The Economy: "The End of Cheap Credit?"
"The End of Cheap Credit?"By Nelson D. Schwartz
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.
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."
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