
The Coming Change in Monetary Policy - dirtyaura
http://avc.com/2015/06/the-coming-change-in-monetary-policy/
======
phkahler
They will raise rates very slowly this time. Greenspan even admitted that
jerking the rates up was partly to blame for the 2008 crisis. They put rates
near zero, then jacked them up a few years later. Then had an oh-shit moment
and dropped them to zero.

[https://en.wikipedia.org/wiki/Federal_funds_rate#/media/File...](https://en.wikipedia.org/wiki/Federal_funds_rate#/media/File:Federal_Funds_Rate_1954_thru_2009_effective.svg)

Mortgage rates follow but don't match the fed funds rate. Home prices vary
inversely with interest rates. Falling rates generally mean rising home
prices. So with rates near zero, there is only one thing for housing prices to
do - fall when they raise rates. The only hope is that inflation will balance
the fall in home prices caused by raising the rates. Otherwise, prepare for
crisis part II.

~~~
cgearhart
Another major concern in 2008 was how little equity homeowners had in their
property. If they had financed 100% of their loan, had exotic loans, or paid
interest only, etc., then they weren't actually losing any money to walk away
from a property. We're now seven years on, which means a hypothetical
homeowner who financed 100% in 2008 may now hold about a 15% equity stake.
That home could lose 15% of its value and the owner could still sell it to pay
off their loan.

~~~
toomuchtodo
[http://www.calculatedriskblog.com/2015/03/zillow-negative-
eq...](http://www.calculatedriskblog.com/2015/03/zillow-negative-equity-rate-
unchanged.html)

"In the fourth quarter of 2014, the U.S. negative equity rate – the percentage
of all homeowners with a mortgage that are underwater, owing more on their
home than it is worth – stood at 16.9 percent, unchanged from the third
quarter. Negative equity had fallen quarter-over-quarter for ten straight
quarters, or two-and-a-half years, prior to flattening out between Q3 and Q4
of last year.

While this may not seem very notable (after all, overall negative equity
didn’t go up, merely flattened out), this represents a major turning point in
the housing market. The days in which rapid and fairly uniform home value
appreciation contributed to steep drops in negative equity are behind us, and
a new normal has arrived. Negative equity, while it may still fall in fits and
spurts, is decidedly here to stay, and will impact the market for years to
come. "

~~~
cgearhart
The peak of negative equity was in 2012 [1], and it has since fallen to a
level more on par with historic norms; chart 5 in [2] shows that pre-2004
vintage loans experienced mid-teens negative equity rates.

Even so -- the raw percentage of homeowners experiencing negative equity is
not a good predictor of the impact of raising interest rates and falling
housing prices. Negative equity doesn't trigger a distressed mortgage, or
force an owner to abandon the property. But _positive_ equity _does_ have an
anchoring effect.

[1] [http://www.zillow.com/research/zillow-negative-
equity-q3-201...](http://www.zillow.com/research/zillow-negative-
equity-q3-2013-5801/)

[2][http://www.newyorkfed.org/research/epr/09v15n1/0907haug.pdf](http://www.newyorkfed.org/research/epr/09v15n1/0907haug.pdf)

~~~
toomuchtodo
> Negative equity doesn't trigger a distressed mortgage, or force an owner to
> abandon the property.

Disagree. As soon as a property has negative equity, a homeowner begins to
contemplate strategic default. As their property tips ever more into negative
equity territory, the benefits of default rise dramatically, whether the
mortgage is recourse or not.

Don't take my word for it; the Federal Reserve did a study on it:

"Our results suggest that while strategic default is fairly common among
deeply underwater borrowers, borrowers do not ruthlessly exercise the default
option at relatively low levels of negative equity. About half of defaults
occurring when equity is below -50 percent are strategic but when negative
equity is above -10 percent, we find that the combination of negative equity
and liquidity shocks or life events drives default. Our results therefore lend
support to both the “double-trigger” theory of default and the view that
mortgage borrowers exercise the implicit put option when it is in their
interest."

[http://www.federalreserve.gov/pubs/feds/2010/201035/201035pa...](http://www.federalreserve.gov/pubs/feds/2010/201035/201035pap.pdf)

~~~
cgearhart
Your quote from the Federal Reserve directly supports my statement; it just
quantifies that ~10% negative equity + a liquidity shock is a good predictor
of default. Put another way, I was suggesting that there is hysteresis in the
response to negative equity. That said, my statement would have been much less
confusing if I had explicitly acknowledged the connection. Perhaps, "Negative
equity doesn't _immediately_ trigger a distressed mortgage, or..."

Furthermore, my central claim -- that the total fraction of houses with
negative equity is a poor predictor of default risk -- is unaffected either
way. It would be more useful to know the distribution of negative equity for
those houses, or summary statistics like the mean or median negative equity.
(If we knew that the median negative equity were 10%, then we could predict
that about half of the 16.9% of all properties that are upside down are at
risk of default if they experience a liquidity shock.)

~~~
toomuchtodo
My mistake then! Here is more data. I believe anyone in the 100% to 120% LTV
will stay current on their mortgage; anyone else above 120% LTV? Highly
possible they'll default.

From Zillow:

"Nationally, of the homeowners who are underwater, around half are only
underwater by 20 percent or less, which is to say they are close to escaping
negative equity. (Figure 2) On the other hand, 1.9 percent of all owners with
a mortgage remain deeply underwater, owing at least twice what their home is
worth. Of the largest metro areas, markets with above average rates of deeply
underwater homeowners include Las Vegas (3.8 percent), Chicago (3.8 percent),
Atlanta (3.5 percent), Detroit (3.3 percent) and Miami (2.8 percent)"

Almost half of the borrowers with negative equity have a LTV of 100% to 120%
(8.2% in Q4 2014). Most of these borrowers are current on their mortgages -
and they have probably either refinanced with HARP or their loans are well
seasoned (most of these properties were purchased in the 2004 through 2006
period, so borrowers have been current for ten years or so). In a few years,
these borrowers will have positive equity.

The key concern is all those borrowers with LTVs above 140% (about 5.2% of
properties with a mortgage according to Zillow). It will take many years to
return to positive equity ... and a large percentage of these properties will
eventually be distressed sales (short sales or foreclosures).

------
snowwrestler
As Fred says, the Fed has been telegraphing their rate increases for a while,
which means that the market has largely priced them in. For example the market
basically did not react at all to Yellen's press conference last week.

The whole point of the Fed deciding to raise interest rates is that it means
that the Fed believes that the economy is strong enough to start removing
fiscal support. If they are right, then there should actually be not a huge
effect on valuations.

~~~
guiomie
" [...] which means that the market has largely priced them in." ... In theory
yah.

------
tomcam
Not addressed: that artificially low interest rates have a ruinous effect on
savings, and therefore affect old people disproportionately.

------
stephengillie
Does this mean that insane valuations (like Uber) will either get reduced, or
start to make sense?

~~~
tomjen3
It may take a dive, but I doubt it will be by that much - Uber makes money
which is always a good argument for having a high price.

That said I seem to remember Sequia talking about the party being over years
ago and utterly nothing came of that.

~~~
ekanes
Link to Sequoia's presentation: [http://www.scribd.com/doc/73886447/R-I-P-
Good-Times-10-7-08-...](http://www.scribd.com/doc/73886447/R-I-P-Good-
Times-10-7-08-Final)

------
MCRed
If you really want to understand what's happening in the economy, with advance
notice, read [http://mises.org](http://mises.org). That site has hundreds of
economics books for free (great reading!) but also regular news articles.

For instance, in 2001, before 9/11 (IIRC) there was an article there about how
as a response to the DotCom boom the low interest rates plus changes in the
CRA would be causing a housing boom and bubble over the next decade.

In 2001 there was no boom, and after 9/11 the economy was bad. But that advice
proved true, and gave me 6 years to time to invest based on the housing bubble
hypothesis (alas I never found a way to short houses and wasn't the kind of
person who could have bought CDOs against the foolishness) ... and I got out
of the market very near its peak in 2007.

Unlike what politicians would want you to believe, Economics is a science and
the consequences of actions in economics are pretty close to those in physics.
They can pretend like one president or another is responsible. (the Housing
Bubble was the result of the actions of Clinton and Bush, and actually Obama
who was a lawyer in the lawsuit that claimed "lending only to people who can
afford to repay the loans is racist"... and like economics predicted (That
banks want money and will disregard race) in the end it turned out that they
weren't being racist but were lending based on likelihood of repayment... and
the winners in Obama's class action lawsuit got their loans... and defaulted.)

The consequences of the terrible actions in 2008- from the bailouts to the
giving of one private bank (the federal reserve) the power to forcibly merge
other banks (without regard to conflict of interest-- say one of the owners of
the federal reserve wants to buy a smaller bank, he can just use the fed to
force it to merge with him on terms he agrees to.... no way this will be
abused, right?) .... these consequences are still playing out and have made
the game much more dangerous than 2008.

One thing I've noticed is that the "Black Swan" events-- like 2008 which
people said "Tehre's no way you could see this coming" despite the popular
sentiment in 2006 being "there's no way there's a housing bubble!" showing
that people did, in fact, see it coming-- really are pretty predictable at
least in terms of risk.

And the risk of a Black Swan has only been going up given the past 3 decades
of irresponsible governance (under congresses and presidents from both
parties.)

Don't look to VCs for economic perspective. They don't have it. All they know
how to do is raise funds and collect a carry. Don't look to political hacks
like "A housing bubble would be good for the economy" Paul Krugman, or any
politicians.... look to actual economists. (Even Keyenes disagrees with the
monetary policy we've been following for these decades, even though the
politicians claim its his idea. IT isn't, it's not what he said at all.)

The current bubble is the dollar, and they can't raise interest rates without
popping it. Whether they intend to pop it I don't know.

~~~
vezzy-fnord
_Unlike what politicians would want you to believe, Economics is a science and
the consequences of actions in economics are pretty close to those in
physics._

Huh. Austrian economics argues _the exact opposite_ , which is generally
correct for most things at a higher level than chemistry, especially something
as stochastic as economic modeling.

 _One thing I 've noticed is that the "Black Swan" events-- like 2008 which
people said "Tehre's no way you could see this coming" despite the popular
sentiment in 2006 being "there's no way there's a housing bubble!" showing
that people did, in fact, see it coming-- really are pretty predictable at
least in terms of risk._

Austrian economists are wary of making predictions in general, which goes hand
in hand with their overall distaste for econometrics. Not to say that the more
naive ones don't yell about incoming collapse all the time.

 _Even Keyenes disagrees with the monetary policy we 've been following for
these decades, even though the politicians claim its his idea. IT isn't, it's
not what he said at all._

We've come a long way since Keynes. Like we've debunked the marginal
propensity to consume since then, for instance, despite the fact that most
laymen and politicians keep making the same fallacy.

~~~
TheOtherHobbes
A lot of economists will be very surprised to hear that MPC has been
"debunked." Last time I looked it's still considered a mainstream idea -
mainstream enough to appear in introductory econ texts, anyway.

Steve Keen makes the - IMO interesting - point that there are different kinds
of consumption, and lumping consumption under a single Benthamite label is a
gross oversimplification.

But MPC is a simple measure of economic freedom. It's not what you spend your
extra earnings on that matters, because - unless you're burning banknotes - it
all goes towards increasing GDP anyway.

Where things get fuzzy is a lack of appreciation for the fact that spending
measures current economic activity, but savings, credit, and investment all
measure faith in future economic activity.

Because faith is based on an irrational thing called "sentiment", you have a
huge chunk of the economy based on hope, fear, and desire - which is maybe not
the most practical and useful way to make the economy work for everyone.

~~~
reagency
GDP is a weak measure of prosperity/utility. War had very high GDP, but has
very low utility. It doesn't burn banknotes, but it burns everything banknotes
buy, so the result is similar. The only thing economically good about war is
that it gives political cover for deficit spending, which encourages
productive activity (which GDP measures poorly)

------
jkot
Party is over.

