the central bank had previously estimated.
In its policy statement, the Fed said downside risks to the outlook had diminished and that the labor market had shown further improvement.
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Bankers: Do not Pass GO, Do Not Collect millions and Go Directly to Jail!

A new banking report is published today in the UK.
There are jobs that nobody wants to do really, aren’t there? As your kids are growing up, you hope they don’t ask you one day to come and sit down as they have something serious to talk to you about. Dread! You know what’s coming: “Hey, mom, dad, I’m…I’m going to be a…a banker!”. Then, your whole life falls apart. It’s like being on a par with gutting social-unacceptable jobs like debt-collector and bailiff, isn’t it? The money might be there, but the morals aren’t?
Well, George Osborne, Chancellor of the Exchequer of the UK, has all eyes focused on him with the idea of the century, it seems. A banking commission headed by Conservative MP, Andrew Tyrie has made 80 recommendations to make the banking sector the place you want your kids to work in when they grow up. Morals will change and the banking will be a good job to have!
George Osborne is giving the Mansion-House (residence of the Lord Mayor of London) speech to the city tonight, an annual speech in which the Chancellor of the Exchequer traditionally gives his impression of the state of the British economy. It seems rather unlikely that he will announce some of the recommendations to the bankers that will be seated at the tables in front of him, however. Not unless he wants them to choke on the spicy ingredients that he have been concocted. These include making bankers wait up to ten years to receive bonuses and going to prison. Heard it all before? Thought it? Dreamt of it? The Report did it.
George Osborne, Mansion House Speech

George Osborne, Mansion House Speech
The report is a hefty two-volume reader’s digest of what to do and what not to do in the banking system, entitled “Changing Banking for Good”. Snazzy little tittle that can be read in two different ways as well. Well done Mr. Tyrie. Only a few pages into the report it states that past regulations and supervisory controls had:
  • “little realistic prospect of effective enforcement action, even in many of the most flagrant cases of failure”.
It goes on to state that:
  • “remuneration has incentivised misconduct and excessive risk-taking, reinforcing a culture where poor standards were often considered normal”.
To take out the excessive risk-taking from the lives of bankers in the workplace, the report puts forward the suggestion not only that the bankers should receive the bonuses after a period that could last up to ten years (now that’s time to forget what you have actually done to get the bonus, isn’t it?) but also that the remuneration be in bail-bonds. It also suggests that for wider cases of misconduct remuneration should be cancelled and that if the taxpayer has to foot the bill, then they should definitely not be made. We know from a recent report from the Chartered Institute of Personal Development also that the majority of bankers are in agreement. They think that they are paid excessive amounts and sometimes they don’t know why they get all the money they do. So, if we all agree, let’s cut the bonuses and improve regulation. What are we waiting for?
Bankers: Bonuses

Bankers: Bonuses
The report states that banks have failed the UK in ‘many respects’. £133 billion have had to be injected in bail-outs, amounting to £2, 000 per every person in the UK today. But, it seems that it is also the shareholders that have been let down too. They have had ‘poor long-term returns’.
Excessive risks that were taken in the period leading up to the financial crisis were not down to miscalculation of mathematical equations that boiled down to the bankers getting their sums wrong, but to the fact that the banks were and still are too big to fail. They are able to take greater risks because they are too complex and too enormous. We can’t let them fail and that they know only too well. It’s all very well saying ‘yes, let them fail and then they will see’. But, what will the average person be eating then? Bread and water will be more than just dietary supplements, they will become the staples. Banks today have access to cheaper credit. Their success is determined not so much by the careful and planned placing of financial equity, but the guarantee that lies steadfastly behind them.
The report clearly states that bankers should not flippantly refuse to accept that public anger at high salaries is purely jealousy-driven or petty ignorance. “Rewards have been paid for failure”. Bonuses may have fallen, although the report points out that this has been off-set by fixed-pay rises.
It has also been suggested that there needs to be greater equality in terms of employing women. Women take fewer risks traditionally on the trading floor and so the report asks for employment policy to be changed in banks.
Senior bankers have also come in for a belting from the report, accused of wearing blindfolds as to their responsibility. They are accused of being so far removed from the misconduct that they have ended up being admonished of all responsibility. The report suggests that a prison sentence would certainly make senior officials think about what is being done. The report states that it would “give pause for thought to the senior officers of UK banks”. However, to what extent would senior officials of any bank really consider their potential criminal liability? It also raises the question as to what extent it would be possible to actually see a conviction and criminal liability recognized in a court of law?  Hard to prove.
The reports can be found here.  Enjoy! If anything actually gets done. Previous suggestions were already ignored by the British government with regard to changes in the banking sector and the report states that it is “disappointed” that this has happened. Aren’t we all?
However, clearly the report states quite a few home truths; things that the average citizen has been feeling and voicing for many a year now. But, until now that has been largely left just as words from angry and jealous members of the public that also want to strike it rich and get paid for doing wrong. Now though, how long will the suggestions that have been made be ignored and how long will the Chancellor of the Exchequer be able to turn a deaf ear to what is being said? The report comes at a timely moment; Mr. Osborne looks like he may still have time to rectify his speech for tonight’s dinner!
The report states “An important lesson of history is that bankers, regulators and politicians alike repeatedly fail to learn the lessons of history”. This time it is (apparently) different. Bankers and everyone else have learned the lessons. Have they?

What do you think? Are bankers going to repeat history or have they learned from their mistakes?

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