11/14/2010

Are Lower Interest Rates the Gas to Fuel the Economy?

The article, "Stable Home Prices, Low Mortgage Rates Could  Gas Economy", suggests the possibility that stronger home prices and further reductions in interest rates, could be what is needed to push the economy in the right direction. 

The author, Stephanie Armour, presents the facts that 30 year loan rates are at 4.17%.  Median home prices in the 3rd quarter were up in 50% in metro areas whereas last year they were only up in 20 of the same metro areas.  Also, the Fed says that it will be putting 600 billion into long term treasuries by June 30th of 2011.  Since May of this year, 30 yr. rates have been below 5% and improvements in home prices have been made even though home purchases fell after the Fed canceled the home buyer tax cuts.

The drop in long-term mortgage rates will entice many more people to refinance drop the cost of their mortgage.  This could increase discretionary income and therefore further spending by the population on the whole.  This could help jumpstart the economy or at minimum give it a boost.

The biggest problem getting the boost to the economy that is needed is that many in the position to need refinancing have poor credit or little equity.  These factors will limit the ability of some to qualify to refinance.  I feel that the lower rates do and will entice people to refinance.  Refinancing will give people more cash to spend getting caught up and possibly ahead in their finances.  Looking at the whole situation from a realist point of view, I'm not confident that there will be enough qualifying individuals to achieve the level of refinances necessary to have a large enough impact.  Therefore, the effect will not be enough fuel to get this economy rolling.

6 comments:

walla walla said...

I agree. I am not optimistic that low interest rates will be enough to put the economy back on track. As mentioned, not enough quality people will qualify for refinancing, or for that matter, new loans, and thus this prerogative has its limitations.

What I believe needs to happen is banks need to reevaluate their lending practices and start lending money again. Having personal experience trying to get a loan during this down economy, I can talk with firsthand knowledge in regards to how difficult it is for consumers with good credit to qualify for financing.

I understand that part of the reason why our economy is so bad is due to the fact that banks were too loose in their lending practices. However, I now believe banks are too tight and are forgoing profitable transactions.

Kimball said...

The article states that long-term interest rates will drop because of the $600 billion in bonds that the fed will buy over the next 8 months or so. I question how effective the reduction in interest rates will be in boosting the economy when the dollar is further devalued by the increase in money supply. I think that inflation will outweigh any benefit gained by the reduction of interest rates in consumers' minds. There are some rumors that living expenses could skyrocket from this move. We need organic growth!

Here are some additional articles that were interesting.

http://www.bloomberg.com/news/2010-11-03/federal-reserve-to-buy-additional-600-billion-of-securities-to-aid-growth.html

http://www.washingtonpost.com/wp-dyn/content/article/2010/11/08/AR2010110806587.html

denver said...

The rates on mortgage loans have already been dramatically low for quite some time so I don’t think that lowering the rates anymore is going to solve the issue. The problem is that there are a lot of consumers that don’t qualify according to current lending practices. As Walla Walla” stated, the banks have tightened up…

We are seeing lenders go back to traditional textbook lending and this is a difficult shift when you have so many people that have lost their jobs and homes and don’t have the down payments, job time, credit or equity to refinance or purchase.

Banks have been given the money to lend and are being told to lend, but in the other ear they are being told by their regulators that they better not make bad loans. This is a tough spot for banks to be in and so they remain cautious.

Both banks and consumers have issues right now and that is not even mentioning the rest of the mortgage crisis that hasn’t hit the fan yet. Consumers are a little hesitant because the future doesn’t look good in the immediate future and banks are hesitant because they don’t want to lose any more money than they have to.

Somehow, I don’t see lower loan rates as the answer to this whole problem. We need to think of a better solution. I think Kimball is right, we need some organic growth! Let’s put a little capitalism back into our economy.

Vladimir said...

If we are lucky we maybe half way through the foreclosure problems. Failures will happen into 2012. It's no longer the sub-primes that are causing the problem. I think we are headed for a double dip in housing prices.
I suggest the best way to insure this is to get the government out of the housing business. If the person does not have the credit, assets, and/or income it's fine with me for the lender to supply the money. But, if the borrower defaults the lender needs to be liable for the losses, not the tax payer.

delta said...

I too think the potential benefits from the $600 Billion is so minimal that it is not worth the cost. I do think that the issue is so complicated and with all the political agendas in the mix it is hard o believe that fiscal policy is truly in the best interest of the average person. I would like to see more efforts being made to promote innovation and technological advancements in our country.

Dave said...

-1 on Delta for poor editing.

Wow. You folks don't actually believe this nonsense, do you?

For any macro-enough group, prices are a wash. Rising prices help suppliers but hurt demanders, while falling prices do the opposite.

The argument here is basically that because one price (of homes) is going up, and one price (of loans) is going down, that the world will be a better place.

This is the sort of nonsense that has to be repeated over and over again, because people don't believe it, or understand it, but they're quite willing to mimic things that hear a lot.

And OMG (and I'm really tempted to stick the F in there ... but this is a family blog), refinancing is a hobgoblin we need to be getting rid of. Obviously, it's often a financially beneficial decision for homeowners. But, this is largely because we eliminated the "deductibility" of all other interest payments in 1986. It's no wonder then, that shifting those payments to deductible mortgage interest makes sense. This is actually the Modigliani-Miller theorem in action: rearranging your assets and liabilities can't create value unless it is in response to some (often boneheaded) policy. The idea that refinancing real estate loans to free up cash for spending is watered down Keynesianism. The spending part is Keynesian. And the backhanded way of changing spending is a testament to the inability of our policymakers to actually pull off the Keynesian policy prescription in the conventional way.

Walla Walla is on the right track. Why on earth are we worried about mortgage rates, when the role of financial institutions is to funnel money to productive enterprises?

Kimball's point is OK, but the worry about inflation is a more medium-term one. It's quite possible for them to "get away" with expansionary policy in the short-run.

Denver echoes Walla Walla's points. But Denver misses the point that "rates ... have been low for some time" meaning they won't have much effect is the argument from earlier in the text about how problematic it is to consistently influence purchases of durable goods. Maybe people don't want to buy new houses because a lot of them just moved into (fairly) new houses.