Refinancing is dead: a generation of Hard Times will continue until secularly real wages improve
New Deal Democrat
writing from The Bonddad Blog On Monday I gave what I think is a reasonable roadmap to the next recession. I want to follow up on this a little.
The post from nearly 10 years ago was entitled, Are Hard Times Near? The great decline in interest rates is ending.” The theory is right in the title. Since the 1970s, real average hourly earnings had declined. Average Americans coped by spouses entering the workforce, by borrowing against appreciating assets, and by refinancing as interest rates declined.
By 1995 the spousal avenue peaked. Borrowing against stock prices ended in 2000. Borrowing against home equity ended in 2006. When interest rates failed to make new lows, the consumer was tapped out, and began to curtail purchases. A recession began – and its effects have lingered and lingered. Hard Times were indeed near.
Here is a graph from 1981 of mortgage rates and 10 year treasuries:
In that article in 2007, I wrote that the consumer might yet have one more chance to refinance debt. In fact after the recession it turned out there were two: in 2009 and again in 2013. Ten year treasuries made a 60 year+ low in 2013 at 1.50%. Even if treasuries, and mortgage rates tied to them, make a new low, the floor is somewhere north of 0%. That -1.5% decline in a mortgage payment on a $250,000 house would be $3750 a year, or a little over $300 a month. That’s the most extreme case. Even if interest rates make new lows, households that refinance are likely to see more on the order of $100 or $200 per month of freed up cash — not enough to power much consumer spending.
Yesterday Molly Boesel of Core Logic confirmed this, writing in her blog
Because a refinance isn’t free, a simple rule of thumb is to add 100 basis points to the current market mortgage rate as the rate at which borrowers would have an incentive to refinance…. According to the chart [bleow], most borrowers hold mortgages with rates up to 4.50 percent, with 62 percent of mortgages and 72 percent of UPB in this range.
If mortgage rates rise as predicted, we will certainly see refinancing volumes fall in 2016. Note there is a small share of outstanding mortgages with interest rates of about 300 basis points or more above the current market rate.
Currently nominal wage growth is running at about 2.5% YoY. Real wages have been boosted in the last 2 years by collapsing gas prices. Once that is over, what happens next? Even 2% YoY inflation eats up nearly all of consumers’ wage growth. A 3% YoY inflation rate means real wages decline.
So the bottom line is, we are already in a period – a period that I expect to last an entire generation – where real gains by average Americans won’t be available from financing gimmicks, but must come from real, actual wage growth. At the moment I see little economic or political impetus to make that happen, even though average Americans understand via their wallets the issue all too well. Eventually it will happen, but I believe between now and then is another recession, one that I fear is likely to be worse than the 2008-09 recession because it is likely to include a spasm of wage-price deflation.
That’s a good analysis. Of course, I’m biased. I’ve been watching these trends since the late 70s when I started investing. Before the 70s, in my father’s generation, the key to investing was to follow income. When people earned more, they spent more and that gave one an opportunity to invest and earn money as well.
Starting in the 1980s, it was all about working spouses and leverage. Income was stagnant. As far as investing was concerned, there was too much capital chasing too little income growth, so all one had to do was buy an index fund and wait. When the economy grew, the market went up. When the economy crashed, the market went down for a few years, then it went up again because there was no other game in town.
Run – you say:
“Borrowing against stock prices
ended in 2000”
Actually one does not borrow against “stock prices”, you borrow against stock values. If you are saying that margin loans (Reg U Loans) have declined since 2000 you would be wrong. Margin loans are at a record today, about double where the were in 2000.
http://www.businessinsider.com/stock-market-margin-debt-2015-6
Home Equity Loans (HELOCS) have declined from $80b in 2006 to $60b today. The drop of $20b is a small fraction of total credit and in no way will create a recession.
If you you have a home with equity you can get a HELOC from a Community Bank at about 3% today.
If you own stocks you can borrow against that at about 1.5% from any broker.
The cost and availability of credit is not goinging to be the source of the next recession.
Bruce:
I posted New Deal Democrat’s post on Angry Bear. I am sure he will answer. This appears to be a one – off from what you are implying here. The price could be a determining factor in value.
Wages will rise as they already are. Lessons coming. Lessons learned.
@BK – Adair Turner begs to disagree with you: http://www.amazon.com/Between-Debt-Devil-Credit-Finance/dp/0691169640/ref=sr_1_1?ie=UTF8&qid=1464660875&sr=8-1&keywords=Adair+Turner
Mark:
Been thinking about you and was going to email you. Glad you beat me to the punch. Good to see you.
MJ – Turner disagrees with me? I think Turner would disagree with this post.
Turner thinks that there is too much private debt. The point of this blog was that the sources of private debt are drying up and as this happens a protracted recession will result.
What’s going to kill us? Too much debt, or too little? I’m with Turner. There is too much, and the amount has grown since 2008. Sooner or later there will be another leg down as a result. I don’t see the next fall coming as a result of the drying up of credit as suggested in the post.
“The point of this blog was that the sources of private debt are drying up”
I guess we always read posts based on our own biases. When I read “Borrowing against stock prices ended in 2000. Borrowing against home equity ended in 2006”, I simply saw evidence that obvious bubble driven borrowing were perturbations.
I see your comment as evidence that you missed the point of the post.
Too much debt? Too little? It’s not an absolute question. Since today’s debts have to be paid with tomorrow’s income, if incomes were growing, growing debt levels might be supportable. Using debt to buy something durable today and then paying that debt back with dollars that are more plentiful tomorrow is a positive thing. But for most people incomes haven’t been growing as fast as their incomes. This means that servicing those debts grows ever more difficult and THAT is not supportable.
As for women joining the workforce, I see that as the economy getting the benefit from improvements in household efficiency….It is easier for women to work outside the home because we have frozen dinners, and permanent press, and many other things that have reduced the time spent maintaining a household.
ack…that should read “incomes haven’t been growing as fast as their debts.”
Appreciating the persistence you put into your blog
and in depth information you present. It’s great to come across a blog every once in a while that isn’t the same outdated rehashed information. Excellent read!
I’ve bookmarked your site and I’m including your RSS feeds to my Google account.