Seattle Bubble Part 3

The last leg of potential real estate price doom in Seattle is the meaty leg of interest rates. They played a big part in allowing buyers to jump in to this market. My super computer X3000b tells me that there would have been exactly 7,452 fewer local buyers in the past two years had interest rates floated between 8-9% instead of 5.5-6.5%. Where would I be without the X3000b. In any case, with higher interest rates, demand would have been down and there would have been much less upward pressure on prices. So.........is there potential for higher interest rates in the future? Will the great Seattle Real Estate bubble be induced by skyrocketing interest rates?

Why did interest rates decline and why did they stay low for so long? The billion dollar question. Some point to the Federal Reserve continually lowering the overnight interest rate in the 90’s as the cause. In actuality, this interest rate and system have little to do with mortgage interest rates. http://library.hsh.com/?row_id=90 (Fed Funds overnight rate vs. Mortgage Interest Rates) I bought my first house with 10.5% interest, and there was a real estate feeding frenzy at the time (late 1989) so many other people were happy with the rate as well. What was different about the past 10 years vs. most of the 1980’s that caused interest rates to fall so far?

Thanks to HSH Associates and their wonderful consumer real estate and finance website, http://library.hsh.com/?row_id=85 (What moves Mortgage Interest Rates,) I got an idea about factors influencing mortgage interest rates. Not that I understood everything, but I got the ideas. The factors influencing M.I. rates are apparently varied and multiple. Their explanation is full of dead-ends, cul-de-sacs and 6-way intersections that make it difficult to explain, but...................................

Mortgage money comes from investors. One difference between 2004 and 1984 might be the presence of more worldwide investors and less stage presence of David Lee Roth (some social conditions do improve over time!) India, China, S. Korea, Hong Kong and Singapore certainly are much wealthier now. Wealthy individuals invest money to earn further income. Mortgages are made to fit certain ‘standards’ of risk and return, and packaged into Mortgaged-Based Securities (MBS.) Investors put their money into MBS because it suits their investment style at the time. The HSH folks explain how MBS competes with other, relatively safe, investments. I guess you can only conclude that a large swath of investors believes American MBS to be a pretty safe bet OR that alternative investments are riskier.

I’ve only invested in real estate, so I don’t know what alternative investments compete with MBS. HSH explains that when large amounts of money come in to MBS, MBS don’t need to pay investors high rates of return (the supply of money is relatively large.) In turn, mortgage lenders can lower interest rates to homebuyers, thereby increasing the supply of buyers in the market, tending to push real estate prices upward.

To predict interest rates, then, we will need to guess how ‘investors’ see the risks of MBS vs. other investments they could make. Investors are surely aware of the terms and conditions of today’s mortgages.....they didn’t get to have sufficient money to invest by being financial bozos who don’t investigate thoroughly where they’re putting their money. In spite of the additional risks presented by 80/20 and no down payment mortgages, investors continue to put their money into MBS. Do investors foresee such a sufficiently strong American economy that they don’t perceive the new mortgages as too risky for their investment money? Do only bonebrained investors invest in current MBS?

Clearly, the money still flows in to MBS in sufficient quantities to keep 30 year fixed rate mortgages still under 6.5%. Is there something on the horizon that will change this drastically? Imminent American economic catastrophe? If investors expected this, the money would already be moving elsewhere. Better places to invest? A possibility, but the likely candidates appear to be India and China. Both have great economic potential, but both are high on the list of nations with unstable investment environments; China because of uncertain potential government actions, and both nations are high on the list of bribery-riddled business and government interaction.

Currently, I see only ‘wild card’ risk factors changing this picture. Wild card risks would be drastic interruption in oil supplies, drastic changes in weather or other natural disasters, even worldwide pandemics. All seem eerily more possible than even 5 years ago. But do investors make their plans as if catastrophes are imminent, or simply have back-up plans if worse comes to worse?

Based on my limited knowledge, I don’t see drastic rises in interest rates in the near future. Anyone who can supply missing information to this equation, please speak up and let’s reformulate the equation.