Higher mortgage rates, in the near-term future, is the conclusion of many economists. They cite an expansion of the money supply, the eventual end of the Fed's mortgage-backed securities purchase program, China's willful selling of US Treasury securites, and a recovering economy. Logic dictates that all those factors would contribute to 70-s style hyperinflation. I agreed until it hit me...
A generation of Americans may have changed their spending habits forever. If sustainability is the new black dress, frugality is the new accessory. Consider this parsed comment by my partner, Sean Purcell:
Religion and economics are very, very similar. They are both based on faith rather than any real, empirical evidence. For decades now economics has tried to establish itself as science in our institutions of higher learning. I remember in the 80s when I was a Psychology major we were doing much the same thing. But Religion, Economics, Psychology.. these are all Social Studies not Social Sciences.
American consumerism was driven by belief in a grander future due to an underlying model. Our post-9/11 model was debt-driven. At one point, a full percentage point of our GDP came from withdrawn home equity; we were robbing Peter to buy from Paul. That strategy was hardly sustainable and not in concert with the frugalty associated with the "American Spirit".
The Fall, 2008 financial meltdown changed that flawed belief in deficit spending (for households). As 'wealth" evaporated, a function of that "wealth", (i.e spending), evaporated as well. Plainly put, you're less likely to spend an extra hundred bucks each month if you lost five grand in your mutual fund. I can't scientifically tell you exactly how much that will affect future GDP but I'm speculating that it removes at least 1-2 percentage points from it. Tightening the belt is not just removing the frothy spending; it contracts spending to the point where you try to "get back your losses". Not only will you cut back on that former expenditure of $100/month, you'll cut back MORE to save $100/month- and you'll do that for the fifty months it takes to get back your losses.
Patagonia is cashing in on the rebirth of American frugality with it's T-shirt. I saw at least ten people wearing these shirts on my vacation to Catalina Island. Americans are questioning restaurant checks, asking for itemized business proposals, and spending time on hold to understand why the local utility provider is collecting "franchise fees" (HINT: it's a tax). We're embracing the simple life and de-cluttering our garages, homes, offices, and lives. It is no longer fashionable to conspicuously consume because your neighbor is wondering if his tax dollars are bailing out the mortgage you used to buy your Hummer. We're seeing inconspicuous consumption in the luxury market. Wealthy people are not comfortable displaying signs of opulence (even though they earned it):
"Luxury shame is very real," says travel industry analyst Henry Harteveldt of Forrester Research. "When your neighbors are losing their jobs and you're doing well, you don't flaunt your success. Of course, there are still people who will continue to enjoy the fruits of their success. They may still rent the beachfront home and continue to fly in the G5 and tool around in the leased Bentley, but they're not going to go home and brag that that's what they did on vacation."
This recession is different from the last big one. The last severe recession was in the early 80's. The Baby Boomers led us out of that recession because they were 20-40 years old; they were still in the acquisition part of the family wealth cycle. Today, those folks are 45-65 and facing reduced income and a longer life span; they're in the conservation part of the family life cycle. Their political heroes have changed from Ronald Reagan (who gave them more money to spend through tax cuts) to Barack Obama (who tells them they won't have to pay for anything). For President Obama's "Care State" to work, he'll have to raise income taxes on the people still working...that "ain't goin' over so good".
Cheap is cool now because cheap suggests future cash in the bank. If a generational shift from conspicuous consumption is underway, economic expansion will be reached with 1-3% GDP growth rather than 4-6% GDP growth. Slower growth rates will contract P/E ratios, leading to stagnated stock prices. Slower growth will lead to lower price/rent ratios, leading to stagnated real estate appreciation.
Slow and predictable growth could lead to a long period of stability in the mortgage markets.
Today's Federally-subsidized mortgage rates are a full percentage point below the real cost of mortgage capital. Jumbo loans, with no Federal guarantees behind them, are currently 6-6.25%. A growing economy could see those rates rise to as much as .7%. When the Fed pulls its mortgages subsidy, we could see conforming mortgage rates rise to about .25%-.5% below the jumbo loan rates.
What this means is that we could see conforming mortgage rates (under $417,000) jump up into the 6's and fluctuate from 5.75% to 6.75% for another 5-7 years. Admittedly, that's materially higher than the current level but a far cry from the double digit mortgage rates world of 1977-1990.
What's that mean to you?
If you have a loan that can be refinanced before the end of the year, do it. If your loan can not be refinanced, and you have an adjustable rate mortgage, you might not have to hit the panic button. Most ARMs adjust to LIBOR plus 2.75%. Today, that adjustment would go to about 5.0%. Your ARM could very well remain in the 5-6.5% range, for the next five years if my newfound theory of anti-consumerism is correct.
