This is the entire reason the Fed manipulates rates in the first place. When it wanted to accelerate growth, it cuts the risk free rate which pushes investment into riskier assets like equities. When it wants to slow the economy, because of elevated inflation, it increases the risk free rate which acts to pull money away from riskier assets like equities.
That’s not a concern, that’s the system working as designed.
You are right of course. The fed wants businesses to stop/slow down investing and only prioritize high returning projects. But since rates went up so quickly, are various sectors really prepared? E.g unsophisticated home buyers who got ARMS clear ly were not. It was shocking to see SVB make a similar mistake .. but was it really a mistake? In hindsight, if you had crappy assets (e.g. low yielding MBS), as soon as the fed started tightening you should have sold off your assets (albeit making a small loss). Are people really doing that? It seems the expectation was that rates would go down again in a year (mid 2024) so it seems people just "let it ride".
I guess the equivalent argument works for a house too but transaction costs are high (and you need a place to live in the interim). Someone could have sold their house right as tightening began and bought the house back once rates stabilized.
For homeowners, I can’t imagine why anyone would have gotten an ARM when 30 year fixed were so low. The US standard mortgage only really exists because of government intervention and was a huge gift.
I mean, I know people did but it’s hard to figure out what they were thinking.
What SVB should have done was raise additional capital much earlier. Rates didn’t just start rising in the last year. Even if rates did start falling again they could do a dividend or stock buyback. We expect banks to be conservative.
I need to tell you something about Canada (and maybe the rest of the world except the US) .. we're F'ed. Most of the world does not have 30 year fixed rates. That's a unique American gift. (I guess because of how Fannie May/Mac work).
To clarify for those who are interested, in Canada you can still get a home mortgage with a 25-year amortization period (or 30-year in some circumstances), but the repayment terms are generally renegotiated on a regular basis: generally on a 5-year cycle, but with options between 1-7 years. For most people, they’re generally just making a choice between fixed- or variable-rate and open or closed (early repayment without or with a penalty). Looking at today’s rates, I’m quite thankful we locked in at a low 5-year fixed rate right before rates started to climb, but there’s a lot of folks who are going to be having a rough time here…
I don’t have a good intuition for when it’s prudent to take a mortgage if only ARMs are available. Off the cuff, I’d think you’d want to have a significantly lower DTI to start with so you can survive some interest rate increases.
The standard US mortgage is a 30 year fixed rate loan, with no prepayment penalty, as low as 15% down, a narrow spread over treasuries, and in some states no recourse beyond the security. Foreclosure is expensive and selling a seized home is expensive.
This is not a loan any sane person would ever write out of his own pocket. It is available because of a web of government programs and incentives, above all Fannie and Freddie.
Thanks for clarifying. I'm in the UK and it doesn't sound that different, except we don't to my understanding have the Fannie/Freddie situation. I don't see why it's such a bad deal for the loaner, unless defaulting is high?
My understanding from some friends in London is that there are not 30 year fixed rate mortgages. The interest rate on your mortgages get fixed for a few years and then float.
Ah - yes. I see the difference now. I don't really understand why the US does it that way, then. Why not do shorter-term mortgages that price in risk? Or is it doing that in a way I don't understand? (But then why is the government involved?)
Well that’s exactly it. For the homeowner 30 year fixed is great. You know that your mortgage payment is never going to go up, regardless of what happens with the interest rate. On the flip side, if interest rates fall since we have no prepayment penalties you can just refinance and pay less.
It’s great for the borrower, which means it’s bad for the lender. There’s some spread of interest over treasuries that might make it worth it for them anyway—like if it was the 30 year bond rate plus 10% or something, but the spreads are narrow.
That’s why I said I don’t think it would exist accept for extensive government intervention, because it’s such a good deal.
As for why the government decided to get so involved, it goes way back to before my time. Now they’d have a hard time extracting themselves without making a lot of homeowners very mad.
That’s not a concern, that’s the system working as designed.