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Thursday, December 11, 2008

The Mini Refi Boom and Top to Bottom Economic Recovery

Introduction: Ever since it was announced that the Treasury was planning on manipulating the mortgage rates to 4.5%, I have been critical of the plan. I have however in the back of my mind always wondered whether or not the Feds are crazy or are they crazy like a fox. What I mean is that this plan is not only hokey but the announcement seemed very peculiar given that they weren't really sure just how they will implement the plan. In the back of my mind, I have wondered if the Feds put this out in the hopes that it would be a self fulfilling prophecy. In other words, were the Feds putting this out hoping that the market would take the news and move the market down on its own. Now, I don't know if this is the case however for the last week rates have come down dramatically. We are now in the low 5's and apparently going even lower. Whether this is in response to the announcement no one knows, however I have no doubt that speculators are driving down these rates. Certainly, speculators could have seen the announcement as an opportunity to drive down rates...

I have for several months hypothesized that the only thing that would save this economy is another min refinancing boom. Since the Tuesday before Thanksgiving that is what we have had. The mortgage market has been as hot as it has been since 2006, Yet, the current reincarnation of the refinancing boom will look significantly different than its prior version in 2001-2003. There are several reasons for this. First, Fannie/Freddie have changed the rules as far as pricing and as a result only those with near perfect credit will now be able to enjoy the low rates we are seeing. Second, the real estate marke has tanked and thus far fewer people will have the sort of equity necessary to be able to take advantage.

As a result, the only folks that will be able to take advantage of the new refinancing boom will be those with plenty of income and a credit profile of someone with wealth. As such, those that will take advantage are going to be overwhelmingly those at the top. As such, the refinancing boom could become a test case for the validity of top to bottom economic building. Those that will now be refinancing will overwhelmingly be those that don't need the extra money. They will do it because the opportunity will be there. Those that support Obamanomics believe that such folks would never use the extra money to spend. Hers is how Robert Frank described the spending habits of such folks.

With few exceptions, high-income taxpayers earn substantially more during their lifetimes than they spend, generally bequeathing the surplus to heirs or charities. If these taxpayers faced slightly higher rates, they would have ample resources to maintain their current lifestyles, so most would keep spending as before. The only consequence would be that, years from now, they would leave smaller bequests.

So, by the estimation of folks like Mr. Frank, this current incarnation of the refinancing boom will do little to help the economy. These folks will likely hoard the money away and it won't be used to stimulate the economy in any way.

Of course, the main problem with this exercise is that it will be nearly impossible to tell what the effect of this stimulus will be on its own. President Obama will soon put together his own stimulus package. He will give tax credits to the middle class. He will begin to spend. So, its very possible that the refinancing boom will stimulate the economy while President Obama attempts to take credit for it through his own stimulus packages.

What will be interesting is how Obama views the refinancing boom. Will he applaud it? Will he recognize that the stimulus will go only to those that are well off? Will he realize that the new refinancing boom is stimulating the economy in the exact opposite way from which he intends? This refinancing boom is a test case for the power, or lack thereof, of top to bottom economic building. Let's hope there will be a way to measure its effectiveness.

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