The Problems are the Path: History Repeats in Interest Rates
REMEMBER! Lenders and owners are Diametrically Opposed! This Adversarial Relationship stems from GREED, an entrepreneurial trait which brings both parties together.
From the 1960's forward, Legislatures and Judiciary parts of our government have worked to protect lenders from the abuses that created an uneven playing field that favored lenders. (Residential)
The most important legislation came from California in the "Anti-deficiency legislation of the 1930's.
Rising inflation during the 1960's produced a severe real estate recession in 1965-67. This occurred while the economy improved due to employment from the war effort of Viet Nam.
1963-64 Boom Led To The Savings and Loan Crisis.
Lenders viewed excess money on deposit as wheat to be harvested. Money was lent quickly and deals where chased aggressively. Brokers were in control, rates were below 7% and deals were taken on without regard to risk as inflation was low.
The result was excess Real Estate inventory. To save themselves Savings and Loan and Small Bank mergers created larger firms with the same insolvent inventory.
In 1965 Interest Rates Increased! Money Supply Tightened! Availability of funds decreased and inflation soared!
Savings and Loans who provided most of mortgages were caught in a vice. The cost of funds, deposit interest, increased over the Fixed Rate Mortgages income of mortgages held. A quarter of the Savings and Loans in California were in Financial Trouble. Added to that risk the developments financed by the Savings and Loans could not sell new homes without mortgage funds and qualified investors. Foreclosures came in by the thousands and a new term for the Balance Sheet of Banks became known as REO, Real Estate Owned.
To avoid "Due on Sale" covenants of mortgages All Inclusive Trust Deeds or wrap mortgages were formed using Land Sale Contracts so the new buyer assumed the old lower mortgage rate. Variable rate or Adjustable Rate mortgages became popular. Land Sale Contracts, Carry Back Financing all were used to bypass the "Due On Sale" clause of mortgages.
While Wall Street and Owners got creative, the Federal Reserve still tried to stop the inflation from the boom in real estate prices. By the time the FED rates hit 14.5% the Real Estate Bubble had busted and with it Savings and Loans! Resolution Trust Company liquidated Savings and Loans REO properties at wholesale prices. Home owners were evicted as the recession was more in line with a depression with loss of jobs and income to support their homes or real estate Speculation. The recession was not kind to other assets, the Stock and Bond Market collapsed. Only Gold became a Store of Value.
The Next Cycle: Millenium Boom
Legislation was passed, interest rates declined and the stock market and bond market rallied from a severely depressed level. But still Foreclosures increased eightfold in the early 1990's. The economy righted itself, jobs and income increased. The dramatic increase is asset values and the return to work created another cycle of inflation.
In 1998 the Federal Reserve once again began rising interest rates to induce a recession. By FED action and legislation real estate prices froze on their highs without having a chance of adjustment. On September 11, 2001 the FED opened the Floodgates controlling the flow on money into mortgages. The FED bought treasuries and loaned money for mortgages. This added large amounts of cash to the Money Supply. The seeds of the MILLENNIUM BOOM began to sprout.
During the same period the U.S. Treasury and Congress deregulated mortgage lenders and Wall Street Bankers. This removed the safe fundamental lending practices for safe mortgage lending. Wall Street bypassed the FED and created MBB, mortgage backed bonds and no longer looked to the FED to create money supply. Wall Street took over with no oversight!
Congress got into the game by 2005. The legislature had succeeded in removing what few restraints remained on mortgage lending by withdrawing bankruptcy court authority to help insolvent and over mortgaged homeowners.
This was the Final Straw following 25 years of loosening controls over Wall Street's involvement in the mortgage industry. By 2007 mortgage borrowers began defaulting en masse! Almost overnight the Millennial Boom became the Great Recession! It left 40% of California's 6.5 million homeowners with Negative Equity! Another foreclosure Crisis was created!
The Next Cycle: Today
Back From the Bottom again, the FED fed money by buying MBB to keep funds flowing into mortgages, government subsidies in the form of tax credits to home buyers were issued. Dodd Frank Act and the creation of the Consumer Financial Protection Bureau were created to help homeowners.
Then came the pandemic and the FED and Government increased the flow of funds into the economy to the tune of a FED Balance Sheet of over $9 trillion dollars! A double in the size of the FED's Balance Sheet which had already doubled from past historic averages.
The Pandemic ended and Americans found themselves with savings and cash reserves from being home bound and splurged, inflation was fed and the FED just watched.
When the FED acted by raising rates rates went to a +20 year high. The economy was resilient just as in the past. Stock prices boomed again, but only in a select group of technology stocks, the Mighty Seven led the run. Last half of 2023 Wall Street pumped the public with forecasts of interest rates cuts in March of 2024 and possibly 7 in total for 2024. The stock market went to a new high on the promise of lower rates. Lower rates that did not come. January 31, 2024 the FED said no rate cuts coming and none for March 2024.
How long will high rates continue? Will high rates create the repetition of the past 60 years?
As Yogi Berra was supposed to have said, "It's Deja Vu All Over Again"?
In the past 60+ years there was never a Soft Landing. Crashes were the norm.
The past does give some guidance as commercial property now seems to be the area of concern. Watch for Commercial sales when owners are Private Equity Groups who purchased property in 2019-2021. The loans given were basically construction loans created in the form of mezzanine loans. These loan give lenders the rent and income flow when in default. The Due On Clause is valid in Commercial Loans where they are not in Residential Home Loans. Generally speaking the Due On Clause is exercised when the commercial units are given building permit releases of their construction permits. At that time the loans must be renegotiated to current market rates or properties must be sold. The refi efforts are the main benefit for new buyers as the refinance rates are +10%. Owners must sell or be faced with high interest rates that may not be able to be covered by rental income. Junk Bond rates for CCC rated corporations are 13.5%,
This the the Opportunity Area for investors.
Signs of lowering rates or a repeat of the past
1. Credit Card Debt as historic high with defaults
2. Luxury Rental Market declines: Austin Texas down 20%, Chicago giving free month(s) rent.
3. December 2023 inflation numbers lower than expected.
To counter the signs of a slowdown the Federal Reserve of Atlanta has forecasted a 3.4% inflation rate for the first quarter of 2024, wll above the 2% FED target. Rate will remain high until signs indicate a FED forecast of 2% inflation rates. What lies ahead? Bond market crash, stock market crash?
History Repeats Itself?
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