an excerpt from Pimco's Gross,
I apologize if this a re-post here,
pimco.com
Into this explosive mixture of fire (debt) and gasoline (pricing power) comes a flame retardant or a fire marshal of sorts - at least in the U.S. Our economic version of Smokey The Bear goes by the name of the refinancable mortgage. No other country really has it and it has saved our fannies up to this point by lowering interest costs and "creating" wealth where no other wealth was to be found. Remember the point about fixed rate debt being a deflationary villain? That applies primarily to companies and in some cases, strangely enough, to consumers via floating, yet somehow, permanently high interest rates in the credit card arena. American style mortgages are another story and because of them, most American homeowners (70% of U.S. households) have been able to keep on consuming via reduced monthly payments, increased equity takeouts, or both. The Queen of England mistakenly knighted Alan Greenspan as the saviour of the global economy. She should have instead tapped the originator of the refinancable mortgage.
But there are limits dear reader, there are limits. And every sophisticated money manager and financial observer is keenly aware of these limits. They half whisper them over the phone or in their nightmares as if to recognize that the margin of error is now very, very slim. Because we are certainly within 1 3/4% of zero as Ed Yardeni might express it and we are therefore within perhaps 50 basis points of the lowest possible 15 and 30-year mortgage rate that Americans are going to be able to refinance into. Mortgage rates will not follow the Fed Funds rate basis point for basis point lower because the extension risk and the negative "convexity" risk to the buyer (PIMCO) becomes outrageous if it does. There will never be much less than a 5% 30-year GNMA, Freddie Mac, or FNMA mortgage issued in size no matter what Greenspan does - and that's a forecast you can take to the bank, with a high probability outcome. No investor in their right mind would be on the buy side of a 30-year mortgage with a 4% coupon and a potential extension from a 5-year, to a 12, to an 18-year average life staring them in the face.
And so? Well, here's what those same astute observers whisper, but are afraid to believe will happen. If the American refinancing boom ends before a new investment boom begins, we are in a world of hurt. Consumption withers, investment rejuvenation will not have begun, and the U.S. global economic locomotive, such as it is, will grind to a halt. How long do we have? Twelve months at the most, even if Greenspan drives rates toward zero. |
