Some people like to say that things are never as good as they appear or as bad as they seem. This kind of talk always reminded me of the kind of wisdom you might hear from a loving grandparent, who by virtue of their age and years of experience can calmly look back at the bumps and travails along their long, well-traveled road secure in the knowledge that none of the potholes matter too much in the end. The problem for those of us that aren’t card-carrying members of AARP is that we are somewhere in the middle of that bumpy, treacherous road and a safe and sound arrival at some point and sometime in the future is anything but certain. Where was I? Oh yes, the wisdom of my Grandma aside, things aren’t always as they appear. No kidding, so what does this have to do with interest rates and mortgage rates? Well, mortgage rates continue to fall to levels not seen since cavemen and cavewomen were out shopping for mortgages for prime real estate on jagged cliffs somewhere in western Nepal circa 10,000 A.D. So what’s wrong with that you ask?
Well for one thing, interest rates don’t fall just because it happens to be a good thing for people who need to or want to borrow money. They generally fall because of lower inflation expectations, which in the case of present economic conditions means that they are falling because the economy is simply that bad and that there is no reason to believe that anything will change for the good anytime soon. Indeed, the rate on 15 year fixed mortgages has dipped under 3% for the first time since, well, as noted above a long time ago if ever at all. Rates for 30 year mortgages are also falling to or below historic levels with recent quotes for a 30 year mortgage coming in at 3.75%. These rates mark the fifth week in a row that interest rates on home mortgages have fallen. Last year at this time the rate for a 30 year fixed mortgage stood at 4.55% while that for a 15 year mortgage was quoted at 3.74%, both of which at the time seemed to be bargains, especially when compared to historical rates.
There is no doubt that lower interest rates are a good thing, in fact a great thing, for consumers and homeowners. It goes without saying that lower monthly payments for things like variable interest rate credit card debt and mortgage payments is perhaps the biggest boost to the overall economic health of most households as more funds are freed-up to pay down outstanding loan balances or put toward other types of consumer spending, which in turn aids the overall economy. But, (you knew there had to be a “but” in there somewhere right?) despite the historically low mortgage rates being posted by many banks, these same banking institutions are grabbing their purse strings tighter than a dislodged mountain climber clings to a safety rope. The requirements to borrow money are now so tight and individual credit ratings so battered due to the effects on their finances in the wake of the recession, that few borrowers are able to take advantage of these lower borrowing rates.
On another level, the lower interest rates along the entire yield curve also reflect and are symptomatic of an ailing economy. Market insiders will argue that near zero interest rates at the front of the curve are the doing of the federal government pumping liquidity into the financial system faster than BP pumped crude oil into the Gulf, and they might be right. However, federal bankers have little control over the longer end of the curve, where rates are falling to levels not seen in most everyone’s lifetime. If the economy had any steam at all and businesses were putting pressure on lenders to borrow money for their companies, the overall level of interest rates would be on the rise. The fact that they are at low levels and still falling isn’t the best news for the economy, though at first glance it would seem to be the case.
The example used to illustrate the problem associated with low interest rates is always Japan, which after its financial bubble burst saw interest rates decline to near zero, where they remained for almost ten years due to the horrendous state of their economy. The situation is known in economics as The Liquidity Trap, an economic quagmire in which government injections of liquidity (free flowing capital) do little or nothing to stimulate the economy. The trap is caused, or created when people simply hoard excess liquidity (cash) because they expect even worse conditions to follow the present calamity they are experiencing.
The U.S. economy has not reached the point of being in a liquidity trap just yet, but if the job market does not improve, and should hundreds of thousand of more homeowners be forced to declare bankruptcy and their homes move into foreclosure, the liquidity trap may very well be the next dire consequence of the greed induced financial meltdown that began in 2007.
Lower interest rates are a good thing when the economy is ailing. And there are signs that businesses are starting to borrow money for expansion and new hiring etc. However, while the banks are able to feast on cheap, if not free capital, and put that capital to work in financial markets games similar to those the precipitated the market collapse, we may never pull out of this problem and the Japanese example could become our reality. No one can force the banks to free up capital and in fact it will take some leadership on the part of one of them to set an example for the rest to follow.
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