Now is the best time to buy a home

I happen to think prices are bottoming out this Summer, and have said so since February (I would only exclude the worst offenders in subprime which additionally have high unemployment, places like the Inland Empire and Las Vegas).

However most people think even with sales picking up prices have more to fall.  So let’s say I’m wrong and prices do fall another 10% into next year.

Even then this is the best time to buy.  Why?  Because mortgage rates are going up and will be way higher this time next year.  About 3 points higher.

Mortgage rates will be up sharply because U.S. treasuries are shooting up (there is, of course, a strong direct correlation between treasury yields and 30-year fixed mortgage rates).  This is not due to inflation fears, or ‘China dumping our treasuries’ or some other ominous headline, but simply because:

a) The economy will continue to improve, and there will be a massive flight away from safety into higher yield asset classes.  People, funds and companies selling their treasuries and putting their dollars into stocks, commodities, hedge funds or Silicon Valley venture funds means treasury prices will go down, and yields up.

b) The Fed will start ratcheting the funds rate up by late 2010 to mop up the massive excess liquidity and keep inflation in check.

So let’s run the numbers using this calculator.

For a $500,000 house, with $100,000 down, at the current 5.5% rate on a 30-year fixed (1.25% tax and 0.5 PMI):

Monthly payment: $2854.49

Total interest paid: $440116.16

Now let’s look at the same house, one year later, now priced at $450,000 with a $90,000 down payment, and an interest rate of 8.48% (corresponding to a 7% treasury yield per this):

Monthly payment: $3,287.99

Total interest paid: $654,925.49

Even though the down payment was $10,000 less and therefore easier to ‘get in the house’, the increase in monthly payment is $433, for 30 years! which comes out to $214,809.33 in additional total interest.  So, again, house price was $50,000 less, and yet payments will be $433 more.

Of course, if prices do stabilize, monthly payments will be even higher ($799).

Some caveats:

• If prices do go down 10% you will lose half of your equity in the near term (50K of the 100K down payment), so this only makes sense if buying for the long term.  But really, is anyone still planning on flipping a house?
• A higher mortgage rate and corresponding monthly payment is not so bad if you’re able to refinance after some years.  But rates are near all-time lows, so they probably won’t come back down anywhere near this for another couple decades, if ever.

So, am I missing something?

China, treasuries and fearmongering

I argued three months ago that China couldn’t possibly dump their treasuries, even as pundits and analysts in the financial channels kept scaring the bejesus out of everyone.

So I was very happy to hear Roger Altman last night say that:

CHARLIE ROSE: Pete Peterson … also talked about the fact that the Chinese hold so much of our debt. Is that going to change, and are they going to change it?

ROGER ALTMAN: A, they’re clearly concerned about it, about the
concentration risk that they have. B, their options for changing it are relatively few, and there’s no scenario in which they can change it quickly. There just isn’t.

CHARLIE ROSE: They’d have to take that money and find another place
to invest it as well, without destroying the American economy.

ROGER ALTMAN: It would be self-defeating to act quickly. Therefore,
any diversification which the Chinese pursue — and they will — will be
slow and gradual. And the risk that so many people talk about, I think
very loosely, you know, the Chinese may, quote, dump the dollar or flee the
dollar. That’s misguided, I think.

CHARLIE ROSE: Because it’s not in their interest.

ROGER ALTMAN: It’s not in their interest and it’s not possible to do
it. So, it’s not a good thing for over the long term, as President Obama
himself said, for China to be — for us to be the consumer and China to be
the lender and have it exponentially grow as it’s been. We have to stop
that. But China’s not going to make — take self-destructive action, and
dumping the dollar or quickly trying to exit the dollar would be very self-
destructive, and they’re way too smart for that.

Bernanke vs. the yield curve

Bloomberg has a great article on the tough spot Bernanke finds himself all of a sudden with long-term rates shooting up.  I was hoping for another 200B in purchase commitments this week, but they have a good point this is unlikely, because….

The Fed probably won’t make any adjustments to the size of the Treasury purchase program before its next policy meeting on June 23-24, in part to avoid reinforcing perceptions policy is reacting to swings in yields, according to Jim Bianco, president of Chicago-based Bianco Research LLC.

“The Fed wants to operate in predictable ways,” Bianco said. “They are also trying to not just look arbitrary, which makes people think ‘I can’t ever go to the bathroom because there could be a press release that the Fed changed the buybacks.’ That’s been a real concern: ‘Wow, I just went to the bathroom and lost $2 million dollars.’”

So why can’t the Fed simply fine tune the current program, purchasing only long-term debt with what remains of the 300 billion they’ve already announced?

Actually, they may be doing just that.  Wednesday’s scheduled purchase is for maturity dates of 2019-26.  Look for that one to be big (10-20B).

China: Back to treasuries

I wandered 2 weeks ago just how long China could continue buying commodities instead of U.S. treasuries.  Seems like the answer was, 2 weeks!

A big reason why the $20 billion Chinalco purchase into Rio Tinto fell through was that commodities have been on a tear (itself due, in large part, to Chinese demand as an alternative to treasuries).

Time says:

The deal’s outcome also leaves another basic question unanswered: What is China going to do with all of it’s money, if the developed world sends signals that it doesn’t really want it — at least in forms other than investments in US Treasury debt? One of the things a country with more cash than it can possibly invest at home — a description which China fits in spades — does is recycle its surpluses is through foreign direct investment. And China, in fact, has done scores of resource deals in the developing world — of late with Russia, Kazakhstan and Brazil in the old and gas sector, for example. But twice now in the developed world, big Chinese investments have been spurned. First CNOOC, now Chinalco.

I know the answer: Treasuries!

China hedging the only way they can

I recently argued that the Chinese have no choice but to keep buying our treasuries.  My friend Aakarsh pointed out they could buy raw materials.  I agreed, but wondered just how much of their 1T in dollar reserves they could possibly convert into ore, beans and oil.

Well it’s happening.  And here’s a rough indication of their pace:

Without this stockpiling of strategic commodities, China’s trade balance likely would have risen in the first quarter instead of falling $51.8 billion to $62.51 billion, he said.

That means about $60 billion per quarter, $240 billion yearly, of which some part is NOT in dollars.  So at this clip, they appear to be using $150 to $200 billion a year of their dollar reserves for materials instead of treasuries.

The question is, how long can they maintain this clip?  It’s not just a question of how much of it they can actually use, but also a matter of how quickly commodity prices bounce back to a point where this strategy is not nearly as attractive.

h/t TBP

Can the Chinese really dump their treasuries?

Seems like a day doesn’t go by without a reporter asking someone whether they think there is any danger of the Chinese not buying our debt any more.  This week their Premier actually voiced ‘concerns’ and everyone took notice.

But can they?  I don’t see how.  Am I missing something here?

The way I see it, they have to for as long as we continue to have a large trade deficit.  In 2008 we exported 71 billion worth of goods and services to China, and imported 338 billion.  That means they ended up with 266 billion dollars (all the money we gave them in exchange for TVs and other trinkets, minus the money they gave back to us to buy turbines and heavy machinery).  Part of that money goes to buying raw materials, but most of it they keep.

What they do with these dollars is put them into some sort of  interest-bearing but very safe vehicle, mostly Treasuries and Fannie/Freddie bonds.  Recently they had even started experimenting with riskier things, famously investing 3 billion on Blackstone in May ’07.

So what could China do with the dollars it has and continues to accumulate?

1. Sell them and keep cash instead:  This would remove whatever risk of default, at the cost of producing a negative return (after inflation).  And there would still be the much larger risk of a dramatic fall in the price of the dollar.
2. Exchange them for local currency: Selling dollars is not what they do.  In fact they’ve been buying 50 billion per month to keep the dollar high and the yuan low.  If they stop doing this the yuan will appreciate, which will make their products more expensive to us and lower demand for them.  Never mind that Washington has been trying to get them to do this for 5 years, it would slow down their growth.
3. Invest in other countries’ debt: The U.S. is still the safest place to park your money, with its comparatively good governance, powerful army and dollar as trading currency for oil and raw materials worldwide.  Additionally, exchanging their dollars into Euros, Rubles and Riyals will depress the dollar, lowering the value of their remaining assets and boosting American exports while slowing their own.
4. Diversify: China already has a considerable real estate investment in the U.S. via their GSE holdings.  Hedge funds and private equity is probably too risky and opaque.  And how many large American corporations can they find to sink hundreds of billions of dollars into without running into regulation snafus like the failed Unocal purchase.

Instead my fear is long-term: When China decides it has developed enough technologically and has brought enough of its population into productivity, they can decide overnight to drastically raise standards of living (lowering taxes on middle class, making credit available, subsidizing cars and housing, etc.) and turn their workforce into consumers.  The moment they do this they won’t need us anymore, and they will be free to dump their dollar-denominated assets, striking a deadly blow to the dollar and acquiring incredible ownership and control beyond their shores.

This is not possible now, but it could be in a decade or two.