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Interest Rates Play Havoc with Banks, Bonds and Borrowers

August 1st, 2013 2:16 PM by Robin Bain

Interest Rates Play Havoc with Banks, Bonds and Borrowers

INTEREST RATES imagesYou can blame Fed Chair Ben Bernanke for even suggesting that the Fed may… could… has considered… or might consider… eventually… some day… the “tapering” off of quantitative easing, causing the yield on 10 year U.S. Treasuries to jump up a few weeks ago. That is to say, you can blame Bernanke, but why bother. After all, the man has pretty much single-handedly kept interest rates artificially low far longer than anyone could have expected.

I mean… QE-1 was expected… QE-2… well, okay… but QE-3’s pumping of $80 billion a month into the financial markets indefinitely? Come on now… not even the most bullish of the bulls saw that coming.

Within hours of Ben’s recent comments, the Fed was tapering off on any talk of tapering in an effort to soothe the savage beasts of the bond market who were fast becoming bearish. Of course, rising interest rates have to be expected… eventually. Back in 2000, the yield on the 10-year Treasury was roughly six percent. A decade before that the yield on these same bonds was almost nine percent.

Contrast those numbers with where things were at the beginning of last August when the yield on 10-year Treasuries was a paltry 1.48%. Was anyone thinking that number would go down from there?

This week, however, with investors still jittery and feverish from Bernanke’s scary speech, Treasuries hit 2.70%, and analysts appeared close to panic-stricken over the possibility of breaking through the 2.75% threshold. Luckily, the Fed’s back-pedaling led to the yield on Treasuries settling back down to a much more comfortable 2.58%.

(It made me wonder… do you think Ben Bernanke BEEPS when he backs up like that?)

If all of the gyrations over a few tenths of a point here and there makes you feel like our financial markets are perilous to say the very least… you’re dead on right to feel that way. Can you envision what would happen if rates were to return to historical levels, like six to nine percent? To the talking heads on CNBC, based on how they reacted to the recent upticks, it might feel just about like the end of the world would feel.

BK images

Long-term interest rates rising means different things to different people, but none of it’s good. Higher long-term rates makes it much more expensive for state and local governments to borrow money, and you can probably guess how that would play in Detroit, or in the slew of other American cities currently lining up behind Motor City, metaphorically holding their breath and hoping against hope for divine intervention.

Higher long-term rates also cause the bonds currently held to fall in value, which means bond investors lose big time… and as mortgage rates go up, mortgage payments do too. And that’s double-whammy time for our anemic housing markets because it means fewer home sales and more foreclosures, which we should all know by now leads to lower home values… and more homeowners underwater, which creates more foreclosures still.

In general, higher interest rates always have the very definite tendency to slow our economy down a notch or two… unemployment rises, and the stock market falls. Conversely, when rates are low, economic activity increases, and even if we don’t all feel it, the stock market sure does.

Yesterday, Fleckenstein Capital president, Bill Fleckenstein, told King World News that were rates to hit the 3% mark, S&P futures would be destroyed and we could see the DOW lose a quarter of its value in three days, and from where the DOW is now, that’s quite a fall.

Of course, the Fed would once again leap into action and start quantitatively easing their little banker hearts out, but I’m not so sure it works when done on cue like that. In fact, that sort of reaction might just have the opposite effect, or no effect at all. It would signify the moment when the Fed lost control.

Refinance activity index already cut by half…

Rising long-term rates wasted no time giving a swift kick in the pants of the residential mortgage market, which was weird because as recently as a couple of weeks ago, all I was hearing from the banking class was that the mortgage business was booming.

According to the Mortgage Bankers Association (“MBA”), since early May, the average interest rate on a 30-year mortgage has gone up by more than a point, reaching 4.7% in early July. The MBA’s index of refinance applications was cut in half over that same timeframe. It now sits where it was in the middle of 2011, and several analysts are predicting that mortgage banking revenue for Q-2 of this year will be down by 25 – 35 percent as compared with the first quarter of this year.

FHA’s increasing costs can’t have helped June and July’s home sales numbers either. According to the L.A. Times“… in the wake of losses tied to bad loans insured during the housing bust years, the FHA has been raising its loan insurance fees and backing more loans to applicants with higher credit scores.”

All of this is leading to next January when the Consumer Financial Protection Bureau’s (“CFPB’s) new Ability to Repay and Qualified Mortgage Rule,” becomes the law in mortgage land. Among other things, the agency’s new rules will mean that, for the most part, borrowers won’t be able to qualify for a mortgage if their back-end debt-to-income ratio is over 43 percent.

I can’t be certain about this, but I’m guessing that pretty much cuts out most everyone I’ve ever met who lives in California. And with Fannie’s and Freddie’s recently seen penchant for making lenders buy back loans the GSEs don’t like for one reason or another, I’m wondering how many are thinking about just throwing in the towel after January 10, 2014, when the CFPB’s new rules go into effect.



                             Dana Bain & Robin Dunbar Bain


By Phone: 978-422-2311 (Office)
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Sterling, MA 01564-2829

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Posted by Robin Bain on August 1st, 2013 2:16 PM


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