There Seem To Be Some Inefficiencies In the Mortgage Market
And they are related to the real problem with inflation.
In some sense inflation is not a problem, it is unpredicted changes in the rates of inflation. As long as everyone knows what the inflation rate will be all prices and contracts can be adjusted so that there are not any unanticipated transfers of wealth as a result.
The possibility or probability of changes in the inflation rate is particularly harmful to long term capital formation. It can be expected that lenders will increase the cost of long term fixed rate capital commitments to protect themselves against inflation risk.
Alternatively, they can refuse to lend at a long term fixed rate. While this protects the lender, it has transferred the risk to the borrower. Rationally borrowers must consider the possibility of a higher cost of capital than they may be paying initially when making any long-term capital commitments, and therefore reduce the size of such commitments.
Variable rate mortgages became much more prevalent when lenders felt that there was an increased probability of unanticipated inflation. Their alternatives were to increase the cost of fixed rate mortgages and assume the inflation risk, or to encourage people to take variable rate mortgages, thereby enabling them to maintain an attractive rate relative to the amount of inflation at the time, and protect themselves against future inflation, by transferring inflation risk to consumers.
In most cases this has not been a major problem for consumers because their source of income, wages, tend to more or less be adjusted for inflation. Actually since most mortgages are indexed to the interest rate of some short-term instrument the rate of new and existing variable rate loans should decline in the immediate future. Over time however the immediate effect of an expansionary or easy money policy, lower interest rates, is offset as the inflationary nature of that policy begins to become more clear and short and long term rates increase.
Rationally mortgage lenders should increase the cost of fixed rate mortgages when manipulative money supply management is depressing the short-term rate of interest.
So far this has not been the case. It seems that whenever short terms rates have gone down so have long term rates. While this made sense when the reduction of short-term rates was a result of market forces anticipating lower rates of inflation now and in the future, it makes no sense when the short-term rates are being brought down by other than market forces (i.e. a Federal Reserve attempting to stimulate the economy).
I would imagine that in the near future lenders would be decreasing the rates of fixed and variable loans.
Since I anticipate that the upcoming economic contraction will have significant elements of inflation in it, one way in which the many homeowners may be able to benefit is to go long current goods and services (buy a house) and go short the dollar (finance the purchase with future dollars borrowed at a fixed rate of interest today based on the current rate of inflation).
The timing of these for a new purchase is tricky since I think that the cost of houses will be going down in the near future and this reduction in value could offset and savings associated with the fixed rate loan. For current homeowners this is not a problem.
Given the record level of consumer debt, record low amount of savings, and the recent reduction in any 401(K) money that was invested in stocks (most of it), which otherwise would have been available to cushion the financial impact of a layoff, I would imagine that the rate of mortgage defaults on both fixed and variable rate mortgages will increase over the next year.
While theoretically the lenders are protected against these defaults by the collateral value of the house, in fact loose lending practices including very high loan to value ratios and generous home appraisals will make many lenders much more vulnerable than they currently perceive.
But when bubbles burst a lot of things change. |
