The Good News and the Bad News About Interest Rates

Amey Stone

This week investors rejoiced that, thanks to low inflation numbers, it looks like the Federal Reserve won't keep hiking rates as long and as sharply as feared. That's the good news.

The bad news is that interest rates are now likely to stay low enough to fuel housing and consumer debt bubbles. My current view is that the housing market is entering a new level of over-headedness. This is the throw-in-the-towel time when all the naysayers decide that the optimists must have been right and the housing market really will keep booming into the foreseeable future. For Internet stocks, it would be circa November, 1999.

Greenspan tried to jawbone the real estate market lower this week by voicing his concerns. But he doesn't have the same sway over homebuyers that he has over investors.

Merrill Lynch's mortgage finance analysts warned in a report today:

Recent headlines and news article continue to focus investor attention on the potential for consumer credit to deteriorate given what is perceived to be an unsustainable amount of leverage of the consumer balance sheet, use of adjustable rate financing in a rising rate environment and an over-inflated housing market fueled at least partially by the use of creative financing.

In a section warning investors to avoid investing in non-prime mortgage companies, the Merrill analysts write:

If housing values fall meaningfully and credit deteriorates simultaneously, which we think is plausible, then we believe the sector could face liquidity issues, causing significant volatility in the shares of companies heavily leveraged to this sector.
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