The Many Dangers of Low-for-Long Interest Rates

1. It encourages households to take on potentially excessive debt
2. It risks inflating a housing bubble
3. It discourages saving
4. It encourages inappropriate risk taking
5. It threatens the health of pension plans
6. It poses a risk to inflation
Ultimately, an extended period of negative real interest rates is a heavy punishment for savers and a juicy reward for debtors. Can there be any doubt that the end result will be a household sector that is overburdened by debt and undersupported by savings?

– from ‘focus’, BMO capital markets weekly ‘financial digest’, article by D Porter and B. Reitzes, 28 oct 2011 (pdf)

A bit late to be warning of this now.
We’ve already had ‘low-for-long interest rates’ for years now, and 1-5 have already come to pass.
– vreaa

30 responses to “The Many Dangers of Low-for-Long Interest Rates

  1. 1. It encourages house-building and creates a ton of jobs….until it ends. The economic multipiers of builders are pretty good and mostly domestic.
    2. It gets governments re-elected.
    3. It allows clowns with little understanding of the macro environment to crow about how astute they are at investing while borrowing more and more to reno their Vancouver Special and leasing some flash car. aka the wealth effect.
    4. It allows local municipal governments to spend like drunken sailors and keep increasing property taxes, since owners are so happy to see their assessment they overlook the tax boost. Until prices drop.
    5. Then it ends. And CMHC tries to bail them out with flexible loan terms (like Obama’s new bill). But it isn’t enough and the Canadian full recourse loans follow around the borrowers for a generation – a new shadow. We rename Gen Y “Gen Debt”.

  2. Basement Suite PhD

    That’s exactly what I’ve been saying. DUH. And no sign of any change in interest rates for the foreseeable future. Thanks Bank of Canada and daddy US fed. Money is increasingly worthless.

    Disclaimer for the wannabe economist with nothing better to do than attack a wannabe PhD economist: Look elsewhere. I am a biostatistician, not a wannabe economist and certainly not a wannabe “quant”. My name on this board is to portray my story, a well-educated high earner living in a basement suite due to Vancouver real estate prices. So get over it.

  3. Here’s a question for fellow posters:

    When the crunch comes and all those over-leveraged home-owners feel the pain, how much schadenfreude will you feel?

    • Royce McCutcheon

      Very little as I don’t live in a vacuum. Even if I’ve “kept my powder dry”, I will be affected. First, even if they’ve been impervious to logic about the market I’ve presented, there’s no joy in seeing family and friends suffer. In fact, they’ll likely become liabilities to me as we’ll have to find ways to pitch in (loyalty carries a price – though providing material support doesn’t mean we have to stay in this city). Second, I work in a field that’s dependent upon government support and public largesse. I’d say researching a major disease is a worthwhile effort and has tangible benefits to our society (cost-benefit work to reduce health care costs is a component of what we do, companies with international sales that create local jobs have spun off from this work’s intellectual property, etc.), but I’m not naive: it is a luxury when people are hungry or trying to keep a roof over their heads today. Third: declining economic circumstances breed unrest. Hard to be smirking if you think you’ll see more byproducts of suburban ennui (Canucks riots!) or face a greater likelihood of getting mugged (or at least paying more to deal with increasing occurrence of such crimes).

      In my opinion, every day that we don’t show a clear move towards a correction is a day that potentially amplifies this region’s later pain. And even then, maybe it’s too late. I mean, at this point we’re damned if prices stay high (a young generation moving away) and we’re damned if they fall (social costs listed above). Maybe an earthquake would be the thing too save us (though hopefully not a bad one). Prices might tumble, but there’d be an influx of external support to assist us. And it’d get people talking about something besides real estate for a while! /sarcasm

    • There will be a lot of misery, and anybody concerned about the city, the citizens, the community, is going to be distressed by that and personally effected by the bust. Vancouver’s economy and social fabric has simply become far too over-dependent on housing prices and the RE industry. So the implosion will effect us all, owners and renters. But the speculative mania must end. The longer it goes on, the more destructive its ultimate effects. Those throwing themselves into the fire at this stage are going to be the worst affected.
      So, even though it’ll be painful, it simply has to end. That’s how bubbles finish up, there is no way of avoiding many experiencing distress.

      Regarding actual schadenfreude: we suspect that it’ll emerge most where hubris has been most ugly. The schadenfreude will be the flip side of the gloating that has been present from some quarters.
      In a related sense, there are some people who have wholesale encouraged the mania for personal gain, and they likely deserve any scorn that comes their way.
      ‘Hoocoodanode?’ will not be a valid defence.

      • “Those throwing themselves into the fire at this stage are going to be the worst affected”

        I am scared to ask my in-laws (earning around 100k a year, less than I thought, with parents’ HELOC funds in hand for a downpayment) if they took on 0.5 Million dollars of debt this week. I really, really hope they listened to the Maths instead of the effects of the “hopium” that they were high on….

        Let me give some examples of this: After they were convinced by the rent vs own math that they would be far ahead by renting UNLESS there was appreciation, they began to argue that appreciation was a dead certainty.

        Then I showed them Landcor data for attached in Burnaby showed sale prices were almost flat since ’08. They asked to see the East Vancouver chart – because the townhouse they are looking at is on the Burnaby side of Boundary, and therefore close to Vancouver. Unfortunately, Vancouver East was very much appreciating on the Landcor charts. They said “see! they are going up!”.

        I showed them the TD bank prediction of 14.8% drop in Vancouver average by 2013. ( They said, “when was this prediction made? Oh, see, July! Well, we saw a house that was bought for $480,000 but sold for $540,000 six months later. So the prediction is incorrect.”

        I showed them the article that describes the increasing mathematical certainty of a price decline the longer the prices rise ( and said they were gambling, picking out pennies in front of a steamroller. They said: “We are not gambling! we are looking at the rate of growth up to today and predicting growth based on that. That’s not gambling!”

        A few hours later, after a movie, the cognitive dissonance kicked in, and they began discussing whether they should go ahead with the purchase they were on the eve of making (they were deep in negotiations with the developer for a second parking spot).

        As I say, I am scared to ask them. I will update once I know either way.

    • Basement Suite PhD

      I for one will be very happy to see the bubble pop. If it causes people pain, lets remember all the years so many of us have waited to be able to own a home. Those who ride the bubble and do not get out in time will feel the pain, that’s just the way it is. I have no pity for them, but I will feel happiness for new families and single folks who can finally afford to buy a decent home with a decent income. So, not so much taking pleasure in the misfortune of others, as much as taking pleasure in the pleasure of others, all of us who’ll finally get the opportunity we’ve waited a long time for.

      Disclaimer for the wannabe economist with nothing better to do than attack a wannabe PhD economist: Look elsewhere. I am a biostatistician, not a wannabe economist and certainly not a wannabe “quant”. My name on this board is to portray my story, a well-educated high earner living in a basement suite due to Vancouver real estate prices. So get over it.

      • “My name on this board is to portray my story, a well-educated high earner living in a basement suite due to Vancouver real estate prices. So get over it”.

        martyrdom and self-pity. So get over it

      • No schadenfreude at all. I am a renter without direct exposure to the real estate market but I hope for a soft landing to normalize prices. Eventually I would like to own a place. But I think that the effects of a real estate crash (or indeed, even of a more gradual decline) would be very widespread, going far beyond the real estate and construction industries. A massive decrease in wealth is bad for everyone. My heart does not bleed for the Range Rover-driving too-rich-to-work douchebags who show up at Coast and now Black & Blue on the weekends. But the multiplier effects of declining assets and dangerous debt situations across a very broad sector of the economy would drag down many industries. I fear that I could lose my job at some point – it’s certainly tied to the overall health of the economy, although as I indicated it’s not directly linked to real estate.

        Scary stuff. Many renters are not positioned to buy in at a low point if their job situations become uncertain. We need a correction, but it could bring a decade of malaise.

      • Basement Suite PhD

        “martyrdom and self-pity. So get over it”

        Actually diablo, the disclaimer was in response to many repeated attacks by matt, but I suppose I can add a plural now to the “for” list of the disclaimer: “Wannabe economist” (him) and “asshole” (you).

  4. Not to sound like a greedy bastard here. But it is what it is. It has been done and I can’t control the interest rates. Do corporate bailouts present a moral hazard? Of course it does. But I can’t control it. So I can only react to what our Central bank / US FED does. And I do not see interest rates rising in the foreseeable future. We might go the way of Japan on low growth and a 0% interest rate for the next decade for all I know. As an investor I can only play the cards that are dealt.

    BTW, if Vancouver prices stay flat and interest rates stay low then there wouldn’t be more pain for Vancouver. Because it would then give everyone who is overleveraged a chance to build up equity using the ridiculously low rate. It would only potentially cause more pain if the prices continue to climb due to the low rates, but I don’t see that happening. However, it would somewhat unfairly punish the savers, but we all know that is certainly not what the FED cares about.

    • This is a good point. The trouble with this blog and it’s ilk (Garth is 10x worse), is they don’t convey that renters have a position in the market and therefore carry risk.

      If the powers that be can manage to move this market sideways for 10 yrs, and they will do everything they can within their very size-able resources to do so, renters and savers are hooped.

      Let’s look at an example of a renter’s risk.

      At point X the renter has moved out of their parent’s home and/or has saved enough money to begin a position in the RE market. They are now speculating on time and price.

      At point Y, in the future (today?), the market has peaked and begun a correction.

      At point Z, the renter decides to make a purchase.

      Between X and Z the ‘owner’ has made payments against their mortgage at (currently below inflation) rates for X-Z period, while the renter has been paying rent and hopefully increasing savings.

      The period between X and Z is unknown but, in VREAA’s case, is likely to be upwards of 6-10 yrs (at least 4yrs X-Y and 2-6 yrs for Y-Z).

      In 5yrs at 3.5%, a homeowner will pay off 13% of their mortgage. In 10 years, they will pay off 31% of their mortgage. This is irrespective of capital movements (up or down). So, for VREAA, btwn X and Z, he/she has to make up 31% of the homeowners mortgage to make his speculation pay off. For a $400,000 mortgage, this would be about $60-125,000.

      AND, price has to move back to X position (or below).

      In 2008 when (I think) this blog started, you could buy a house and your mortgage payments would be about market rent, so in fact we should double the equity build-up above because both parties could be saving at the same rate with similar living expenses.

      In many cases, homeowners will also be saving on top of their mortgage payments so these examples aren’t cut and dry. And to be fair, some will be taking money out of their equity too.

      I know many homeowners who’s mortgage payments are less than 1/2 market rent, so these people enjoy a multiplier effect that compounds the diligent renters uphill battle.

      I am not saying this to tell people to jump into the market but just to let people know that everyone needs a place to live and therefore we are all ‘playahs’. Bear bloggers are just as culpable as RE marketers are for shaping opinion. They carry a lot of weight in some people’s minds (reinforcing belief).

      In today’s market, that NW condo does not look like a bad way to manage risk (is it concrete?).

      • Seems to me that a problem here would be just how much of the economy is propped up by HELOC’s, which appears to be a very large amount. Assuming everything else remains constant, people depending on credit to maintain lifestyle will be forced to cut back if their house doesn’t increase in value. This would result in less consumer spending overall and probably deflation to go along with it. Eventually, some marginal buyer will lose their job and be forced to sell, dragging prices down with them.

        Renters never need to buy, there is certain to be people that need to sell quickly at some point, if just by the fact that there’s a huge diversity of different financial situations.

      • blammo ->
        Yes, all positions have associated risks; even cash in the mattress has risk. We’ve always discussed that here. We’ve weighted the risk of housing prices continuing up unabated, without a very significant correction, as less than 5%. That’s our genuine assessment of the risk; what else can we say?

        Essentially you’re saying that, if you rent, you are wise to be prudent with your savings and investments, and we’d agree.

        But you do seem to be getting some wires crossed: you talk of models where there is no price appreciation, and you mix that in with stories of price appreciation (you say “I know many homeowners whose mortgage payments are less than 1/2 market rent”: these are buyers who bought in the past, right? They can’t be recent buyers because such cash-flow positive properties haven’t existed here for years.)

        You say “Bear bloggers are just as culpable as RE marketers are for shaping opinion.” Well, thanks for the compliment, but we think you overestimate our powers. Bear blogs are a very small marginal sideline when it comes to disseminating information about RE in Vancouver. ‘RE marketers’ have been very happy to pump the mania, making use of intrusive & ubiquitous advertising, co-opting the mainstream media, shaping public policy, all for personal profit. We find it hard to compare them to bear bloggers.

    • ” if Vancouver prices stay flat and interest rates stay low then there wouldn’t be more pain for Vancouver”

      I think you misunderstand what low interest rates mean.

      • How so, please explain. I am just using simple math here. The only way I see more pain for Vancouver (not for the savers btw as of course savers are always hurt by low interest rates), but for the real estate market is if low interest rates lead to continued escalation in price appreciation. I frankly don’t see that happening.

        If I am overleveraged, and you keep the rate low for say a decade, then I can slowly pay my way back to my correct leverage. It would punish the prudent, but that is not for me to judge as I can’t control that so no point for me to waste my time.

        Btw, one of the things that caused the housing crash, amongst a ton of other reasons, is the fact that Bernanke raised the rates too fast. Doubt rates are going to go up anytime soon, especially if the US government keep on preventing Obama from implementing his policies.

      • Julian ->
        Rates don’t need to go up for the market to crash.
        Flat rates and exhaustion of buyers (happening now?) will cause flat or slight price drops (5%-10%; happening now?). This will remove the speculative component from the market, and the market will crash.
        The moment price momentum is questionable, momentum buyers leave.
        (And what’s happening in Europe; China RE; Stock gyrations all don’t help).

        Thus pain for recent buyers (how many years = ‘recent’?) and especially for those stretching now to “take advantage” of “rock bottom rates”.

      • @vreaa, I get that part of your argument. What I am saying is whether low rates will cause more pain for Vancouver real estate. My argument is that in the case of deleveraging, you need to keep the rates low so that people can deleverage. The problem with that is two folds, one you will punish the prudent, two, you could cause inflation. The FED is clearly not interested in helping those who save, as long as the threat of inflation is not there currently, then rates will still be kept low.

  5. I don’t see current renters buying any time soon. Bloggers on this site expect a crash – so when an opportunity to get into the market presents it’ll still be seen as overpriced. Then prices rise. Repeat this cycle several times and suddenly we’re 10 years down the road, and 10 years worth of appreciation and debt repayment is not small change, plus you’ve probably moved 6 times.
    Rock/hard place

  6. Let’s think about the efficient frontier. Cash is at the bottom left. The real return is small negative and the (leverage, concentration, illiquidity, future uncertainty) risk is low. There are a choice of risky assets to the right. Now when the expected returns on those reach or approach the same as cash investors are not brave, but crazy to proceed. We can complain all we like about negative real rates in cash, but if say RE also offers negative expected real returns (write down some scenarios with probabilities) then cash is the right answer! Now there are other risky assets, but they too have to measure up to the cash option. In theory we own a blend of cash (or debt) with the best choices.

    We’re in a low return environment for a reason. Adding leverage and risk isn’t going to help. I agree it’s a rock and hard place, but the hardness must be weighed against the rockiness. If they are equally bad, then lower risk for goodness sake.

    • Amen.

      Hard to convince people who don’t understand, especially since, in Vancouver RE, risk has seemed so low, for so long. Risk seems, to them, to be almost everywhere else.
      If owners really understood the downside risk, well, that’d bring on and demonstrate the downside risk!

  7. “It poses a risk to inflation”

    I think it poses a risk of deflation. Longer term effects of asset price bubbles aren’t captured well with standard consumer inflation measures.

    • Do low interest rates automatically mean asset bubbles? If there is an asset bubble in place, what is the best course of action? Like I said before, the US tried to cool its asset bubble down in 07 by raising rates, certainly didn’t work out too well for them. Now their rates are at 0%, doesn’t mean that they now have an asset bubble to deal with currently as a result of it.

      • Does fuel automatically mean fire?
        No, you need other factors as well.
        If you look at the hundreds of asset bubbles through history, of which Vanc RE 2001-2011 is but one, a ready supply of capital has always been part of the picture. But you also need ‘a story’, and ready speculators. [see ‘Prediction’ sidebar for more on these factors]

      • Robert Dudek

        In the US, the low interest rates are at present fighting the deflationary forces. But zero interest rates were deemed insufficient for the task so various QE programmes were unveiled. QE is essentially a centrally-planned liquidity bubble which aims to counteract the deflationary forces.

        Elsewhere in the world, the QE programs of US and Europe are causing speculative flows into certain commodities, which creates either inflationary pressures (such as in most of the developing world – the trigger for Egypt erupting was rising food prices) or else currency appreciation in the “commodity” currencies such as CDN and AUD.

  8. Hey zerohedge-reading shitheads,

    [Hey, matt, you non-zerohedge-reading shithead, who exactly are you addressing here? If you look at the preceding comments, there is as much said about deflationary risk as inflationary. Perhaps you should strive to be a more close-reading-shithead, rather than a shoot-from-the-hip-without-reading and cut-n-paste shithead.
    And, as we’ve asked you before, please keep the dialogue civil, we value that here. -ed.

    Sorry to interrupt your bitcoin mining but I’d like to draw your attention to a counterargument published by Martin Wolf of the FT. The blog entry is entitled “Is monetary policy too expansionary or not expansionary enough?”

    Here’s the pastebin in case you need a subscription.

    Mr. Wolf makes the following points.

    1) “The monetary base does not itself have any impact on spending by the public.” This is because money is not exchanged directly between the public and the central bank. Rather, the money is held by commercial banks.
    2) These funds held by commercial banks have no direct impact on lending by said commercial banks. Commercial banks only care if central banks will provide them with sufficient liquidity. Their decision to lend to the proles are based on other factors. Some of you may have heard about how awesome the Canadian banking system has weathered the great recession due to Canadian rules on capitalization. That implies our banks didn’t go to shit because they had to keep x amount of money lying around in ratio to the money that was lended. Well if this were to hold true, you might want to ask yourself what low central bank interest rates have to do with any of this.
    3) Which brings us to point 3, the total amount of money held by the public is not impacted by the size of the central bank’s balance sheet. That mechanism is governed by the relationship between the central bank and the commercial bank.
    4) The 4th point Mr. Wolf makes is key. A central bank’s balance has an impact on inflation only if the money supply is greater than that of what the public is willing hold on to. Consumer confidence keeps falling in Canada which implies we’re not going to be falling into an inflationary spiral any time soon.
    5) “[the] inflationary impact of “money printing” can indeed only happen if the overall money supply start to grow rapidly. This is not now happening. Only the monetary base is expanding rapidly.” Mr. Wolf’s view is that an expansionary impact is a sign that money printing is succeeding in solving the credit crunch, and that should compel the central bank to raise rates.

  9. Basement Suite PhD

    “Hey zerohedge-reading shitheads”
    matt being polite as always. You really should get over yourself. And what’s your obsession with “zerohedge”, you’re the only one who keeps bringing them up around here.

    • Basement Suite PhD

      P.s. I’m sorry I missed your previous posts this morning before VREAA pulled them, I’m sure they held great entertainment value. Just more drivel from the wannabe “quant”.

      • Basement -> We didn’t pull any posts this morning (and we think the above is matt’s only post for last few days).
        FTR, we very, very seldom pull comments … only a handful in the blog’s entire history.

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