Why Low Interest Rates Hurt Real Estate

Why Low Interest Rates Hurt Real Estate

This was the exact same scenario that caused the banking debacle of 2008, just a different investment and derivative instrument. Instead of REIT fund of funds it was Bond Fund of Funds. and instead of Credit Default Swaps it was Interest Rate Derivatives. There is nothing wrong with the basic investment concept, it is the quantity of the derivatives that posed the risk. With Interest Rate Derivatives accounting for 82% of the derivatives sold, a bubble was forming.

If the Federal save Bank raised these already a small amount, then edges that sold Interest Rate Derivatives would have Buy Side Institutions redeeming those Derivatives. The similarity is that when Subprime Mortgages started to default, the Buy Side Institutions that had purchased the Credit Default Swaps as insurance redeemed those, creating the implosion as the edges were unable to meet the obligation of such a enormous redemption need.

REIT investment collapsed and CDSs forced edges into default. A similar risk was developing in interest rate swaps IF the Federal save Bank had raised interest rates already a slight amount. T-Bills were at near zero interest rates and continue to keep low because the Fed is not raising them, despite what the news media purports.

Low rates assistance big edges and financial sets companies, boosting their revenues and earnings. However, the Federal save Bank will not be able to keep the rates at this level forever. Those who thought it could or should, were not facing some basic realities about the importance of relative rates to the stock market and certain areas of the economy. Not all industries assistance from near zero rates. Near zero interest rates have truly hampered growth for many areas.

Historically low rates were touted as being advantageous to the stock market, however historically the stock market and interest rates have been in sync. As the stock market rises the Fed tends to raise them in response, assuming they can control the stock market buyers. When the stock market falls interest rates are lowered in an attempt to control stock market sellers, which doesn’t work either.

This time as the stock market rose rates did not, which allowed for growth in the derivatives market. The difference this time was that Interest Rate Derivatives were cleared due to new regulations in place, which allowed for a complete documentation of the risk factors within the bond and Interest rate derivatives market. Not all interest rate swaps are cleared, but more are than ever before.

The enormous exodus out of Bond Funds and Bond Fund of Funds that started last year about this time, has lowered some of the risk factors of interest rate swaps. Keeping rates lower reduced the risk of a systemic market collapse, however interest rates at historically low rates causes problems for many industries.

Although the concept that low rates would help the housing and real estate industry, they have not. In fact edges held onto foreclosed housing inventories instead of placing homes on the market, as a surge of qualified home buyers wanted to buy homes. Low rates on 30 year mortgages was not something edges were interested in investing in, when they could make far more profits on interest rate swaps and bond fund sales.

It is a fact that during the late 70’s and early 80’s the chief rate rose to an all time high of 20%. This was at the height of the Real Estate expansion that started in 1975, and continued by the mid 80’s ending with the Savings and Loan Debacle of that era and Junk Bonds.

Despite double-digit mortgage rates, buyers flocked to home buying as the largest generation in US history at that time started buying their first homes. It was a huge Real Estate market for houses which quadrupled in values in a few years, already though mortgage rates for homes skyrocketed. Nothing quelled the need for new home buyers, and houses were flipped monthly causing the same kind of rampant house valuation that occurred between 2003-2007.

The concept that low rates help the Real Estate housing market is not supported by historical empirical evidence. The true driving force behind all Real Estate Booms is generations reaching adulthood. Interest rates tend to rise during Real Estate booms but in 2003-2007 rates did not rise as much as before. In the past 5 years they have been at record lows, but the housing market has suffered for it. edges are reluctant to loan to home buyers already those with stellar credit, because the 30 year loan on a home at that low rate is not a viable investment for the bank.

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