4.50% Interest Rates…Hold Your Horses

A report leaked last week that the Federal Reserve was considering lowering the 30 year fixed rate to 4.50%, over a percent lower than the current market, in an effort to stimulate home buying.

The Wall Street Journal reported the following:

- “The plan, which is in the development stage, would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5%.”

- “The plan remains in discussion and may not be made final before the Bush administration’s term ends in January.”

- “The lower interest rates would be available only to borrowers who are buying a home, not those refinancing a mortgage.”

- “Borrowers would have to qualify for a mortgage guaranteed by Fannie, Freddie or the Federal Housing Administration. Those guarantees apply to loans where borrowers can document their income and afford their monthly payments, steering the government away from backing loans considered risky.”

How would this happen…and would it work?

Fixed mortgage rates are tied to Mortgage Backed Securities (MBS) which are similar to stocks except that they are tied to mortgages as the security whereas a company is the security for a stock. Both stocks and MBS are priced based on supply and demand. The more investors want a stock the higher the price goes and vice versa. MBS function the same way.

Because the  price is determined by supply and demand, the Fed would have to artificially drive the rates down to 4.50%. In plain terms, they would pay to get them down. The only source of cash I know about would come through borrowing or printing the money needed to pay the difference between the current market rates and the new target rate.

When the government borrows and/or prints money, it is inflationary. Inflation simply means that the dollar you have now will not go as far in the future because it is worth less. By artificially driving down rates they will be stoking the inflation fire.

The reason this is bad for interest rates lies in the mechanics behind how rates work. As mentioned before, rates come from an investment vehicle called MBS. Investors who choose to put their money in MBS instead of stocks do it because they are looking for a safe, fixed return. If the return they want is say 4.50% and inflation strikes, the return of 4.50% is actually worth less than that. In other words, if your 4.50% investment paid you $1000 month and the inflation rate goes up, due to the government borrowing or printing money (which it will), then your $1000 will only buy you $900 worth of goods and services. Now the investor needs a 5% return to buy the equivalent to $1000 worth of goods and services. This is a vicious cycle and will work against the very mechanism used to artificially drive down rates.

In summary, can the government artificially drive down rates? Yes.

If they do, will it last long? I do not see how it could based on the mechanics of the market I have described above.

If they do it, who will benefit? Because it will take money to drive the rates down the Feds would need to identify some parameters on what loans they would offer this on. It will certainly only be purchase loans as mentioned in the WSJ and I speculate that it will be for a specific target market, maybe a certain loan amount range and quality of buyer. They do not have the money to open it up to all loans of any size or type and any and all borrowers.

If it happens, great. If it does not, rates are fantastic now and more importantly, the big money is made on a purchase through negotiating the right price, not a little lower interest rate. What makes buying now so appealing is the phenomenal deals you can get. If 4.50% comes and everyone jumps in, don't you think sellers will hold more firm on their prices with buyers swarming everywhere?

Don't Be a Fearmonger

If you look around you will notice that nearly everyone around you is scared. They are not sure what will happen with the economy and more importantly their jobs. Will they ever be able to recover from the 45% haircut the stock market drop has given them?

A very insightful article came out in the New York Times on Sunday titled In Hard Times, Fear Can Impair Decision Making. It is written by Gregory Berns, a neuroeconomist and directs the Center for Neuropolicy at Emory University. In the article he makes the following observations:

“And while fear is a deep-seated and adaptive evolutionary drive for self-preservation, it makes it impossible to concentrate on anything but saving our skin by getting out of the box intact.”

“Ultimately, no good can come from this type of decision making. Fear prompts retreat. It is the antipode to progress. Just when we need new ideas most, everyone is seized up in fear, trying to prevent losing what we have.”

Take some time to observe your own behavior and test what he is saying. It is certainly true with me. Now is the time to go against the grain and create opportunities for ourselves. You may be thinking, easier said than done. You may be surprised.

“The most concrete thing that neuroscience tells us is that when the fear system of the brain is active, exploratory activity and risk-taking are turned off. The first order of business, then, is to neutralize the system.”

“This means not being a fearmonger. It means avoiding people who are overly pessimistic about the economy. It means tuning out media that fan emotional flames. Unless you are a day-trader, it means closing the Web page with the market ticker. It does mean being prepared, but not being a hypervigilant, everyone-in-the-bunker type.”

I would suggest a couple of more things that you can do to “neutralize the (fear) system”:

1. Spend 10-15 minutes each morning visualizing your ideal life
2. Spend 20-30 minutes reading something uplifting (personal growth book, poetry, human victory story)
3. Workout for at least 30 minutes per day
4. Start a gratitude journal, taking careful inventory of all that you are blessed with
5. Set goals and clear daily and weekly objectives so you have a clear path of the life you are designing. This will take you out of the helpless victim role that often accompanies fear.

            

My Wife Was Right... Again

As is true to the relationship my wife and I have, she was right, but I wouldn’t accept it until someone else told me.

I had tried to get her to read more business and personal growth books for a number of years as she read a bunch of stuff that would surely never make anybody any money. She reads a wide variety of literature including the classics and poetry.

Wise old me had spent the last decade reading the business bestsellers along with every financial book I could find. Although I have learned a lot over the years, it was not the secret formula.

It was then that I was introduced to an article in the New York Times titled C.E.O. Libraries Reveal Keys to Success.

Michael Moritz, venture capitalist and owner of a huge library, says he can’t discard books.

The article is summed up best by a line in it that declares, “Serious leaders who are serious readers build personal libraries dedicated to how to think, not how to compete.”

To be really wealthy I cannot copy or mimic what others are doing and expect to get top 1% results. In other words, if I spend my time attempting to do what others have done I will always be one step behind. I must learn to think for myself.

What do the best thinkers in our country read?

Read the article and see for yourself, but don’t tell your wife that this is where you learned it!

I.O.U.S.A.

If money plays a role in your life then I highly suggest watching the movie I.O.U.S.A. Roger Ebert said, "...it accomplishes an amazing thing. It explains the national debt..."

Visit the official movie website

Reuters said "I.O.U.S.A." "may be to the U.S. economy what 'An Inconvenient Truth' was to the environment."

We must educate ourselves on the forces that will determine our ability to live the American Dream.

Watch the 2 minute trailer

Or watch the Byte Sized 30 minute version of the movie

http://www.youtube.com/watch?v=O_TjBNjc9Bo

To get involved I recommend 

http://ww.pgpf.org/getinvolved/signup/

Seems So Obvious

In every choice there are two elements of the equation, pain and pleasure. In this lies one of the great secrets of life: we have the free agency to choose which one comes first with the great caveat, the element not selected will always come second and last longer. Let me say it another way, the element we choose first has a short duration and the second element will last far longer.

Here is what I mean; not long after I was introduced to this principle I was driving home from Seattle to Portland with a few colleagues. A short distance into the drive I pulled over to get some gas. I broke from the lively discussion on this very topic to go into the quickie mart and proceeded to buy a 44 ounce soda and a 3-packer of cupcakes. You know the really healthy Hostess type. Back in the car and two and half cupcakes down it dawned on me that I had just scheduled pleasure (sugar high) first with the pain (gut ache and life of flab if continued) to follow. What was just as eye opening was that it did not matter whether I was aware of the principle or not. It is a mechanism or principle that functions just the same.

What if I had scheduled pain first by way of water and a Power Bar? Consequently I would have benefitted from long lasting energy and a show stopping six-pack, pleasure! Far better decision.

This principle is highly active and visible in personal finance. I can schedule the pleasure (new outfit from Nordstrom’s) now and the pain (lack of savings for retirement and/or college fund for children) will most certainly follow and last well beyond the awe inspiring confidence of some new digs.

Where in your life are you ignorantly scheduling pleasure first, unaware that a long period of pain is waiting to pounce?

Take an inventory of your personal finances and identify at least one change you could make today by reversing the order of pleasure and pain.

From experience, the short term pain of saying “no” results in long lasting pleasure in the form of great peace and possibility.

Seven Simple Rules to Follow in Life

Joshua Wooden, father of the great John Wooden, gave him a little white note card for his elementary school graduation (back then, graduation of elementary school was a big deal as many did not graduate high school). He wrote the creed he had so often shared with his kids: 

Seven Simple Rules to Follow in Life

1.    Be true to yourself

2.    Help others

3.    Make each day your masterpiece

4.    Drink deeply from good books, especially the Bible

5.    Make friendship a fine art

6.    Build a shelter against a rainy day

7.    Pray for guidance, and count and give thanks for your blessings every day

As he read the card his dad said, “Johnny, try and live up to these and you’ll do alright.”

In a world that is ever-changing and at a rapidly increasing pace, I have begun a quest for principles that are timeless. What can I be sure of in building my foundation?

This was advice given before 1920 and is quite possibly more valuable today than it was then.

It helped build a foundation for John Wooden that led to 53 years of marriage and made him the greatest college basketball coach of all time. He led UCLA to win 10 National Championships in 12 years.

What would the integration of these principles do for your family, career and life? I have no doubt that they will make me a better, more successful and happier person.