Krugman: Question of Interest (rates)

[DeepModem Mom]

OP-ED COLUMNIST
Questions of Interest
By PAUL KRUGMAN

Published: April 20, 2004


....If the economy fully recovers — or even if investors just think it will — interest rates will rise sharply. In its World Economic Outlook report, to be issued tomorrow, the International Monetary Fund urges the Federal Reserve to prepare the economy for higher rates to "avoid financial market disruption both domestically and abroad."

But how far will rates rise? Let's not get into Greenspan Kremlinology, parsing the chairman's mumbles for clues about the Fed's next move. Let's ask, instead, how much rates will rise if and when normal conditions of supply and demand resume in the bond market.

My calculations keep leading me to a 10-year bond rate of 7 percent, and a mortgage rate of 8.5 percent — with a substantial possibility that the numbers will be even higher. Current rates are about 4.3 and 5.8 percent, respectively; you can see why the I.M.F. is worried about "financial market disruption."...

***

Now for the obvious point: many American families and businesses will be in big trouble if interest rates really do go as high as I'm suggesting. That's why the I.M.F. is urging the Fed to get the word out.

And one suspects that the fund, which, like Alan Greenspan, tends to convey messages in code, is firing a shot across Mr. Greenspan's bow. A number of analysts have accused Mr. Greenspan of fostering a debt bubble in recent years, just as they accuse him of feeding the stock bubble during the 1990's. Just two months ago, Mr. Greenspan went out of his way to emphasize the financial benefits of adjustable-rate, as opposed to fixed-rate, mortgages. Let's hope that not too many families regarded that as useful advice.


http://www.nytimes.com/2004/04/20/opinion/20KRUG.html

[hadrons]

1. emphasize the financial benefits of adjustable-rate ....

I'm a renter in NYC ... never owned a house, but even I know how insane this is

[The Backlash Cometh]

2. I was around for the late seventies & eighties and double digit interest

rates was no fun a'tall.

[RC]

3. That depends on whether you are saving or spending.

[The Backlash Cometh]

4. When you're fresh out of college, you're not in a saving mode.

Too busy working to pay off the last generation's deficit.

[finecraft]

6. Yep - 11.5% mortgage rates in 1984

We bought our first house in 1984. If we had gone fixed rate, the 30-year mortgage rate would have been 11.5%. We went with a 5-year adjustable rate at 9.75%.

[papau]

9. Prudential Ins's placement of 15% commercial mortgages was the top

It may have gotten a fraction above 15% at one point even - but there was a rapid drop to 11%to 12% on commercial - and a point or two less on home mortgages.

Overnight hit 21% to 22% at one point.

But for most folks we are talking a topping out at 10 to 11% om mortgage loans.

Funny how high interest rates under a Dem - Carter - did not stop great GDP growth - an average 3.3% compounded each year for 4 years - even after reduction for the effect of inflation (3.3% in "constant dollars")

but under the GOP all we get are excuses if the Fed raises the rate from the current 40 year low of 1%.

These folks could not lead/organize a 2 car parade.

[ramapo]

10. I Topped out at 12.25%

We bought in 1981 after enjoying earning interest on our down payment at something like 14%. Could only qualify for an adjustable with a "low" entry rate of 10.25%. It was a one-year adjustable so we went up to 12.25% in 1982.

All in all we did ok with the adjustable and the risk was somewhat limited with 2%/5% yearly/lifetime caps.

Rates came down but prices sure went up. We paid $68,000 for a house that today lists at $400K+ and property taxes are much, much higher.

[papau]

5. Krugman writes the way I wish I could - 7% 10 y rate/8.5% mortgage

coming soon.

He must be smart because we agree!

:-)

[mastein]

7. Agreed, but. . .

Yes, we all know that the business cycle does still exist and that at some point rates will go back up and beyond that it is a guessing game. He also doesn't say over what period of time this rise in rates will occur. If it is rather slow over a period of several years, there is a good chance this will not be all that disruptive to the economy. If on the other hand the rise is steep, then problems will emerge much more quickly and there will serious issues about economic stability of entire communities.

One note about another post above... Student loan rates were changed to variable rates from fixed rates several years ago, so rising rates hurts grads fresh out of school as much as anyone because they have so much debt on those loans and that debt is compounding at a much higher rate than the fixed 8 or 5% that I had (before mine went variable. To give you a historical perspective, I will celebrate 10 years out of my bachelors next month)

[ramapo]

8. Bad news for Kerry

Looks like rates will begin to rise soon but the big impact will be during the next administration. If Kerry wins, he'll have to fend off the dogs blaming him for the rise in rates. I know I'm getting way ahead here but I can hear the Repub attack ads, "Remember when mortgage rates were low under President Bush, then along comes tax and spend Kerry and now your mortgage is 6%".