Debt Shakes The World Economy — And Mortgage Rates

The world’s financial markets — and thus the world — have watched with some horror as things have recently gone very wrong in Greece, Puerto Rico and China. One very real possibility that could emerge from these events is that U.S. mortgage interest levels might remain pretty much where they are for the remainder of the year, if not longer. The reason? The world economy has piled up $57 trillion in new debt since the end of the financial crisis, in some cases money which will never be repaid.

In the usual relationship between lenders and borrowers is a trade: Lenders provide cash and borrowers are expected to pay it back with interest. This formula generally works pretty well except when comes to nation states. If a country reneges on its debts then we no longer have a lending issue, instead we have very serious questions which can topple entire governments and destabilize financial systems.

Consider Greece. It has a national debt of some $385 billion (Note: eruo exchange rate — $344 x 1.12 = $385 billion). There is no possibility this sum can be fully repaid so the essential question is what can such lender nations as Germany, France and Italy do to get back as much of their money as possible.

In the end it will happen that the lenders will have to either lend more and postpone the inevitable or lose a large chunk of their existing debt right now. As to Greece hard times lie ahead, at least in the short run. One possibility is that Greece will leave the euro zone, dump the euro and bring back the drachma.

Meanwhile, it’s not just Greece. Puerto Rico owes $72 billion it cannot repay. In China, the stock market has plummeted during the past month and some $3 trillion in equity has been lost. That’s a huge and troubling amount in a stock market which allows extensive leverage. Lastly, and largely overlooked, oil prices are down to $52.82 a barrel at this writing, a price which means governments in Russia, Venezuela and Iran are not earning nearly enough from oil sales to support national infrastructures.

So how does this impact U.S. mortgage rates?

Interest rates at this writing are just over 4 percent, less than half the norm during the past few decades. One reason for low rates is that the economy is flooded with capital, much of it from overseas.

“Yields on Treasury securities declined this week in response to investor concerns about events in Greece and China,” said Freddie Mac chief economist Sean Becketti.

“Overseas volatility is likely to persist for some time, providing some restraint on potential U.S. rate increases,” he added. “In addition, the minutes of the June meeting of the Federal Open Market Committee suggest the Federal Reserve will proceed cautiously — monitoring events both overseas and in the U.S. to ascertain the appropriate moment to begin raising short-term interest rates. As a result, mortgage rates may remain in the neighborhood of 4 percent for a while.”

The International Monetary Fund says it would like to see “a gradual path of policy rate increases starting in the first half of 2016.”

Translation: No interest rate hikes from the Fed in 2015, please.

Higher U.S. interest rates, explains the IMF, could lead to “continued weakening of growth in the rest of the world could suppress U.S. exports and investment in tradable sectors. Weaker global growth or a pronounced China slowdown, alongside a stronger dollar, would also weaken profits of U.S. multinationals and could trigger a re-pricing of equity valuations (with the attendant harm to U.S. consumption via wealth effects). Finally, risks from Russia/Ukraine, Greece or the Middle East represent an unpredictable wild card with negative, but difficult to quantify, effects for the U.S.”

It’s hard to imagine that government officials feel any differently — especially with elections looming ahead. The U.S. federal debt amounts to $18.3 trillion dollars. If rates rise the budget will suddenly face huge new expenses and the deficit will soar — not good campaign news for political incumbents of either party.

To make matters more complex, global debt is rising. A new study by the McKinsey Global Institute estimates that debt worldwide has increased by $57 trillion since the mortgage meltdown.

“By borrowing another $57 trillion since 2008 and pushing interest rates down to zero and below, the (formerly) rich countries are now living in an ‘all news is bad news’ world,” says John Rubino at

Rubino says “if growth stays low then all that new borrowing was worse than wasted, increasing leverage and financial fragility while leaving central banks and governments with few options going forward. If the past seven years’ debt orgy didn’t ignite a boom, will another binge be worth the effort? Will borrowers be energized by -2 percent rates if 0 percent left them cold?”

That’s right. While there’s a boatload of new debt it’s not exactly the kind of debt that warms lender hearts, it’s too often debt with “negative interest,” an expression which means that every dollar loaned is a sure loser. For instance, with negative interest if I loan you $1,000 you would give me back maybe $980.

Trillions of dollars in Europe and Asia have been loaned with negative interest. Why? Because negative interest is seen as a better alternative than investments in local stock markets, real estate or commodities.

However, why should investors get negative interest at all when they can buy U.S. mortgages? They can get interest, real interest, with debt secured by housing inside our borders. With much of the world economy in shambles, that’s a very good deal and a big part of the reason why the U.S. is being flooded with foreign investments.

More investment cash, of course, pushes down interest costs and that’s a problem for the Fed. What happens if the Fed raises bank rates and mortgage interest levels — which the Fed does not control — rise for a few weeks and then fall again? That’s exactly what happened as the Fed ended its quantitative easing (QE) program in October 2014.

It’s not just the IMF and federal officials who oppose a rate hike at this moment, many within the Fed itself likely fear what will happen. For instance, the Fed promised to raise rates when unemployment fell below 6.5 percent — and then, when that finally happened in 2014, simply said that it’s guidance had become “outdated” and interest rates would not rise.

For U.S. borrowers the world’s mounting financial woes have resulted in remarkably low mortgage rates here at home. Let’s hope our good fortune continues — and that somehow the rest of the world also sees better times.


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To search and research real estate data for more than 130 million properties nationwide, sign up for a FREE trial to RealtyTrac.

For the latest real estate news and trends get a FREE issue of our award-winning real estate newsletter, the Housing News Report.

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