A reader's (JF) response to HP's "what popped the bubble" question. I found this very, very interesting. Intended by the government, or just an unintended consequence?
Intended I'd say. I remember finding it odd when they pulled the 30-year, but couldn't figure out why. Now I know. I also found it odd when the Fed stopped publishing M3, the money supply. But know I know why. Crank the presses.
Note the Fed pulled the 30-year on 10/31/2001. You got it - LIFTOFF! And they put it back on the market 1/18/2006. You got it - CRASHAROLA!
Dear Keith:
It's very simple.
In 2001 the Feds got rid of the 30 year, so anyone overseas who wanted to park their
dollars here in the US had to buy the 10 year. That bid the price up and made the
interest rate go down. The mortgage rate is tied to the 10 year, so the mortgage
rate went down.
In 2006, February, the Feds put the 30 year back in place. Now anyone overseas who
wants to park their dollars here in the US can buy the 30 year. That means there are
less buyers for the 10 year, so the price will go down and the interest rate will go up.
The mortgage rate is tied to the 10 year, so the mortgage rate will go up. And it will continue to go up even after the Fed stops raising the short-term rates, because there will be less buyers of the 10 year and more buying of the 30 year.
It's very simple.
July 06, 2006
Pulling the 30-year bond caused the bubble. Reintroducing it helped pop it.
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19 comments:
maybe...but then shouldn't the yield on the 30 year be significantly higher than the 10 year?
as of today:
10 year: 5.18%
30 year: 5.22%
I think the real culprit has been the central bank of Japan which has created a sunamai of liquidity, and then charged 0% interest for it. The liquidity went all over the globe, including into US treasuries - depressing interest rates everywhere and also bidding up the prices of most all assets.
Now, they (perhaps) are finally going to raise their rate to .25% and have cut back on the liquidity big time. Hence the huge cratering of global markets and commodities in May.
this stuff is complex to say the least..
And why did Greenspan say the failure of the 10-year rates to rise when he was raising rates was a "conundrum"?
There were always 30yr bonds they weren't pulled, just no sales for a few years because the govt could get better terms with other instruments. Anyone who thinks mortgage rates are "tied" to the 10yr souldn't be trusted with a portfolio.
maybe...but then shouldn't the yield on the 30 year be significantly higher than the 10 year?
as of today:
10 year: 5.18%
30 year: 5.22%
You have it backwards. Demand moves in the same direction as bond prices, and bond prices move inversely to interest rates. Therefore with high demand for 30-year bonds, it should not be surprising to see them at a rate which is not much higher than the 10-year.
Anyone who thinks mortgage rates are "tied" to the 10yr souldn't be trusted with a portfolio.
Correct, they are not "tied", but for 30-year fixed-rate mortgages, the 10-year generally (and I emphasize "generally") moves in the same direction and in a similar amount to the mortgage rates. This is because the average time that a mortgage exists until it is paid off is closer to 10 years than the other Treasury bonds and notes on the yield curve.
chris g, you capture my sentiments. And yes, the average mortgage used to be held about 7 years so the 10yr made a good indicator. In addition to your comments I expect a widening lending risk premium and a widening volume premium and a widening inflation risk premium to pad the difference a lot more than we see now. This is already showing up in the 15yr fixed product.
Gentlemen, the principal culprit in the bubble was/is the socialization of the mortgage credit market risk via Freddie and Fannie. After the Fannie book surpassed $1T in assets, Raines and his incompetent staff and PR hacks predicted that their book would grow to $3T and then $5T in 3-5 years. And no one in the regulatory or oversight function in Congress did or said a bloody thing in response to the delusional pronouncements and maniacal rate of securitization being done. Freddie and Fannie permitted lenders to throw paper at anything with a pulse, and the socialized agencies were there to take anything dished to them. Even though the feds say that Freddie and Fannie are not backed by the "full faith and credit" of Uncle Sam, we all know that this is pure nonsense. The feds allowed the agencies enough rope to hang us all, and now they have no choice but to bail them out to the tune of hundreds of billions or trillions of dollars when the bubble bursts and carnage rages across the land. Some of the singularly most incompetent people I have ever met in my life work for Fannie Mae. Raines was symptomatic of the incompetence. In effect, the US real estate market is quasi-socialist, and the bubble is a function of gov't subsidizing the rentier class and socializing risk to the masses. Corporate-socialism at its finest. When gov't guarantees trillions of dollars of mortgage credit, the central bank effectively monetizes it, and tens of thousands of people you wouldn't trust your mutt to hike his leg on become paper millionaires, you know the world is about to end and the gov't is effectively insolvent, only most of us don't yet know it. Heaven help us.
I regret that we did not sell a bunch of 30 years when the interest rates were at historical lows. But, if the Fed is trying to keep rates down, selling a bunch of taking money in from the market would work against them....
Fani and Fredi helped, but the really nasty loans came from the private markets, and securitization. With low interest rates, anything with an extra few points in yield got sucked up. Fani and Fredi still stay away from toxic mortgages.
It's a good point, one that boind traders would probably agree with. But I don't agree that this subject is "simple" nor that you can really point to one issue in so facile a way. Like most questions in economics, causes are numerous and overlapping. If things were simple, economics wouldn't be so hard, economists wouldn't constantly be in disagreement about policy, and trends would be more predictable. They aren't.
To paraphrase Mao, whenever you hear somewhat say things are "simple" in explaining the economy, you should reach for your revolver.
Could someone tell me where this money is coming from?
The House in May passed a defense authorization bill approving a $50 billion supplemental request to support operations in Iraq and Afghanistan. It authorized $5.1 billion for weapon system procurement; $37 million for research and development; $31.9 billion for operations and maintenance; $950 million for defense health programs; $9.4 billion for personnel accounts; and $2.5 billion for classified programs.
The House on June 16 approved a defense appropriations bill that also sets aside $50 billion for operations in Iraq and Afghanistan, including: $5.5 billion for procurement; $37.4 billion for operations and maintenance; $5.9 billion for personnel accounts; and $1 billion for increased fuel costs.
The Senate Armed Services Committee, meanwhile, on June 22 authorized a similar $50 billion bridge fund for the war on terrorism, authorizing $2.1 billion for procurement -- significantly less than the $8.6 billion the Pentagon is seeking -- as well as $32.2 billion for operations and maintenance; $960 million for defense health programs; $7.3 billion to pay troops; $3 billion for classified programs; $2.1 billion for efforts to defeat roadside bombs; and $2.2 billion for the Iraqi Freedom Fund.
BC_OR, your take on this is brilliant and I agree totally!
Not Socialism bs, Mercantlism. Classic Mercantlism, though with the failure of the market shortterm over the years, somebody had to try and prop up Real Estate. They just went to far this time.
Yeah.. I'm short FNM. Any idea when these guys will let it fall?
BTW, I think it was a concerted effort by FNM, BoJ, Fed, Treasury to:
1. encourage borrowing (creating money)
2. find places to park all the extra money outside the CPI
just for the record, the note says repeatedly "the Feds" did this and "the Feds" did that. He is clearly trying to cause readers to conclude that "The Fed" is responsible for setting the auction schedule and maturities of bonds that are issued. In fact, of course, it is the Treasury, which at the time the decision was made, erroneously believed that deficits were going to remain low, and the huge that had plagued the long end of the yield curve due to illiquidity were best solved by not issuing these bonds any more.
"the principal culprit in the bubble was/is the socialization of the mortgage credit market risk via Freddie and Fannie. "
That is part of it, but let's remember that still, Fannie and Freddie buy the most conservative "conforming" loans, and have a maximum loan size too.
Combining the two of these (reasonable loan/value relationship and max size) it must mean that Fan and Fred own less in highly bubbleized areas which have inflated greatly.
So it is really the private sector pimping the junk loans which is more to blame for the *bubble* than Fan and Fred, contrary to the prejudices of the reflexive anti-government Talibanism one may see, e.g. in the WSJ.
Fan and Fred do have special advantages and surely Raines et al were corrupt---but I doubt it was at a level significantly different than a fair amount of equivalent private sector earnings massaging, and with greater public scrutiny.
The real reason for the bubble comes from Japan and China. We buy their stuff, give them dollars, they loan the same dollars back to them to buy more stuff.
When Japan and US central banks were accomodative, and China persists in its strategic mercantalism, you get the Mother of All Bubbles.
Securitization is A-OK.
What is NOT fine is sticking the INSURANCE of these loans on the U.S. taxpayer and that's what Fan & Fred effectively did.
That causes the bubble by distorting real risks.
If people had to "eat what they bought" then things would be far different.
If you have optimistic insurance, the carry trade is a no-brainer:
0) Recognize: Bank of Japan and Fannie & Freddie's poop have the same credit rating.
1) Borrow yen.
2) Buy loans
3) Lever up the wazoo.
4) Profit!!
And to think that the big investment bankers are making a million dollars a year off this ten minute trade.
China is a big part of it too, because Chinese goods deflation and mercantilism were forcing the Bank of Japan to keep low low rates to halt domestic deflation and
The Chinese may turn out to be the smartest ones in the end. Orthodox economics says that capitalism beats mercantilism, but I'm not so sure. They are pursuing the strategic deindustrialization of the USA. What better way than to destroy domestic manufacturing then inflate and pop the US domestic demand bubble? In the end of the day, the US will have crappy condos with poor people living in them, and the Chinese will have high-tech factories and knowledge and supply chains.
I thought the treasury called many thirty year bonds, am I wrong?
"What is NOT fine is sticking the INSURANCE of these loans on the U.S. taxpayer and that's what Fan & Fred effectively did."
This is a real important issue. I keep reading that the GSEs are NOT backed by the US Gov't and there will be no bailouts. But if the GSEs guarentee the loans, how can loans in the $T be secured by GSEs with market caps in the $B? And who is propping up the price of FNM?
If the US Gov't has to pay the bill on GSE guarentees (to the ultimate bagholders that bought that lousey loan, and probably a foriegn bagholder at that) then I will be paying the bill. That is not right.
Anyone here able to explain TOMO and POMO?
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