A lot of people in the media are calling it the “cost of living crisis” but us lot who were around in the 1970s know it as “inflation”. Back then – if the government’s figures are/were to be believed – it peaked at 25%. The 1970s were a pretty horrible decade all round. As well as inflation, there were constant strikes, bankrupt nationalised industries and a general air of doom. A Samizdata contributor, growing up in France even had an economics text book with a chapter entitled, “Britain: headed for the Third World?”
Since the mid-1980s inflation has been much lower. It’s been present but until now it has been far less of a day-to-day problem. So, what happened? The Thatcher government put up interest rates. For reasons that I may have once understood, but no longer do, this reduced inflation. But it came at a price. Huge numbers of businesses went bust or reduced their workforces. Unemployment skyrocketed. By the mid-1980s growth had returned but many previously industrialised areas did not recover and still haven’t. I doubt they ever will.
Are there lessons in this? Harbingers more like. Interest rates have been very low for a very long time. Homeowners – as opposed to businesses last time round – have borrowed a lot. If you are on an average income and want to own your own house and bring up a family that is what you have to do. Should interest rates go up, millions will find they cannot pay their mortgages. A cynic might argue that at least in the 1980s, the pain was borne by people who weren’t going to vote Conservative anyway. This time, that’s not so clear.
Update 16/4/22. I see from the comments that a lot of people in the US have fixed rate mortgages. Very sensible. I wonder if that is the case here in the UK? Also, how easy is for banks to call a loan in?
It occurs to me that lots of people with fixed-rate mortgages might not be all that good a get-out-of-jail-free card. If interest rates do go up that would severely depress house prices. Sure, homeowners would still be able to pay off their mortgages but their properties would be worth a lot less.
Homeowners of course are not the only borrowers. A few years ago – when I was into this sort of thing – I came across a couple of reasonably-large, barely-profitable companies with large amounts of debt that periodically needed to be refinanced. If interest rates go up they would be in a lot of trouble. I wonder how prevalent this is?
That’s not how that works, at least for anyone with a room temperature IQ.
You can get two kinds of home loans (at least over here in the colonies), “fixed” and “variable”. The variable loans start off with a lower rate that is guaranteed for a certain length of time, and then goes to market rates. I don’t really understand it, but I think it’s good for people who intend to only own a property for a short time.
Fixed rate loans are, as the name indicates, fixed. I refinanced my home last year when rates were about as low as they’re ever going to get. I have a VA loan, and I got a 2.25 percent interest rate.
No amount of inflation or interest rate increases will make that go up unless I need money *so* badly that I choose to refinance. Property values might rise (they also might fall, there are scenarios where that makes sense) so taxes might go up, but my interest rate–and hence my house payment–are fixed for the next 25 years or so. I also put solar panels on my roof this year, borrowed money at 2.9 percent to do that. I’ve got enough up there–and a battery backup system–that even in late march and early April I’m producing more electricity than I used–thus fixing my electrical costs for the next 15 years. Again, fixed rate loan.
It’s those who don’t have a house and want one, or who are forced to move and need to sell that are screwed. Well, and those that build houses.
But this is a feature to The Party. If they can keep inflation up for a decade they will have inflated most of the national debt away. Of course they’ll have impoverished millions, and killed a bunch of people, but that too is a feature.
Can kicking eventually runs out of road. The West has been kicking its can down its road for over 20 years now, living well beyond its means, living on debts and cheap imports that kept the price of ‘stuff’ down. Its answer to any economic crisis has been to print money, and rely on the deflationary power of the global supply chain to offset that inflationary monetary stimulus. Only they killed the golden goose by over reacting to covid with lockdowns, and now the deflationary effect of the global supply chain has flipped into creating inflation instead. Add in the stupendous amounts of money printed to allow Western countries to continue living the high life during covid despite no-one doing any work, and the idiot ‘green’ policies they have been pursuing, and you have the perfect storm. There’s no going back from this. Money printing can’t continue without causing a currency collapse, and societal collapse with it, and without money printing the West will be forced to live within its means. Which is a considerably lower standard of living than anyone born since about 1970 has experienced. And the anti-fossil fuels policies will only make the entire sh*tstorm worse, and abandoning them would mean the entire Western political class having to admit they got it wrong. Which just won’t happen, because it would threaten their very grip on power.
The future in the West looks grim. The only way the Western Elites can maintain their position of power is to double down on the greenery, maintain the money printing but attempt to control the resulting inflation by extreme control measures on the masses – a prices and incomes policy for the 21st century in effect. There will be no market prices or wages, not officially anyway. Everything will be controlled. And given they have considerably more powers over people and businesses nowadays due to electronic banking and PAYE systems they could just make it work, or at least work enough that it doesn’t collapse immediately. Life is about to get a lot more like Germany c.1938.
In America, only about 8% of mortgages are variable-rate. They have traditionally been reserved for the less credit-worthy, or the less . . . intelligent (in my mind.) The rest are fixed interest rates for the life of the loan. Is this the case in the rest of the world? I remember, during the life of my last two mortgages, being rather smug when interest rates rose drastically and I had and retained my cheaper loan.
According to official figures in 2020 63% of people in England owed or presumably were in the process of purchasing their own home. I’m surprised it’s that high.
However only 20% of our black Africans and 17% of our ethnic Arabs were home owners. They might be a problem when the inevitable rent increases start to bite even though a large proportion occupy heavily subsided if not outright free social housing which would shift the “problem” as usual to Joe Taxpayer.
I do not like debt, and avoid it like the plague. We own our two cars, we own our share of the cooperative (but what will inflation do to the fees?). We use credit cards and pay them off at the end of the month. We don’t have debt. I am not sure whether this will prove to be good or bad as the inflation happens. But I was born at the tail end of the Great Depression, and raised by parents who lived through it. I hope the habits I got work this time around.
The US market for uncallable 30 year fixed rate mortgages to 80% (or more) of home value exists only because of government policy, in particular Fannie Mae/Freddie Mac. It is rather unique in the global economy (in Mexico, a good credit borrower might be able to mortgage 30% of a property’s value over a much shorter term). The business side is borrow short term and lend long at higher rates. As long as rates are flat or declining, this works fine. If rates move up significantly and lenders start to bleed cash, the government bails out the note-holders (mostly Fannie/Freddie at this point). The market used to be borrow long, lend long or longer at a premium – this was the S&L model, and they had enough redemption penalties on CDs to survive the increase in rates in the 70s – but crashed in the 80s as rates fell and mortgagees refinanced to lower rates leaving already weakened S&L’s underwater on the high rate CDs they couldn’t call. There’s no way that 30 year fixed would exist in a purely private mortgage market – the lending risk premium would be have to be much higher given the risk exposure, and few borrowers would be willing to pay it.
Even within the US market, variable loans make sense when they match your time horizon for owning a property. Adjustables are typically reset annually with rate caps (both annual and lifetime, 2%/6% was common in the 90s) and can be reasonable in some environments (not now obviously). Balloon notes (fixed for 3, 5 or 7 years, paid on a 30 year schedule, with the rate to be reset at the end of the fixed period) can make sense if you have a high likelihood of moving within that time frame – no need to pay for something you don’t plan on using. Variables were a lot more common when long rates were much higher and the yield curve steeper.
Adjustables can really pay off in a declining rate environment (as long as the spread between short and long term rates is generally stable). As rates fell dramatically in the mid-80s to early 90s a variable rate was a great deal, 2% cheaper to start and dropping 25-50 basis points annually without having to refi. Obviously when the tide turns you want to switch, and anyone with a variable loan should have refinanced the minute the Fed started to signal rate hikes around the end of last year.
My own mortgages in the 90s were some form of variable rate loan (one annual, one a 7 year balloon), both of which were cheaper over the period I carried them than a fixed rate loan would have been. The annually adjusted loan was the last one I held on my first house, once it was clear we were moving in a 2-3 year range, and was 2% under what a fixed would have cost me (4% better than the fixed I refinanced out of). The balloon was a half point cheaper than a straight 30 year and I refinanced at the end, which I would have anyway as rates were down. The property tax hikes I got hit with during those years were worse than the interest rate risks I was running. After that lower spreads and cheap refinancing made 30 years with a couple of opportunistic refis pretty much no brainers, but by then it was also clear we weren’t moving again for at least 20 years.
The key to the ’08 crash was not so much variable rates as low down payment teasers – that is below-market rates for the first year of the mortgage that had large resets t built into them. These only work if property values are increasing rapidly, so that you can refi on the basis of equity from appreciation (as you aren’t paying down meaningful principal). When the market stalled these loans were almost immediately underwater and many of the borrowers lacked the income to cover the payments once the loans reset to market rates. This kind of loan is nuts if you want to hold a property – it’s for speculators, but was pushed on some naive borrowers.
Best advise. Get a fixed rate mortgage.
BTW – the S&L system was just as backstopped by the government as the current Fannie/Freddie paradigm is. In that case it was Federal deposit insurance of the CDs that effectively subsidized below-market 30 year rates.
The banking system is often described as privatizing profits, socializing losses, but at least in the US it’s rather more than that. The mortgage market is more a case of socializing risk over time and place. Homeowners, basically the upper 2/3rds of the US income distribution, get to lock in their individual long-term interest rate exposure at below market rates, with the government guaranteeing the risk. The government spreads this risk over the broader economy, which can absorb it at lower cost than an individual could. Any realized losses are spread over the same tax base that is benefiting from the system in the first place, so the system is more or less fair, int he same way that insurance is.
The problem really shows up when the system gets extended beyond its intended purpose. It is common financial advice to maintain a more or less constant 30 year mortgage and invest the money that would have paid down the principal in the stock market, effectively using your home to as security for a below-market margin loan that can’t be called. This benefits a much smaller segment of the population (not the wealthiest, they don’t really get much from this, more the 1-10% range). As well as increasing the amount of speculation in real estate (more on the margins, that is buying more house than you would otherwise, since these loans are restricted to owner-occupied homes). Another example of how most broad Federal policy mainly benefits the middle class, with the upper middle having the chance to squeeze out something extra.
Best advice – don’t buy a house you can’t afford. If the only way you can buy a house is with an adjustable rate mortgage – you can’t afford it.
phwest, you have convinced me that my “less intelligent” comment was overly simplistic. Yes, I always looked at properties as long-term holdings, but clearly variables had their place in other situations.
Like Ellen, I’m generally averse to debt. But with serious inflation looming, partly here, I kind of like owing 50% on my house at ~4%. The government is going to inflate away most of my retirement nest egg, but my home mortgage debt will also get inflated away. Real estate in general is probably not a bad idea…pity I didn’t have the wherewithal to buy some 3 years ago when prices were half what they are now!
btw, does anyone know how the US government or any government calculates inflation? Do they publish their algorithm? We all know it’s bs, but I’d at least like to see what bs they are purporting to be the truth. I’m curiuos: is it based on average prices or the price of things in the “shopping basket” of a typical family of four? That is, while energy and real estate have risen horribly, the overall inflation a family feels is probably lower. Gotta weight these individual commodity prices by how much the make up people’s cost of living.
Greg, in the us the “official” measure most often cited is the consumer price index
https://www.bls.gov/cpi/
george m weinberg, I think the correct website is https://www.bs.gov/cpi/
my serious point being that I no longer trust any government agency of any kind to put out truthful information of any consequence!
If things get as bad as some people think both businesses and people will be shut down by some process like seizure, foreclosure or bankruptcy, whether formal or informal.
The businesses and people will lose their assets, which will eventually wind up in the hands of those with a better mix of efficiency, capitalization, preparedness, intelligence, knowledge, work ethic, energy, health, physical strength and luck.
This is very much like what happens when a government program fails….. Right?
I think the entire philosophy of society is putrid. Once upon a time, you could borrow 2.5 tines joint wage. I’m told that multiplier is a lot more. The demand for houses benefits banks and builders. The population is just a cash cow.
Inflation will/is causing demand destruction. That will lead to unemployment and an eventual recession. I predict it’ll be in full bloom by by mid-fall whether it is reported that we’ve had 3 consecutive declines of GDP or not. Christmas will be a disaster. That is as simple as I can make it although a few other parts fit in to the up and coming SHTF times.
What you are missing is the biggest borrowers of short term loans that must be periodically refinanced are GOVERNEMENTS! When the rates rise, most countries including the USA, will be bankrupt. God help us!
“Sure, homeowners would still be able to pay off their mortgages but their properties would be worth a lot less.”
That only matters when you try to sell, or get a 2nd mortgage on your house. Otherwise, you still have a property you own. If/when the downturn turns around, property values increase.
“a sharp economic downturn has already begun, and we could be facing the worst depression since the 1930s”
You know who said that, where and when?
https://www.weforum.org/agenda/2020/06/now-is-the-time-for-a-great-reset/
Things have only gone downhill since then, and the Russia/Ukraine conflict is only exacerbating it.
When you mentioned how many things were bad in the 70’s you failed to point out the loony fashion of the time. I can’t say it had anything to do with the economy, but many people (including me, sadly) dressed like moronic clowns every day. Maybe it was a reaction to the dismal economy. It apparently made people stupid.
“ Also, how easy is for banks to call a loan in?”
IMO, adjustable mortgages were one of main causes of the 2008 housing crash, along with the Clinton Housing Initiative (everyone should be able to own a house). Lending regulations had been so relaxed there was basically no income verification. People were buying more house than they could afford. And as interest rates climbed, they could no longer make the payments.
For most loans, once you are delinquent 90 days the process starts. If you make no effort to work with the lender, the lawsuit will come within the 120-180 day range. Once the lawsuit is heard, the bank owns the home.
In my area after the 2008 crash, some banks had so many foreclosures they began to rent them to keep the property up and have income flowing onto the balance sheet. A few still failed.
The borrowers in the US most likely to be impacted by rising interest rates are holders of short-term loans; in my little corner of the world what I see are loans on multi-family apartment buildings and loans on “handyman specials” that typically mature in 1-5 years. Depending on how leveraged those individual real estate investors are, refinancing those loans could be problematic in the face of an interest-rate spike.
Inflation is good for those with fixed interest rates. You borrow expensive dollars and pay back in cheap inflated dollars. For instance, my parents got a mortgage circa 1970 that was a substantial portion of their income. By the time they paid it off it was chump change. I think $125.00 a month. And, if you happened to borrow at high interest rates and the rates go down, you can always refinance. I haven’t heard of a bank “calling a mortgage in” since The Depression. I think it is illegal in the U.S.