In part one of this article we talked about the Obama administration’s discussion about limiting the government’s involvement in the mortgage markets and the potential for drastic interest rate hikes. This next realization only adds fuel to the fire and makes it even more probable than ever that a drastic increase in home mortgage interest rates is looming just over the horizon.
Let’s talk about “Deficit reduction” What a beautifully Orwellian form of double speak? The politicians love to tout Deficit Reduction as such a great thing! It is not a great thing, it is not even a good thing – it is really just a little bit less of a very very bad thing! Deficit reduction does mean that we live within our means; it does not mean that we stop spending money that we really don’t have. It just means that we stop spending as much money as we don’t have. Let’s make this as clear and simple for everyone. If you or I were to earn $100,000 per year – but we live a lifestyle that we cannot afford and spend $200,000 per year – like our federal government does at the end of the year we would have had to borrow an additional $100,000 just to make ends meet. After doing this the first year – we would finish off with not only nothing – but an additional $100,000 in debt as well. Realizing of course that this cannot go on forever, we wise up and decide to reduce our deficit by half, (just like the Obama administration claims to be doing) we cut back on some expenses and agree to only spend $150,000 on our unaffordable lifestyle. Yet we still only earn $100,000 per year. So again at the end of the year we have spent everything we earned, have saved or invested nothing and still have to borrow another $50,000 just to make ends meet. So what did this great deficit reduction accomplish – not only absolutely nothing – it actually left us in worse financial condition as now we owe a total of $150,000 that we cannot pay back! This is what your federal government is talking about with their great “deficit reduction”.
If you or I were to try running our own businesses or god forbid our family finances in this manner – we would be out in the streets in no time at all. But there is still a bigger problem here – all of this money we keep borrowing has to be paid back – with interest! So now even if we did finally wise up and live within our means on our fictional $100,000 per year salary – we don’t even have that to spend because we still have the principal and interest to pay back on that other $150,000 that we borrowed and spent. So now a part of that $100,000 per year salary has to be used to paying off our debt and we end up with even less to live on and have to further do without because of it. Sounding familiar yet? Al least in our simple example – the problem can’t get too bad or go on for very long because eventually we would be regulated and corrected by the fact that no one will lend us any more money anyway. Unfortunately the federal government doesn’t believe it has that problem – they somehow think they can go on borrowing and spending forever. Even Deficit Reduction is still more spending money that we don’t have. Have I digressed? This article was about the future and the impending rise in interest rates.
Now let’s see part II of the problem. Capital (money) is said to be like water always flowing to its best return. But the supply of capital is not infinite – there is only so much of it to go around. It is just like water in a bucket – if the government drinks it all – what is left in the pail for us? If water is scarce and in short supply whoever can pay the most for it will be the one to get it. With capital – the price is the “return” or interest rate.
The government can pay whatever the market will bear. Can we? When the government borrows – it has an unfair advantage over you and I – the interest paid by the government is tax-free – when we pay interest it is not. They can pay less and the investor is still better off – we have to pay more in interest to have access to that capital (loans) because it is a rigged game. Put these together and what do you get? This idea of deficit reduction is still not enough. You get a government still on a spend and borrow binge, taking capital out of the markets and leaving less for consumers such as us which makes money more scarce and further driving interest rates up for the rest of us. Deficit reduction is not a balanced budget, it still takes capital out of the markets leaving less for the rest of us and forcing us to pay even higher interest rates. This effect went largely unnoticed when the government was using much of this borrowed money to subsidize interest rates through the purchase and insuring of mortgage backed securities ( see part 1). Now with the government pulling back from the mortgage market game, yet still increasing their borrowing, we now have a double pronged scenario for another storm in the mortgage markets with catastrophic implications for an already fragile housing market. How high will interest rates go and how quickly? No one knows for sure but if you were planning on buying and financing any real estate in the next few years – you might want to do it now. Even further price declines will most likely be offset by increased borrowing costs making the next several months the time that many of us will look back upon as the best time to buy real estate that any of us ever missed!