Wednesday, January 13, 2016

Who Is Financing Real Estate Loans?

The question arises, what bank is nuts enough to write home loans at even 4% for 30 years. The answer absolutely none. The savings and loan fiasco of the 1990’s was caused by Savings institutions loaning long and paying short term depositors interest. They loaned money for 30 years at 5%. When short term rates went to 6% their depositors move their funds to a bank paying higher rates and we had massive failures of Savings and Loans.

The banks could do 4% loans, but why bother with the potential risk, when you can make 12% to 36% on credit card loans.

The invisible banker in this whole mess is the Federal Reserve. They are financing the current real estate bubble. It’s kind of a peculiar arrangement. The Federal Reserve can keep a loan on the books for 30 years at zero percent interest and when it gets paid off, they get their money. Now if an investor has a 100k 30-year Treasury at 1% interest and rates go to 8% the current value of that bond is reduced to about $12,500. If they need cash, they will be eaten alive. If they can wait like the government can, they get every penny back in 30 years. Receiving interests on a loan is a human gratification, not a governmental expectation.

Most home loans end up being for about 5 years, the buyer sells (moves gets divorced, etc). So a loan written for 30 years, ends up being a 5 year loan after the home is sold and repurchased by a new owner. The Federal Reserve has amassed about 3 to 6 trillion dollars’ worth of real estate debt. The interest rate is really irrelevant to the Federal Reserve, they are not a bank, and do not have to show a profit. Time is an option that they don’t have to bother with. But the financing pool of money has to be very large. So when a bank writes a loan, they farm it out to a buyer like the Federal Reserve. The Fed has to buy all loans offered in order to keep interest rates low, just like what they are doing with T-Bills. If they don’t, prices rise until a buyer appears and purchases the note.

If you are following retirement funds and other investment operations, many are becoming involved in rental real estate. Notice the zero overhead of purchasing renting real estate for the Investment funds. They have the purchase money and need an investment return, plus they get to depreciate the investment. The base line return can be as high as 15% and most appear to be around 8%. In bad economic times projecting an 8% return just might not float the boat. But right now, the investment funds have a 4 percent hedge on potential home buyers; whose cost of funds is at 4 percent and no depreciation.

If we reduce it down to a personal level, for every dollar the Fed loans out, it will get one dollar back (if it waits long enough). Where you and I depend on the interest generated on loaning out dollars to create investment income for our retirement.

The real problem starts when the Federal Reserve stops buying real estate loans. The question now being asked, “Do they dare?” The questions of a lot of bystanders, is, “How can these crap shacks be worth so much?” Zero interest rates have distorted real estate values.

Just maybe, the Feds will be forced to take possession of the bad crap shack loans--- If this real estate bubble pops, they own it all, the only problem is the "they" bit; its you and me, AKA Taxpayer.

Reality might have “left the building” 20 years ago, but it will return. Stocks, bonds and real estate will return to historic norms. Once government influence drops from the equation, the mis-allocation of resources will stop. Just how this will happen is up for debate, but the drop in the world stock markets and the fall of oil prices seem to point to an uncertainty that could speed up the process a bit.


dearieme said...

It's odd that the price of oil hasn't caused more panic than it has.

Jim in San Marcos said...

Hi dearieme

The real panic is in the Middle East. These countries planed their budgets for this year, last year, using oil at $100 a barrel. They now have to pump three times as much oil in order to meet budget. That's a lot of oil coming on line.

Drillers stateside borrowed millions at very low interest rates figuring they could produce oil at $60 a barrel and sell it for $100 a barrel. That market fell out of bed. These people are facing bankruptcy.

For the rest of us, it means we get to keep more of our earnings.

A side note for thought, my wife and I drink about 10 gallons of bottled water a week (Southern California water isn't fit to drink). At the same time we consume 30 gallons of gasoline (15 gallons per car). Gasoline could become cheaper than drinking water--or maybe it already has, I see 12oz bottles of water going for $1.65, go figure!

dearieme said...

We buy bottled sparkling water at 2 litres for 19p i.e. about 30 cents. The supermarkets will even deliver to our kitchen table. (2 litres = a smidgen more than 0.5 US gallons.)

The local tap water is passable but it doesn't fizz. We're in a dry region of England; our water is artesian, coming from chalk, and is therefore "hard".

dearieme said...

We buy bottled sparkling water at 2 litres for 19p i.e. about 30 cents. The supermarkets will even deliver to our kitchen table. (2 litres = a smidgen more than 0.5 US gallons.)

The local tap water is passable but it doesn't fizz. We're in a dry region of England; our water is artesian, coming from chalk, and is therefore "hard".

AIM said...

You all could save money if you invested in a 5-6 stage reverse osmosis filter that will totally purify your tap water. Purer than bottled water. You just need to remineralize the RO water since the filter system takes EVERYTHING out of the water. We use a plant based liquid filled with trace minerals to remineralize our drinking water so that it is as healthy and clean as if you took it from a running stream 1,000 years ago, before there was chemical pollution.

Jim: Here is the latest addition to our government's use of "pretend and extend". All the big banks that are holding all of these energy/oil based junk bonds (that are now beginning to be defaulted on by these US energy companies) have just been told by The Fed that, in order to make their balance sheets look good, they no longer need to mark them to market! Totally amazing. You just can't make this stuff up. This is why all the forecasters of collapse continue to be wrong: the powers that be can continue the Ponzi scheme and facade of growth for a very long time to come with these types of "pretend and extend" tricks.

AIM said...

Oops! I forgot to supply you and your readers with the link.

AIM said...

And here is a follow up article...

Personally, I'd never trust a career politician (or any politician) or a government as far as I could throw them. Liars and self-serving criminals all.

In an recent interview of Rand Paul, he made this statement. To paraphrase: "Don't you think it odd that The Fed lobbies for itself? They have gone around to every Congress person's office to lobby on the subject that members of Congress should vote NO on the bill to audit The Fed."

Hmmm... I wonder... what are they so desperate about and afraid of? Is it possible that they are hiding things from the American public?

Jim in San Marcos said...


Thank you for the links.

When you think about it, auditing the Fed would do little, but would be a good idea. We know what they are doing and it doesn't appear to have accomplished much. I don't think they have broken any laws.

After an audit, Congress might change some rules for the Fed, that could keep this mess from repeating ever again.

AIM said...

Right. But it would be a start. The real target being Congress. Congress twisted The Fed way back in time to help with WWI and WWII. The Fed was originally only buying corporate bonds to maintain liquidity for American businesses during bust cycles. Plus, interest rates were different for each region of the USA. Congress forced them to stop buying corporate and start buying US Treasuries to support the war efforts. They never changed it back because Congress loves having the potential for unlimited spending. The Fed is just a tool of Congress. Ties into the Military-Industrial-Congressional Complex that we all know about. They are all in major profit mode these days and it is party time in DC for all of our criminal politicians, while the rest of America is falling by the wayside economically. If we audit The Fed and then follow the money I believe some amazing disclosures would occur that the US public would not be happy about, at all.

Anonymous said...

it's 10 years later but you might finally be getting your depression Jim. For the first time in a couple of decades, things are starting to look real bad to me.
Both financially and geopolitically.

got my popcorn and eager to see how things unfold.