Federal Reserve Interest Rate Note

06/15/2006

With the Federal Reserve’s recent, relentless increase in the discount rate, fueled, some would say, by high oil prices and a slowing economy, we can anticipate a major ramp up of mortgage defaults by the end of the year. Much of the economic growth we have enjoyed over the last four or five years has been powered by an unusually strong residential real estate market.

A large part of the strength of that market was based upon record-breaking consumer acceptance of a dazzling array of new mortgage products, principally various forms and combinations of interest-only mortgages, adjustable rate mortgages, and “no money down” 100% (or even 125%!) mortgages. Rising interest rates are triggering substantial monthly payment increases in the ARMs, and the mere passage of time is converting many interest-only mortgages into more expensive amortizing instruments. And one cannot forget that the insurance industry has put a heavy thumb on homeowner insurance premiums following monumental industry losses from 9-11 and recent hurricanes, and that many cities in renewal (including Richmond) have experienced substantial increases in real estate assessments (and real estate taxes).

All this will mean that the last to buy will be the first to lose. The buyers who could only qualify for an interest-only mortgage, or other gimmick financing, will lead the default parade as rising interest rates skyrocket their monthly payments. These are the folks who have probably dug deep into their credit cards as well, and the fall will be hard when it comes. Consumer bankruptcy attorneys, Realtors®, auctioneers, and the lawyers that represent the lenders will probably do well. As for the rest of us, every boom must have a bust.