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Why Interest Rates Matter

Gather round the campfire kids, class is in session.

Ever since the great inflation and interest rate debacles of the late 70’s and early 80’s the economy has been ever more greatly influenced by the Federal Reserve Board. Who are these dastardly no-gooders anyway? Well they are a purportedly very smart group of economists who set the overnight lending rates that the Federal Reserve Bank charges financial institutions here in the US to borrow money.

If they feel like the economy is “too good” and that there could be an intolerable amount of inflation they will raise interest rates to “slow it down a bit.” Let it “cool off.”

If they feel the economy needs to be doing better or that unemployment is too high they will lower interest rates to spur people to borrow money, take risks and get things going in the right direction.

In other words when it comes to the US economy they are looking for the Goldilocks scenario: Not too hot, not too cold.

Interest rates are currently at historic lows as the Fed has lowered them to near zero to try and help the economy during the global pandemic. The problems with rates being low for a long period of time is it means the very wealthy can’t make much return on money market, certificate deposits or very safe US treasury bond investments. Neither can the average Joe but that’s not the guy who affects the markets.

So the wealthy have to turn elsewhere. This creates more demand for “elsewhere.” In this case I give you the US stock market and the US housing market.

Despite the media’s non-stop mania that Donald Trump would nuke someone at any moment during his presidency the stock market rallied big time. The Fed actually began raising interest rates as Trump’s tax and regulation cuts had jump started the economy and in 2018 and 2019 everyone was back in business and doing great. Unemployment, particularly for minority job seekers, were at all time lows.

But then the Covid hit. And yes, the stock market took a temporary dump in March of 2020, but has recovered all of its losses and then some since. The housing market barely noticed Covid and kept on going up.

Part of the problem is that so much money has flooded into the US housing market it has attracted a huge number of investors. Many of these investors pool together funds of money and go around literally buying up houses fifty and sixty (or more) at a time.

A company in Luxembourg now owns over a thousand modest ranch style homes in Florida. They are easy to maintain, manage and command a princely sum of rent.

When I was still in Indianapolis a firm from London came to town and scooped up over two hundred homes. Players like this pay cash and close fast.

And that’s a lethal combination to people who want to buy a home and live in it. Most new home buyers are using an FHA loan where they only need to put 3-5% down. If I’m selling a home and get two offers that are the same price, and one is cash and the other is FHA which has to jump through a bunch of hoops to get to closing I’m going with the cash offer every single time. The first time buyer just can’t compete.

So we’ve created demand for stocks and houses. Prices have gone up accordingly, which is what always happens when increased demand meets limited supply. And the rich get richer, and the poor get further away from ever being able to own a house. Good work Federal Reserve, you’ve created the perfect economic environment to further divide us!

Now here is the really scary part – when this market crashes (not if, but when) what will happen? Do you think a company in Luxembourg gives a shit about a thousand houses in Florida if suddenly the tenants can’t pay and they lose 30% of their value? 40%? 50%? They’ll blow them all out to someone else and the tenants will be lucky to have anyone who will answer the phone when they need a repair.

And then the government will respond and tighten banking regulations so that “it won’t happen again!” Except then all the people who want to buy a house to live in will find it increasingly difficult, if not completely impossible, to get a bank to loan them any money to do so. This story sounds all to familiar can you give me a #2008?

The bottom line is the only way to get us out of this is to get the economy moving again – and the policies that were doing that quite effectively barely three years ago are now all being wiped away one by one with stroke of a man with dementia’s pen. I wonder if it’s one Nancy’s impeachment pens? Hmm.

Will we get there before it’s too late? I have my serious doubts. Save your stimulus checks if you can kids, and any other cash that you can, I think you’re going to need it.

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