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American Consumers Face End of Era of Cheap Credit

G-khan

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#1
Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.

That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.
“Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.

Along with the sell-off in bonds, the Federal Reserve has halted its emergency $1.25 trillion program to buy mortgage debt, placing even more upward pressure on rates.

“Mortgage rates are unlikely to go lower than they are now, and if they go higher, we’re likely to see a reversal of the gains in the housing market,” said Christopher J. Mayer, a professor of finance and economics at Columbia Business School. “It’s a really big risk.”

Each increase of 1 percentage point in rates adds as much as 19 percent to the total cost of a home, according to Mr. Mayer.

The Mortgage Bankers Association expects the rise to continue, with the 30-year mortgage rate going to 5.5 percent by late summer and as high as 6 percent by the end of the year.

Another area in which higher rates are likely to affect consumers is credit card use. And last week, the Federal Reserve reported that the average interest rate on credit cards reached 14.26 percent in February, the highest since 2001. That is up from 12.03 percent when rates bottomed in the fourth quarter of 2008 — a jump that amounts to about $200 a year in additional interest payments for the typical American household.

With losses from credit card defaults rising and with capital to back credit cards harder to come by, issuers are likely to increase rates to 16 or 17 percent by the fall, according to Dennis Moroney, a research director at the TowerGroup, a financial research company.
“The banks don’t have a lot of pricing options,” Mr. Moroney said. “They’re targeting people who carry a balance from month to month.”

Similarly, many car loans have already become significantly more expensive, with rates at auto finance companies rising to 4.72 percent in February from 3.26 percent in December, according to the Federal Reserve.

Washington, too, is expecting to have to pay more to borrow the money it needs for programs. The Office of Management and Budget expects the rate on the benchmark 10-year United States Treasury note to remain close to 3.9 percent for the rest of the year, but then rise to 4.5 percent in 2011 and 5 percent in 2012.

The run-up in rates is quickening as investors steer more of their money away from bonds and as Washington unplugs the economic life support programs that kept rates low through the financial crisis. Mortgage rates and car loans are linked to the yield on long-term bonds.

Besides the inflation fears set off by the strengthening economy, Mr. Gross said he was also wary of Treasury bonds because he feared the burgeoning supply of new debt issued to finance the government’s huge budget deficits would overwhelm demand, driving interest rates higher.

Nine months ago, United States government debt accounted for half of the assets in Mr. Gross’s flagship fund, Pimco Total Return. That has shrunk to 30 percent now — the lowest ever in the fund’s 23-year history — as Mr. Gross has sold American bonds in favor of debt from Europe, particularly Germany, as well as from developing countries like Brazil.

Last week, the yield on the benchmark 10-year Treasury note briefly crossed the psychologically important threshold of 4 percent, as the Treasury auctioned off $82 billion in new debt. That is nearly twice as much as the government paid in the fall of 2008, when investors sought out ultrasafe assets like Treasury securities after the collapse of Lehman Brothers and the beginning of the credit crisis.

Though still very low by historical standards, the rise of bond yields since then is reversing a decline that began in 1981, when 10-year note yields reached nearly 16 percent.


From that peak, steadily dropping interest rates have fed a three-decade lending boom, during which American consumers borrowed more and more but managed to hold down the portion of their income devoted to paying off loans.

Indeed, total household debt is now nine times what it was in 1981 — rising twice as fast as disposable income over the same period — yet the portion of disposable income that goes toward covering that debt has budged only slightly, increasing to 12.6 percent from 10.7 percent.

Household debt has been dropping for the last two years as recession-battered consumers cut back on borrowing, but at $13.5 trillion, it still exceeds disposable income by $2.5 trillion.

The long decline in rates also helped prop up the stock market; lower rates for investments like bonds make stocks more attractive.

That tailwind, which prevented even worse economic pain during the recession, has ceased, according to interviews with economists, analysts and money managers.

“We’ve had almost a 30-year rally,” said David Wyss, chief economist for Standard & Poor’s. “That’s come to an end.”

Just as significant as the bottom-line impact will be the psychological fallout from not being able to buy more while paying less — an unusual state of affairs that made consumer spending the most important measure of economic health.

“We’ve gotten spoiled by the idea that interest rates will stay in the low single-digits forever,” said Jim Caron, an interest rate strategist with Morgan Stanley. “We’ve also had a generation of consumers and investors get used to low rates.”

For young home buyers today considering 30-year mortgages with a rate of just over 5 percent, it might be hard to conceive of a time like October 1981, when mortgage rates peaked at 18.2 percent. That meant monthly payments of $1,523 then compared with $556 now for a $100,000 loan.

No one expects rates to return to anything resembling 1981 levels. Still, for much of Wall Street, the question is not whether rates will go up, but rather by how much.

Some firms, like Morgan Stanley, are predicting that rates could rise by a percentage point and a half by the end of the year. Others, like JPMorgan Chase are forecasting a more modest half-point jump.

But the consensus is clear, according to Terrence M. Belton, global head of fixed-income strategy for J. P. Morgan Securities. “Everyone knows that rates will eventually go higher,” he said.

http://www.nytimes.com/2010/04/11/business/economy/11rates.html
 

Fanakapan

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To raise interest rates now, would be akin to fighting a fire with petrol ? or lets put it another way, imagine all those people sitting on negative equity properties, and those just keeping ahead of their repayments, and those who are 30 - 60 days delinquent, tot up that lot and you might get to 30% of adult Americans if not more ? Then imagine if you pull the rug from that 30% ?? it would be like the 1930's Okie belt on Steroids, and spread across the whole USA to boot ?

Raising Interest Rates is the one thing they Cannot do, and if they do, it'll be goodnight USA ?
 

Julian

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Fanakapan, the problem is that the federal reserve has only so much control over interest rates. The market can(and probably will) force rates up even if the FED stays put.
 

VTEEZER

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Homeowners that have negative equity have been given a go sign to walk from their mortgages even if they can make the payments and they are doing just that. There's no incentive to stay. It's time to raise rates and let the chips fall. Many people especially retirees who depend on interest from their investments will benefit and it will actually help stimulate the economy as they will be able to start buying goods and services again. Anyone who can't afford a home at 7% fixed interest rate can't afford a home period. That's why we're in this mess that we're in now. Moderately higher rates should not make a difference at this point. Some serious pain is coming no matter what the Fed does. They have saved as many of their buddies as they can and the banks can't lend because they know rates have to go up and they'll get burned. Time to move on. JMHO!
 

diversified2

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I'm with you on that one VTEEZER. This whole country is just one big moral hazzard mess. I believe in personal responsibility and living within ones means. If you make bad decisions and end up on the street don't go looking for a handout or someone to feel sorry for you. I don't feel like I should have to pay for others corruption and incompetance either. Just my 2 pesos and I am sorry if I offend anyone with
this post!!!!!!!!!!
 
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#6
I'm betting my financial future on higher interest rates and inflation. Just locked in a 30 yr home loan @ 5%, a 5 year car loan @ just over 3%, student loans at 2.5% fixed and i have a small position in TBT, a double leveraged ETF which shorts long term US Treasuries.

I guess if we get deflation i'm in trouble, but with all the debt out there that needs to be auctioned off, i'm on the inflation side.
 

Fanakapan

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Fanakapan, the problem is that the federal reserve has only so much control over interest rates. The market can(and probably will) force rates up even if the FED stays put.
Agreed, your system is a little different from ours, but the number of folks who are in debt, I imagine outnumbers the number of folks with money in the bank several times over. So if the Street starts to push rates up, it might be, that there's going to be a lot of unhappy campers out there ? unhappy to the point of Torches and Pitchforks ???

Plus I hate to think what such a move would do to the US housing market, which is still a long way from bottom yet. this in turn would not bode well for the STILL insolvent banks ? so I just dont see how one part of the financial market could push ahead with actions that would bring the entire house down ?
 

Carrion Crow

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I'm betting my financial future on higher interest rates and inflation. Just locked in a 30 yr home loan @ 5%, a 5 year car loan @ just over 3%, student loans at 2.5% fixed and i have a small position in TBT, a double leveraged ETF which shorts long term US Treasuries.
Wow, that’s a lot of debt going a bunch of different places (regardless of the interest rates) along with gambling on TBT.
Best of luck.