Tangential question: One of HN's frequent subjects is the rapid rise in Bay Area housing prices. Since real estate is an asset like any other, how does the Fed's policy of inflating asset prices contribute to this phenomenon?

Selections from an article titled If You're Over 65, You Should Love the Fed by N Kocherlakota, former president of Fed Reserve Bank of Minneapolis:

Conventional wisdom suggests that monetary stimulus is particularly bad for senior citizens: When the Federal Reserve holds interest rates low, retirees tend to get less income from their nest eggs. Over the past eight years, though, they've done a lot better than this simple logic would imply.

Consider the amount of goods and services that seniors consume -- an important indicator of their well-being. According to the Consumer Expenditure Survey, the average household headed by someone aged 65 or older consumed 5 percent more in 2014 than in 2007, adjusted for inflation. That compares to declines of 5 percent for all households and 7 percent for households headed by someone aged 35 to 44...

Seniors hold more assets like stocks, bonds, and homes than do younger folks. All of these assets have appreciated a lot over the past seven years, providing seniors with a source of spending money that offsets some of the effect of low interest rates...

We should assess the appropriateness of monetary policy in terms of macroeconomic outcomes, not in terms of the level of interest rates. And when we judge by outcomes, we have to conclude that monetary policy has not been appropriate for the economy as a whole, because inflation and employment have been too low. Unduly tight monetary policy has systematically shifted the distribution of resources toward people who are not working and who receive payments that are, in large part, not indexed to inflation -- that is, toward retirees.

http://www.bloombergview.com/articles/2016-03-18/if-you-re-o...

There's no question that it's a major factor. Even well-heeled individuals/couples don't take out mortgages on the order of $800,000 if they don't get minuscule rates on the order of ~3%. Banks wouldn't be able to hand out those rates for spans of ~30 years unless the government gives them access to cheap money and guarantees the loan.

Agree entirely. Once interest rates rise, you'll see a direct impact on SF housing prices.

People who can afford an $800,000 mortgage at 3%, can't borrow anywhere near that amount when rates are 6% (closer to the historical average).

Yeah, it goes down to $563,000 if its 6%, a 30% drop in affordable home price.

It's funny, as someone who was still a kid back in the 80s, the idea of a 6% mortgage sounds ridiculous to me. How on Earth could someone afford to pay all that interest? Yet, mortgage rates were at times in the past over 15% (!!!)

It's not so bad when the actual price of the home is 30% lower.

The interest rate on my first house in Sunnyvale was 13% and it adjusted every 6 months. Of course the house cost $153,000. Still it took both my wife and I working (she is also an engineer) to make the payments and we didn't have kids yet.

At the same time my Vanguard money market account was paying 15% annual interest. That was pretty awesome.

In New Zealand, interest rates were around 8% when I was growing up, and were around 20% when my parents bought a house. Would have been cheaper to put it on your credit card...

Because inflation? I assume the "real interest rate" was much lower.

Not being from US, are most mortgages there fixed for their lifetimes or tied to fluctuating interest rates?

Many are fixed for the entire duration of the mortgage's length (e.g. 25 years). You can find variable rates as well though.

Being from Canada, I couldn't believe that this was possible when I first came down here because it seems to defy belief that any bank would take on the risk to extend a loan at such low-interest over that kind of time frame. It turns out that it's possible because the banks aren't taking any risk; instead it's all outsourced to US taxpayers ;)

That's very recent, though. We had thirty year mortgages long before the government started holding most of the paper.

Banks have been selling loans for ages - when I bought my first house in the '90s the bank which originated the loan sold it to a life insurance company four days after escrow closed. After a few years that insurance company sold it to someone else.

Life insurance is a good fit for mortgages. Insurance companies need a safe investment to pay out when people die, and usually the payout isn't inflation adjusted.

Besides, if you have to invest money for the long term but can't (by statute or temperament) handle much risk, what are you going to invest in? Twenty year T-Bills are at 2.30%.

> Twenty year T-Bills are at 2.30%

FYI, T-bills have maturities of one year or less, T-notes two to ten years, and T-bonds 10 to 30 years. The term "Treasuries" helpfully covers all three.

Selling the loans forward sounds a bit weird system. In Finland it's usually the other way around -- customers may take their loans with them to another bank. This happens every now and then when competing banks offer better margins on the loans, or if customer isn't happy with the bank's service.

Yes, which blows my mind too since APRs (as the US calls them) are standard in my experience here in Australia except that our banks tie the interest rate to the reserve rate which is revised monthly, not yearly. Fixing an interest rate is something you do for a span of 3-5 years, not the life of the loan.

The US does a lot of things strangely, this is but one of them :)

Interest rate has a huge impact on housing price, as most people borrow to buy houses these days. People evaluate monthly payment more than the price. If they can afford the monthly payment, they can afford the house. Lower interest rate lowers the monthly payment. People can afford higher priced houses. When everyone does it, the general housing price goes up.

Real estate prices, as with all other assets, are a function of supply and demand. In the case of San Francisco, supply has remained relatively constant (due to stability in the housing stock) and demand has increased.

Without looking at the data, I'd imagine the recent explosion of the technology industry in the Bay Area has been the largest driver of demand for houses. An increased number of people moving to the area for employment will naturally increase the demand for houses.

However, Fed policies also contribute to the demand for housing. As the Fed has kept interest rates close to 0%, it is much easier to finance mortgages for houses, so the housing becomes more affordable (when considering amortization). Additionally, these policies have also driven investment into higher yielding assets, such as equities, in search for greater return. This has had the effect of increasing many individuals' wealth, making them more capable of purchasing houses.

With increases in the ability to pay for housing (assuming housing is a normal good), there will be an increase in demand for housing.

The zero interest rate definitely does contribute, but a bigger deal for mortgage rates is that the Fed continues to buy $24-26 billion a month in mortgage-backed securities. It is keeping its total holdings of MBS constant, but since total holdings are still over $1.7 trillion, that results in a lot of purchases each month to cover the reduction in principal from people paying off mortgages in existing MBS.

This article has a good explaination: http://www.cnbc.com/2015/12/16/why-the-fed-move-doesnt-matte...

>The zero interest rate definitely does contribute, but a bigger deal for mortgage rates is that the Fed continues to buy $24-26 billion a month in mortgage-backed securities

I think you've got the right idea, but you are misinterpreting things slightly. Purchasing MBS contributes to ZIRP (as opposed to serving a separate policy objective). MBS are interest rate products based on mortgages instead of US Government credit (although you can view MBS as a US Treasury + some spread). In sustaining purchases of MBS (supporting their price), the Fed drives down their yields (note that yields necessarily move inversely with price). In effect, these purchases result in lower interest rates and go hand in hand with ZIRP.

> that results in a lot of purchases each month to cover the reduction in principal from people paying off mortgages in existing MBS.

I'm not sure what you mean by this. A person's principal is only changed when she makes a payment on the principal. Fed's purchases will affect the yield on the MBS.

"... it is much easier to finance mortgages for houses, so the housing becomes more affordable ..."

Not necessarily. Widespread access to greater amounts of affordable credit also means that more people can afford to buy more expensive houses, which puts upward pressure on housing prices. So sure, you might get a better rate, but that better rate may well be negated by a higher purchase price.

I'm glad we agree...

"With increases in the ability to pay for housing (assuming housing is a normal good), there will be an increase in demand for housing."

Real estate prices are not solely a function of supply and demand. If the value of your money goes down, so too will the price of your house.

>Real estate prices are not solely a function of supply and demand. If the value of your money goes down, so too will the price of your house.

Sorry, but that statement is pure nonsense. If the value of your money goes down, you will need more if it to purchase any good (since it is less valuable). Therefore the price of your house has increased, since you need a nominally greater amount of money to purchase the house.

And, yes, all asset prices are ultimately determined by supply and demand. Suppose you are the last person on earth. You necessarily own all houses on earth. However, you cannot sell them for any price, so no price exists. Now suppose you own the only house on earth (with its current population). I imagine you might be unwilling to give up the comforts of a home at any price (although people will likely offer huge sums for the house). As you can see, the supply and demand of assets fundamentally determines their values.

The housing prices don't really adjust for foreign exchange rates of a currency most of the time. There are forces in both directions with foreign and local buyers both being impacted in different ways.

> The housing prices don't really adjust for foreign exchange rates of a currency most of the time.

That's really not a correct statement. The drivers of currency fluctuations are absolutely going to affect the value of housing (interest rates, legal infrastructure, etc.) As a prime example, consider the housing market in Vancouver. Prices have increased significantly, in large part due to capital flight from China. As holding RMB became less attractive, buyers altered their asset allocations.

> There are forces in both directions with foreign and local buyers both being impacted in different ways.

That's tautological. Holding one currency has the opportunity cost of not holding other currencies. If EURUSD increases, then holders of EUR will benefit exactly as much as holders of USD suffer (relative to one another).

I encourage you to look at an actual graph of housing prices and foreign exchange rates. They really don't track each other.

Short and long term there are different and very complex with multiple feedback loops. Also, most people have home loans and houses are not currency. Further, having your currency appreciate is bad for many parts of the economy.

Sure, long term there are impacts especially with foreign investors. But it's also vary local with Las Vegas housing market tracking different things than rural Minnesota. Even as interest rates have long term impacts.

> I encourage you to look at an actual graph of housing prices and foreign exchange rates. They really don't track each other.

I'd be very interested to see such a graph. I'd also be interested to know what you mean by foreign exchange rates (I've been assuming you're talking about USD relative to all other currencies). [0] seems to indicate that FX rates affect real estate prices.

> Also, most people have home loans and houses are not currency.

I really struggle to see how that's relevant in the slightest. No one claimed that houses are currency.

> Further, having your currency appreciate is bad for many parts of the economy.

That supports the notion that FX fluctuations will affect real estate prices. A region with worse economic prospects will likely have less demand for housing than an otherwise identical area with better economic prospects.

[0] http://www.investopedia.com/articles/forex/053115/understand...

Low interest rates means you can afford to borrow more money to buy a house. 3000 dollars a month payment radically changes based on how much the interest changes.

The US Fed was a very large buyer of Mortgage Backed Securities, lower the rate of US mortgages. This means that they directly contribute to the housing rate increase. (This is in addition to the indirect aspect of lower long term rates raising equity prices, and people putting that money into houses)

https://www.newyorkfed.org/markets/mbs_faq.html

http://www.bloomberg.com/news/articles/2013-10-28/fed-sees-a...

http://www.marketwatch.com/story/fed-bought-up-half-of-agenc...

Real estate price rises at that level imply the pursuit of land rents. This doesn't happen in Texas. Compare and contrast.

Housing is one of the preferred assets for the US government placing the money it creates. It's this way here at Brazil too.

The cheap money policies are the entire cause of the recent housing price explosion in a big part of the world.

That's what I think too. In my home country, it's conventional wisdom that the central bank's policy of low interest rates is pumping up a bubble in housing prices. But somehow here in the United States, people feel it's more of a secondary issue.

It won't direct affect cash buyers, who currently constitute about a quarter of the housing market. Nothing will really change for foreign investors looking to park their assets in a safe location. But a stock market crash could reduce the number of buyers who are able to cash out stocks from IPOs and buy homes.

http://www.sfchronicle.com/business/networth/article/All-cas...

I also enjoy the side effect of keeping the rate of return for savings accounts at zero.

This is a frequent misguided criticism. The job of central banks isn't to ensure that savings accounts have a high rate of return. They're not robbing virtuous savers.

It is the nominal rate of return which we are talking about too, which means that the rate reflects the low rate of inflation. An increase as a result of inflation would amount to no long-term gain for savers.

Real returns result from real investments, not fluctuations in the money supply.

Which means that savings accounts give zero return or negative return to force you to make real investments.

The person above you wasn't wrong, and what you described is the entire point of the operation.

> force you to make real investments.

There lies the problem. Real investments aren't made, unless pushing the price of housing stock to extract more from renters and to-be homeowners, as well as stock buybacks in large corporations, are the "real investments" central banks are preferring.

Although that is what is happening, I think it will take quite a while for people's investment profiles to change.

Right now there are people that think "I can't keep my money in the bank without it loosing money, let alone keep up with inflation, what am I supposed to do put it under a mattress!?"

It will be quite a while before people become corporate bond investors as commonplace (which would put money back into the economy).

In Switzerland, for example as a nation of savers, the corporate bond market has basically dried up. Because even higher risking bonds have too low yields to be attractive for the risk. (Although the Swiss National Bank hasn't prompted bank savings account interest rates to go negative.. yet).

As someone who has been burned several times by the stock market and supposedly safe index funds, I have no idea where I would put my savings (if I had any substantial amount). Stock market / mutual funds have a high risk of loss. Bank accounts will not grow (and will lose eventually due to inflation). Inflation-adjusted savings securities seem like the best bet, but they won't grow. There's no safe return anywhere anymore.

>As someone who has been burned several times by the stock market and supposedly safe index funds...

I'm curious to know what this means. You can only get "burned" in index funds if you pull your money out when the market is down. Are you investing money you need to pay the bills?

Bad timing. I'm sure the stock market is fine for people with an infinite time horizon, but I no longer trust it as a place to park savings for 5-10 years that you want to grow in order to buy a house or spend on grad school.

You are not alone. If you look at the "target retirement date" funds Vanguard etc. run you'll see that by the time the target date is 5-10 years out they have shifted largely to bonds to provide defined income.

Sounds like you need better advice. Most advisors will tell you that 5-10 years isn't quite long enough for the risks of stocks to pay off. Sounds like you wanted medium-term bonds instead of stocks!

> no safe return anywhere anymore

Just means your risk profile is too low. As detailed earlier, the central banks literally don't want you to do the things you were considering doing. Their distortions of the market are not arbitrary.

They want you to make private equity investments (the ones that don't come with hundreds of pages of disclosures), they want you to buy corporate bonds.

They want you to do things that actually put money back into the economy, and give a potentially higher return with a higher risk of loss.

The line between investing and gambling has always been a social construct. You hop into derivatives and even the "positive vs negative expected value" distinction falls apart.

There never was any safe return anywhere. It was all an illusion. Even US government bonds carry some risk once you account for black swan events across a sufficiently long period of time.

Does this mean I'm better off not having any money in a savings account (except perhaps 1 month's expenses or so) and putting that money in stocks and bonds? I've been thinking recently of moving (part of) my 5-month emergency fund to intermediate term muni bonds (VWITX specifically). But I'm not sure if that's a good move.

IANAFA (not a financial advisor :P), but it really depends on your goals and risk tolerance. Sure, interest rates are low but so are inflation rates. Sitting on cash isn't as bad as it used to be if you want instant-access to dollars. If you don't need that 5-month-emergency-fund to grow, you probably don't need to put it in riskier vehicles. I believe putting that fund in VWITX would still give you quick access (on the order of a day or two) to if you needed it. You should look at the size of the fund and weigh the risks: definite loss due to inflation over N years, or the small risk-reward spread of medium-term bonds (i.e. they will probably grow, and you'll be earning interest, but there is a chance you'll be forced to sell at a time when bond prices have dropped).

The government does have a responsibility to alleviate the pain of economic dislocation. The nation might gain as companies fail and jobs are lost, but individuals are hurt. Unfortunately, the best solutions -- unemployment insurance, free education, free healthcare, or basic income -- are politically unpalatable (for the strange ethics of "fairness"), so we end up with awkward compromises that set us up for catastrophic failures.

I am constantly reminded of that 90's movie Weekend at Bernie's where, in order to keep the party going, two guys drag a rich dead guy around and make it appear as though he's still alive in order to keep the party going and have access to all his stuff and wealth.

- and stay out of trouble.

All true but done in light of the historical record of every other time the party crashed to a halt suddenly. They're trying to not let everything go to shit while a solution is prayed for.

Actually, every other time after the Great Depression (which was arguably different, because there was still the gold standard), markets rebounded quite quickly after a crash; you could say that each crash was a "clean cut", while what we have now is a "botched surgery massacring the patient".

Why did the gold standard cause the depression to linger? Because the standard meant less financial tools available to policy makers?

Theories vary. It's believed in some theories that some nations "cheated" and held more gold than the currency offered would imply.

Historically, things are just as unstable with gold as without it. And if you have productivity rises and inadequate increase in gold supplies, you get deflationary effects. This being said, fiat seems just as capable of that.

Just as an example, the Swiss National Bank notoriously took a $120M+ loss on Valeant. [1]

[1] http://www.fuw.ch/article/die-angst-der-snb-vor-dem-eigenen-...

> Pension funds, retirement savings, the top 1%’s majority of assets, and so on are all in the market so governments of the world have decided that the market shouldn’t go down, at least not very much.

Yeah, that's kind of my worry with the move to long-term wide-spread stock investing for retirement. Ostensibly, that strategy has done well, but once everyone does it, that prods massive political favor toward propping up the largest companies (that are getting this investment).