Baby what a big surprise Right before my very eyes
Yesterday it seemed to me My life was nothing more than wasted time But here today you've softly changed my mind
Chicago -- Baby What a Big Surprise
I recently wrote that mortgage interest rates hit a five-month high. The real story isn't that interest rates moved higher, it is that mortgage interest rates went up quickly, and the reasons for that move are not centered in real estate.
Rates have been going down along with mortgage demand and home sales since the expiration of the tax credits in the spring of 2010.
Unfortunately, the rise in interest rates is not being caused by a resurging economy paying a premium for capital. The economy is still in the doldrums, home sales are way down, the banks own a lot of homes, and they will ultimately foreclose on many more. Rising mortgage interest rates will hurt pricing and sales volumes. The weight of inventory will push prices lower.
Has the bond market finally turned? And if so, what is this going to mean for you and your money?
Here's the answer to the first question: It sure looks like it.
The interest rate on five-year Treasury bonds has nearly doubled to 1.9%. The rate on the 10-year has rocketed to 3.2% from 2.4%. The 30-year bond is now paying 4.4%—nearly a full percentage point more than it was at the lows a few months ago. (Bonds work like a seesaw: The yields rise when the price falls.)
At the peak of the boom, about six weeks ago, investors in bond funds lined up to buy Wal-Mart Stores bonds in the hopes of earning 5% a year for 30 years. How's that working out? So far they have already seen their first year's interest effectively wiped out, as the bonds have slumped about 5% in price since the sale.
The usual caveats about forecasts—namely, that nothing in this business is certain—apply. Nonetheless, this looks ominously like the end of the bond mania.
Bonds were a bubble but for a different cause. The real estate bubble was formed because people drove up prices chasing appreciation. The bond bubble was formed because people drove up prices chasing capital protection and cashflow. To much money chasing too few opportunities bids up prices to unsustainable heights.
The reasons are partly positive and partly negative.
The positive: Fears of deflation, and a second economic downturn, have receded. As a result, it isn't just that the yields on regular bonds have risen. So, too, have the yields on inflation-protected government bonds.
But then there are negative reasons. Bonds looked seriously overvalued. Yields were desperately low. They offered little reward and a lot of risk. Meanwhile, the governance and finances of the U.S. government are deteriorating before our eyes.
No wonder bond prices have tumbled, sending yields much higher.
The asset overvaluation of a bubble creates the circumstances where there is little potential reward for a great deal of risk. It is an imbalance that needs to be corrected -- usually by a violent change in price. Quantitative easing and the market's perception of government policy could serve as a catalyst to the price correction needed in the bond market.
The rumblings began in August, when Federal Reserve Chairman Ben Bernanke first unveiled his plans to invent yet more dollars and pump them into the economy. The market really began to sell off a month ago, when the elections left a bitterly dividend government.
But President Obama's tax Munich this week, apparently, has been the final straw. Economists at Macroeconomic Advisers estimate that the tax cuts and minor spending increases will add another $900 billion to the deficit in two years' time. But that's just the start. The real issue is the signal it sends about longer-term fiscal discipline.
So much for all those concerns about deficits.
At some point, without fiscal discipline, the world will simply lose confidence in U.S. government finances. They will demand higher yields as more compensation for risk, and for the dangers of inflation.
Are we at that point? Maybe not completely. But the movement in bond prices tells you people are worried.
Ben Bernanke is trying to devalue the dollar and generate inflation. His success will be presaged by a selloff in the bond market as investors come to believe Bernanke will succeed in printing enough money to create inflation. Right now deflation is still a problem.
So what does this mean for your finances?
We've seen so many bear markets in the past decade. But Treasury bonds are much more dangerous on the way down than other assets. When the dot-com bubble burst, blue chips like Johnson & Johnson and Bank of America carried on pretty much unscathed. When the real-estate market crashed, bull markets continued in the likes of Apple and gold and ExxonMobil. When Lehman Brothers imploded, at least Treasury bonds rose.
But if the Treasury market loses control, almost nothing will be safe.
Here's how the repercussions will be felt:
1. The wealth effect. Americans have at least $3 trillion invested in bond funds, according to the Investment Company Institute. A lot of that is in paper backed by one issuer: the U.S. Treasury. Investors have been assured that bonds are "safer" than stocks, but this is a half-truth at best. They are vulnerable to inflation, and to rises in interest rates. A 30-year bond paying $50 in coupons each year is worth $1,000 in an environment where long-term interest rates are 5%. If those long-term rates rise just to 6%, it's worth only $860—and the owner is down 14%. If those rates rise to 7%, that bond's value falls to $750—a 25% loss. Bonds are owned especially by older investors, who in turn are more dependent on their investments for income. A sustained slump can seriously hurt spending and confidence.
2. Corporate bonds. When Treasurys sell off, these get hit too. That's because they are priced in relation to Treasurys. When Treasury yields were down on the floor, brokers and advisers were able to argue corporate bonds were "cheap" because their yields were higher than Treasurys. (The gap is called the "spread.") But once the yields on Treasurys rise, those on corporate bonds have to follow suit just to maintain the same spread.
3. Real estate. Mortgage rates are effectively set relative to the yields on 10-year Treasury bonds. And the turmoil in the bond market has just sent those mortgage rates jumping to six-month highs. According to Bankrate.com, you'll now pay 4.91% on a typical 30-year conforming loan—compared to rates of just 4.4% a few weeks ago. Sure, 4.91% is still pretty low—if it stays there. But it's still very unwelcome news for the flattened housing market.
4. Corporate profits. The bond boom was terrific news for companies. They could take advantage of it to issue long-term paper at very low rates. They could often invest that money at higher rates via expansion—typically overseas, such as in Asia—or even just by buying back their stock. That boosted profits and cut taxes. But if the bond market has now peaked, that game is going to be over. Companies that need cash in the future are going to find it harder to come by—and they will have to pay more for it.
5. Everything else. When Treasury yields rise, that makes every other asset seem less valuable. There are two reasons for this. The first is that when Treasurys offer a higher yield, the yield on other assets needs to rise to compete. The second is that economists and investment analysts use Treasury rates—typically the rate on 10-year bonds—as the basis for many long-term calculations. All other things being equal, higher rates make future profits less valuable in today's money.
Maybe bonds will recover. This business is full of uncertainties. But investors need to understand that there is now a serious danger that the events of the last month are the start of a long-term slump in Treasurys. That makes this investment environment more dangerous than many people seem to realize. Look out.
The macroeconomic issues that move the bond market can have significant impact on mortgage interest rates. In markets with elevated prices dependant upon borrowers maximizing their loans (see Orange County), rising interest rates will lower prices because higher interest rates make for smaller loan balances.
So what do you think will happen? Have we seen the peak of the bond market? Have we seen the bottom of interest rates?
Loan Modification: Fail!
The owners of today's featured property paid $460,000 on 11/20/2003. The mortgage data is unclear as my records show two mortgages for $68,900 which would leave a huge down payment.
On 3/27/2007 these owners obtained a HELOC for $242,798.
Somewhere after that, these people defaulted on some debt and restructured with a loan modification. The strange part is that IndyMac Bank is showing up as the loan originator on 12/28/2009, well after IndyMac was shut down. The loan was a $455,000 first mortgage at 1%. The owners went into default shortly thereafter.
Foreclosure Record Recording Date: 10/07/2010 Document Type: Notice of Sale
Foreclosure Record Recording Date: 05/06/2010 Document Type: Notice of Sale
The house was purchased by OneWest Bank on 11/3/2010 for $473,681.
Home Purchase Price … $460,000 Home Purchase Date .... 11/20/2003
Net Gain (Loss) .......... $24,100 Percent Change .......... 5.2% Annual Appreciation … 1.6%
Cost of Ownership ------------------------------------------------- $515,000 .......... Asking Price $18,025 .......... 3.5% Down FHA Financing 4.87% ............... Mortgage Interest Rate $496,975 .......... 30-Year Mortgage $105,063 .......... Income Requirement
$2,629 .......... Monthly Mortgage Payment
$446 .......... Property Tax $150 .......... Special Taxes and Levies (Mello Roos) $86 .......... Homeowners Insurance $134 .......... Homeowners Association Fees ============================================ $3,445 .......... Monthly Cash Outlays
-$431 .......... Tax Savings (% of Interest and Property Tax) -$612 .......... Equity Hidden in Payment $34 .......... Lost Income to Down Payment (net of taxes) $64 .......... Maintenance and Replacement Reserves ============================================ $2,500 .......... Monthly Cost of Ownership
Cash Acquisition Demands ------------------------------------------------------------------------------ $5,150 .......... Furnishing and Move In @1% $5,150 .......... Closing Costs @1% $4,970 ............ Interest Points @1% of Loan $18,025 .......... Down Payment ============================================ $33,295 .......... Total Cash Costs $38,300 ............ Emergency Cash Reserves ============================================ $71,595 .......... Total Savings Needed
Property Details for 162 TRELLIS Ln Irvine, CA 92620 ------------------------------------------------------------------------------ Beds: 2 Baths: 1 full 1 part baths Home size: 1,180 sq ft ($436 / sq ft) Lot Size: 2,408 sq ft Year Built: 1998 Days on Market: 23 Listing Updated: 40511 MLS Number: P761192 Property Type: Single Family, Residential Community: Northwood Tract: Glle ------------------------------------------------------------------------------ According to the listing agent, this listing is a bank owned (foreclosed) property.
What a lovely home in Glenneyre at Lanes End. This is a 2 bedroom + an office, den or gym. All bedrooms are upstairs with 2 full bathrooms. The property is in EXCELLENT condition, including appliances. You enter through a white picket gate, it's quite charming. The downstairs has an open floor plan. Gorgeous parquet floors throughout the downstairs. The living room and dining area both have a view of the fireplace, as does the kitchen. The kitchen has a garden window over the sink, looking toward the yard. There is also a guest bathroom downstairs as well a direct garage access. This home will sell quickly!!
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