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admin
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Joined: 14 Jul 2005
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 Posted: Wed Jun 11, 2008 8:16 pm GMT Post subject: Call for questions on "A History of Interest Rates, 4th |
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I just finished reading A History of Interest Rates, Fourth Edition by Sidney Homer and Richard Sylla. While it does weigh in at a hefty 710 pages, it was an interesting read. I'd like to solicit questions on the book while it is fresh in my mind. Please post any questions you may have.
Originally, I was hoping that the book would illuminate the causes of various interest rate levels. It did not address this, though perhaps that is a good thing since the authors pointed out that assigning causation is inexact and too subjective for a pure history. Instead, it was mainly an objective survey of where rates have been.
Even though it didn't fully meet my original goal, it was still pretty interesting. It covered several millennia, which is a pretty incredible perspective. One of the biggest things that stuck out at me was that the high rates from the mid-1960's through the mid-1980's were dramatically higher than what has been normal for the last several centuries. Another big thing was that the very long term trend of rates has been downward when looking at various centuries, except when an empire is waning (and then the trend is up).
If you have a question about the history of interest rates or the authors' treatment of it, please post it within this thread.
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john p
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| Posted: Wed Jun 11, 2008 8:29 pm GMT Post subject: |
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What did it say about:
Wartime affects?
One generation overspending or population bubbles like our babyboom generation?
Inflation premiums?
Class structure or concentration of wealth related to interest rates?
Currency evaluation and debasement and trade policy?
Basically all the current context similarities.... (whatever jumped out to you being relevant to today), and of course any outcomes that grew out of a context like what we're in... |
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admin
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| Posted: Thu Jun 12, 2008 7:11 pm GMT Post subject: |
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| john p wrote: | What did it say about:
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It did not have much to say about cause and effect relationships or correlations. The original author intentionally tried to stay away from that because he thought that it was often a matter of opinion or speculation. I can try to use the data that it does provide to look at your questions, but this will be my application of it rather than something which the book commits to.
| john p wrote: | Wartime affects?
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The book actually does address this one. Here's an excerpt from the top of page 335, which I think was written in or shortly before 1991:
For those who have been impressed by the regular coincidence of interest-rate peaks with wars over several centuries, World War II presented a notable exception, both here and in Europe. On the other hand the Cold War, or armed truce, which closely followed World War II, was a basic inflationary force and was accompanied by the largest rise in American bond yields and fall in American bond prices in this record. As the 1980s ended, signs of the ending of the Cold War were evident. An end to the Cold War would increase the likelihood that peak yields of the greatest bear market in bonds were reached in 1981.
I don't know if the war in Iraq is of a similar enough magnitude to the wars discussed to draw parallels. Vietnam comes to mind as a closer comparison. Rates continued to rise after Vietnam ended, but that was of course during the Cold War, so its effects may have been outweighed.
| john p wrote: | | One generation overspending or population bubbles like our babyboom generation? |
With regards to over-spending, the author did mention that in the 1980's the US quickly went from being the largest creditor nation to the largest debtor nation. That did coincide with falling interest rates, oddly enough. However, the author blamed the higher rates and spiraling inflation which preceded it on an overemphasis on stimulation of consumption.
I don't remember reading anything about population bubbles, but if you have specific time periods in mind where you think that effect should be apparent, let me know.
| john p wrote: | | Inflation premiums? |
The second author, who took over the updates after the first author passed away, presents the model that an interest rate is composed of three parts: "a real yield on capital, an expected rate of inflation, and a risk premium reflecting the expected volatility of yields." His opinion was that there isn't much of a reason to expect the other two components of interest rates to change and that inflation expectations would be the dominant factor going forward.
There was also a chapter on real interest rates. The stratospheric rates of the mid 1960's through mid 1980's actually look perfectly normal when viewed through this lense.
| john p wrote: | | Class structure or concentration of wealth related to interest rates? |
I don't remember this being addressed. There was some discussion of how money lenders were viewed by society, but I don't think that's what you're looking for.
| john p wrote: | | Currency evaluation and debasement and trade policy? |
There was an entire chapter dedicated to Latin America in recent decades. Many of the countries experienced hyperinflation and correspondingly had extremely high interest rates.
A long decline in US rates which started around 1933 or 1934 was actually accompanied by a devaluation of the dollar in terms of gold. France devalued its currency in 1925 - 1926 and rates subsequently fell. Britain devalued the pound in 1949 as rates were rising and they continued to rise. I guess these samples would lead me to believe that currency devaluation isn't necessarily a dominant factor if it isn't too extreme.
| john p wrote: | | Basically all the current context similarities.... (whatever jumped out to you being relevant to today), and of course any outcomes that grew out of a context like what we're in... |
One thing that I thought was relevant was that interest rate trends can last for decades on end. Even though the general trend over the centuries has been downward, there have been plenty of long stretches where if you waited for rates to be where you want them or where you think they should be, you could have ended up waiting for decades. Along the same lines, the author mentions that each generation tends to think of the rates that they grew up with as "normal" and rates later on as either too high or too low based on that original frame of reference, even if a longer historical view would suggest otherwise.
Consequently, I no longer think that we will necessarily return to historically average mortgage rates in the US as the history there is brief compared with rates in general and is dominated by the unprecedented period of the great inflation. It is unsettling that those lofty highs were set so recently, and high rates could return for similar reasons, but I don't think that they will return as a result of reversion to the mean.
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john p
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| Posted: Fri Jun 13, 2008 1:59 am GMT Post subject: |
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Thank you for your answers.
I'm sure you wouldn't have read seven hundred plus pages if you weren't hoping to gain and ability to have a more sophisticated insight on predicting the future.
What I'm thinking about now is that we skated around a recession last year and if we did catch a germ, we were going to catch a flu for sure. Well, this whole oil prices, I think this could be a germ that could cause a recession. I think that based on affordability reach, I saw a correction/bottom this Spring. I wonder how many people would hold off that long knowing that they could afford a place. The FED has a two front war: Inflation versus lower rates to improve affordablity and help support house prices.
What current issues do you think will impact mortgage rates for the next year or so? |
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balor123
Joined: 08 Mar 2008
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| Posted: Fri Jun 13, 2008 2:05 am GMT Post subject: |
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| Check out housing tracker - affordability is getting worse in Boston, not better. And that ignores the effects of inflation (reduction in disposable income)! |
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john p
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admin
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| Posted: Fri Jun 13, 2008 2:48 pm GMT Post subject: |
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| john p wrote: | Thank you for your answers.
I'm sure you wouldn't have read seven hundred plus pages if you weren't hoping to gain and ability to have a more sophisticated insight on predicting the future.
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That was the original intent, but I gave up on that near the start when the author explicitly stated that he was going to avoid attempting to identify causes and effects. He indicated that there are multiple hypotheses as to what determines interest rates and that none were certain. Sure, I could have stopped reading at that point, but it was actually pretty interesting reading about a large chunk of world history through a narrow, economic lense. Also, getting a feeling for what has been normal in the past has given me a better sense of what probably won't happen, which is better than nothing.
Maybe it did provide the first step toward prediction, though. What did seem critically important was inflation. If you can predict inflation, you are a good part of the way toward being able to predict interest rates. So while the book didn't tell me exactly what I wanted to know, it may have pointed in the right direction, which is valuable in and of itself.
| john p wrote: | What I'm thinking about now is that we skated around a recession last year and if we did catch a germ, we were going to catch a flu for sure. Well, this whole oil prices, I think this could be a germ that could cause a recession. I think that based on affordability reach, I saw a correction/bottom this Spring. I wonder how many people would hold off that long knowing that they could afford a place. The FED has a two front war: Inflation versus lower rates to improve affordablity and help support house prices.
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The Fed isn't interested in supporting housing prices, except to the extent that they pose a systemic risk to the economy. The Fed's dual mandate is to promote broad price stability and high employment. Inflation versus employment is where The Fed's two front war is, and that could very well be turning into a quagmire. The fear is that they will end up being forced to choose between high inflation and high unemployment. Controlling inflation would be better for the long term health of the economy, but controlling unemployment would be more politically expedient. The Fed was structured to be isolated from political influence precisely to guard against shortsightedness in this type of situation, but unfortunately Congress has been corroding this protection by cutting off the Fed's human resource's for short term political gain. This could end badly.
| john p wrote: | | What current issues do you think will impact mortgage rates for the next year or so? |
Inflation expectations. If this genie gets out of the bottle, The Fed will have a long, arduous time of getting it back in. They have some control over expectations now and could retain it by being hawkish, if inflation or inflation expectations get worse - today's report would indicate they have a little breathing room at the moment.
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john p
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| Posted: Fri Jun 13, 2008 3:52 pm GMT Post subject: |
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What is your take on "trickle-down" economics?
If the FED floods money into circulation, the rich will typically get it first, and the younger will have to reach higher to buy things like houses. Now the older family selling to the younger one that made a bundle on home appreciation has a bunch of money to spend. It seems that colleges and universities pumped out lots of that capital, the health care industry, etc. but where and when do you think that the younger generation that is in debt will start to get some traction in salary growth?
I mean the younger generation that did not get the house appreciation chunk of money is carrying more load, and there is a disparity in generational equity. That website the Baylor pointed out clearly shows that around 1997 houses were 3 times household salary and now it is just above 5 times. I would imagine that either prices come down, or salaries go up, or a combination of both. |
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admin
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| Posted: Fri Jun 13, 2008 9:26 pm GMT Post subject: |
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| Quote: | | What is your take on "trickle-down" economics? |
I think that there is some truth to it. I have more faith in private individuals to efficiently allocate capital than in the government. Let the rich keep more of what they have and they invest it, creating jobs. "Trickle-down" isn't some panacea, though, and it is a target of unrealistic expectations when people treat it that way. It may raise most boats a little, but it isn't going to give everyone yachts.
| Quote: | If the FED floods money into circulation, the rich will typically get it first, and the younger will have to reach higher to buy things like houses. Now the older family selling to the younger one that made a bundle on home appreciation has a bunch of money to spend. It seems that colleges and universities pumped out lots of that capital, the health care industry, etc. but where and when do you think that the younger generation that is in debt will start to get some traction in salary growth?
I mean the younger generation that did not get the house appreciation chunk of money is carrying more load, and there is a disparity in generational equity. That website the Baylor pointed out clearly shows that around 1997 houses were 3 times household salary and now it is just above 5 times. I would imagine that either prices come down, or salaries go up, or a combination of both. |
I'm not optimistic about the traction happening anytime soon. Maybe it will happen once the Baby Boomers start retiring and Gen-X'ers get accelerated promotions out of necessity. But for now I feel that the Boomers are in control of the economic winds (not necessarily consciously) due to their sheer numbers. I also think that being saddled with mounds of debt is a self-reinforcing situation since it reduces your negotiating power as potential employers know you are an indentured servant.
By the way, I took a look at the newly released CPI-NU today and I want to take back what I said about The Fed having some breathing room with regard to inflation. That article I linked to referred to "core inflation." Actual inflation looked fairly high. Right now I think they need to be most concerned about inflation expectations and those will be driven by actual inflation, not core inflation.
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john p
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| Posted: Fri Jun 13, 2008 10:55 pm GMT Post subject: |
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So you see the FED needing to confront inflation by increasing reserves and tightening credit which will result in higher mortgage rates, and decreased affordability which will put downward pressure on house prices, which will increase foreclosures due to short sales. With increased foreclosures, you'll have more distressed properties on the market (based on reports to seemingly to peak in 2nd quarter 09). That is definately a possiblity. If the economy does drop, babyboomers might postpone retirement and stay in their homes for a bit longer, especially if they will take a loss in the sale of their homes. It seems that with this outlook one would see the value in waiting longer to purchase as opposed to value shopping now?
Do you see much of the basis for the "Boston Premium" remaining?
The basis for my house purchase in 06 was that if I bought and the market continued to drop (as it has), I would need enough of a discount to cover the drop. Currently, someone might be able to get a house like mine today for the house I paid, and they could get the rate I got back then today. If rates go up, prices will go down, and if I bought in the near future, I'm sure my monthly payment would end up being approx. the same due to the premium in mortgage rate. I couldn't bank on rates dropping when I willed them to, so if I waited a few to five years, I would have to consider a 25 year mortgage for it to be an apples to apples comparison because I would have paid five years into my mortgage by that point. It has been two years since I bought, and I really wouldn't have been in a better position today as back then as far as buying power. It's possible that my bargain shopping skills might have landed me a better crib, but adding two more years of shopping to the two prior years would have just been too much of an investment of my time and it was time to get on with other things (like blogging about real estate  )This whole real estate stuff has got it's hooks in me; it's so friggin interesting. Anyway, if people say to buy in 09, take into account that you'll most likely need like at least a 10 percent down payment, and your interest rate might be north of 7 percent, so when you run your mortgage payment, you wonder how much better you'd be off. I am sure deals are out there but most distressed homes are in distressed areas (most, not all). Many people who bought before this bubble are in decent shape, unless they refinanced and I am not sure of the percentage that did this. So our strategy was to buy in 06 at a discount that would absorb a further correction, and if rates went up, our mortage payment would have been steeper anyway, if they went down signficantly, house prices would have risen due to affordability, I may have gained equity in appreciation, and I would have refinanced for a shorter 15 year note. We could have saved an extra $15K a year from renting in a much smaller place, but the interest rate premium associated with a future purchase would have eaten much of that because a 1 point increase in interest rate would have felt like a 6% increase in pricipal of house cost.
I'm dying to see June's numbers come out.... |
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admin
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| Posted: Sat Jun 14, 2008 6:27 pm GMT Post subject: |
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| Quote: | | So you see the FED needing to confront inflation by increasing reserves and tightening credit which will result in higher mortgage rates, and decreased affordability which will put downward pressure on house prices, which will increase foreclosures due to short sales. With increased foreclosures, you'll have more distressed properties on the market (based on reports to seemingly to peak in 2nd quarter 09). That is definately a possiblity. If the economy does drop, babyboomers might postpone retirement and stay in their homes for a bit longer, especially if they will take a loss in the sale of their homes. It seems that with this outlook one would see the value in waiting longer to purchase as opposed to value shopping now? |
Assuming inflation is a problem, I think that mortgage rates will go higher regardless of whether The Fed confronts it or not. If The Fed does confront inflation, it will push rates somewhat higher as you describe. On the other hand, if The Fed allows inflation to remain high or grow, inflation expectations will increase and investors will demand a higher inflation premium on all interest bearing assets, including mortgages. Once inflation expectations rise, they can snowball and take forever to rein back in, so I think that over the longer term mortgage rates are likely to rise the most if The Fed doesn't act.
I do see the value in waiting. Given equal monthly payments, a higher interest rate means lower risk. Also, the price to income ratio must eventually return to its historical average (I say "must" because the average increases each year the ratio is above it). I also think that general seller sentiment will be much more favorable for buyers if the protracted declines priced into the futures market play out as expected and capitulation sets in.
| Quote: | | Do you see much of the basis for the "Boston Premium" remaining? |
Yes. I assume you're referring to The Globe's recent blog entry comparing Greater Boston prices to national prices. Access to higher paying jobs, educational opportunities, leisure activities, infrastructure, and other factors make it advantageous to live near a major city. That justifies a premium. Whether the current premium is justified or not is a different matter. For my own personal preference, the premium of ~1.8X definitely seems worth it to live in Boston as opposed to somewhere rural.
| Quote: | | The basis for my house purchase in 06 was that if I bought and the market continued to drop (as it has), I would need enough of a discount to cover the drop. Currently, someone might be able to get a house like mine today for the house I paid, and they could get the rate I got back then today. If rates go up, prices will go down, and if I bought in the near future, I'm sure my monthly payment would end up being approx. the same due to the premium in mortgage rate. I couldn't bank on rates dropping when I willed them to, so if I waited a few to five years, I would have to consider a 25 year mortgage for it to be an apples to apples comparison because I would have paid five years into my mortgage by that point. It has been two years since I bought, and I really wouldn't have been in a better position today as back then as far as buying power. It's possible that my bargain shopping skills might have landed me a better crib, but adding two more years of shopping to the two prior years would have just been too much of an investment of my time and it was time to get on with other things (like blogging about real estate )This whole real estate stuff has got it's hooks in me; it's so friggin interesting. Anyway, if people say to buy in 09, take into account that you'll most likely need like at least a 10 percent down payment, and your interest rate might be north of 7 percent, so when you run your mortgage payment, you wonder how much better you'd be off. I am sure deals are out there but most distressed homes are in distressed areas (most, not all). Many people who bought before this bubble are in decent shape, unless they refinanced and I am not sure of the percentage that did this. So our strategy was to buy in 06 at a discount that would absorb a further correction, and if rates went up, our mortage payment would have been steeper anyway, if they went down signficantly, house prices would have risen due to affordability, I may have gained equity in appreciation, and I would have refinanced for a shorter 15 year note. We could have saved an extra $15K a year from renting in a much smaller place, but the interest rate premium associated with a future purchase would have eaten much of that because a 1 point increase in interest rate would have felt like a 6% increase in pricipal of house cost. |
I think all the prospective buyers here should thank you for pointing the market in the right direction. You were ahead of the curve (which also gives you a margin of safety).
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