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The Fed and interest rates—what one does, the other follows. Over the past two years, we’ve seen interest rates crash to all-time lows, only to skyrocket back up to decade-long highs at the start of this month. This turbulence has swept the legs of many prospective homebuyers and has caused the housing market to go from red-hot to lukewarm in only a matter of weeks. What’s causing these rapid fluctuations and are rising interest rates the new norm?

There’s arguably no one better to ask this question than Nick Timiraos, reporter and economic correspondent at The Wall Street Journal. Nick keeps a tight pulse check on The Federal Reserve at all times. In his newest book, Trillion Dollar Triage, he discusses why The Federal Reserve made the shocking moves they did in 2020, and how their decisions affect every American today.

Dave Meyer and James Dainard use today’s interview with Nick as a chance to ask the how, why, and when questions about The Federal Reserve, inflation, interest rates, and the housing market as a whole. Nick discusses the warning messages that The Fed has been sending over the past few months that should give investors an inkling of what is to come in the second half of 2022. If you’re a real estate investor or casual homebuyer, these signals could dramatically shift when and how much you offer on a home.

David:
Welcome to On The Market. We have an awesome show for you today. If you were like me and are eagerly watching what the Federal Reserve is doing and are concerned about rising interest rates and they’re implications for the housing market and being a real estate or any type of investor in general, you’re definitely going to want to check out this show. We have Nick Timiraos, the chief economics correspondent for The Wall Street Journal joining us.
And he is an unbelievable wealth of knowledge about the Federal Reserve, how they’re thinking about the current economy and what you can expect over the next couple of months. To join me for this interview. I have my good friend, James Dainard here with me today. James, what’s going on, man?

James:
I am so excited to talk to Nick. I downloaded his book last night and started listening to his sweet nothings last night.

David:
I knew you were the perfect co-host for this episode because you like me love this nerdery and love talking about financial policy and what’s going on with the Fed, because it actually really matters. It plays a huge role in what goes on in the world and lives of real estate investors.

James:
Yeah. I mean, they are the puppet masters. Whatever they do is what we’re going to fall. But yeah, I mean, and this guy’s been like in the war room of 2008. I mean, he’s been through all the different for economic downturns and upsides. I’m really excited to hear what he has said.

David:
What do you think people should be listening out for as they listen to this interview with Nick?

James:
I think just what is the government trends with the treasury, what he’s going to talk about on the treasury and buying bonds, and then just the interest rate. And also what’s the tone of the Fed. Is the tone of the Fed actually is it urgent or is it something that they feel like they can get a control? Because he knows all these people so, well, I want to know what his inside look is on that as well.

David:
All right. Well, we’re going to just jump right into this interview, because there’s so much to unpack here with Nick from The Wall Street Journal. So let’s welcome Nick onto On The Market. It is my pleasure to introduce, Nick Timiraos who is the chief economics correspondent for The Wall Street Journal and the author of Trillion Dollar Triage. Nick, thank you so much for joining On The Market today.

Nick:
Thanks for having me, Dave.

David:
So you are obviously an authority on the Fed and the Federal Reserve policy. For our listeners, could you just start by giving us a background on what exactly the Federal Reserve does and how it uses its authority to manage the U.S. economy?

Nick:
Yeah. That’s a great question. The Federal Reserve is a bank for banks. That’s the easiest way to think about it. So they set the price of overnight money. That is their short-term interest rate. So whenever you hear about a Fed meeting and they decided to move up their interest rate, they’re deciding to set the overnight price of money either they’re raising interest rates because they want to try to slow down the economy or they’re cutting interest rates because they want to provide more stimulus. And that’s the ballgame for the Fed.
They have two goals assigned to them by Congress, which is to maintain stable prices and to have maximum employment. And you could think of that as the most employment possible without having inflation. And those are their two goals. And then in addition to all of that, they’re charged with regulating the banking sector. Again, think of a bank for banks. They are there to make sure the banks don’t turn themselves casinos.

David:
And when you say one of their responsibilities is stable pricing, what you mean by that is controlling inflation.

Nick:
Yeah. Having mild inflation for a long time, the Fed didn’t say exactly how they defined that price stability objective. And then about 10 years ago, they formally set a 2% target for inflation. The idea behind 2% was you wouldn’t want it to be zero because you maybe get too close to deflation.
Central bankers are very nervous about having negative prices because that’s a very hard problem to solve. So they set 2% as target. And until last year they had managed to keep inflation right around 2%. And so that is their price stability objective.

David:
Great. Thank you for that background. And think it’s a super important point that people know that the Federal Government or the Federal Reserve, I should say does target some inflation because does stimulate the economy and get people to spend their money, which is something that we should all aspire to. I do want to jump into the state of affairs today, but I think it’s helpful for our listeners to understand the context of the Federal Reserve’s policy over the last, as far back as you think is relevant, but specific since the great recession.
It seems like the Fed has really shifted their policy and their approach to managing the economy over the last 15 or so years. And we’d love for you, just some overview for our listeners on what exactly the Fed’s been up to since the great recession.

Nick:
Yeah. The great recession was a seismic shift in both what we learned about the economy, but also global interest rates. So global interest rates had been drifting lower even before the 2008 financial crisis. And afterwards you saw not just in the U.S. but around the world interest rates at a much lower level. And when central banks tried to raise interest rates in large developed economies, Europe would be the best example. It actually created problems. And Europe had another recession in 2011, 2012 after the European central bank raised interest rates in 2011.
So what we’ve seen over the past 15 years is we moved into a world of lower growth and lower inflation and lower interest rates. And that was a big concern for the Fed because after the financial crisis, they cut rates to zero and they are not really interested in having negative interest rates. They don’t think it would work very well. They think the costs of having negative interest rates would outweigh the benefits. So for all intents and purposes, zero is as low as the Fed will go. They call it the effective lower bound for interest rates.
And so the reason that zero interest rates were such a concern for the Fed is if you get hit with another shock, if you have another downturn and you’ve already cut your main tool for providing stimulus to its lower bound, there isn’t as much for you to do to stimulate growth. And that animated a lot of the Fed’s policy decision over the ensuing years, you hear sometimes about QE or quantitative easing, which is really just a fancy way for saying bond purchases. When you’ve cut interest rates to zero, what Ben Bernanke decided to do in 2010, ’11, ’12 was, well, you can still bring interest rates down for longer dated securities.
So as I said before, the Fed sets the price of overnight money, short-term interest rates, but the market determines five year treasury yields, 10 year treasury yields, and the Fed decided to try to influence longer term yields to provide even more stimulus by purchasing treasury securities and mortgage back securities. So that became a second tool for providing stimulus in the Fed’s toolkit. They had interest rates that they could move up and down and once they got to zero, they couldn’t move them down. So they began to increase their asset holdings, their purchases of treasury and mortgage-backed securities to provide more stimulus.
Then in 2017, when they began to raise interest rates and tide policy, they were both raising interest rates and reducing the size of their asset holdings to remove accommodation from the economy.

David:
So just to summarize that after the great recession, the Federal Reserve lowered their target interest rate, which is a short-term rate down to near zero and stayed there for a long time. But in addition to that, I believe correct me if I’m wrong, Nick, this was the first time the Federal Reserve did quantitative easing, which was buying bonds and mortgage-backed securities to help lower those longer term rates in the market.
And both of those combined to create a, what I believe looks like in retrospect, a very powerful stimulus for the economy that has in my mind, this is just opinion, driven a lot of the asset appreciation and boom in the economy over the last 10 to 15 years.

Nick:
Yeah. That’s right. That was what they did. And there’s a big debate about how effective quantitative easing was. Some people say it didn’t really do what the Fed said it was going to do, it didn’t boost growth all that much. We still had around 2% growth last decade. But you’re right, when you lower long-term yields, when you make it cheaper to borrow, you make asset prices rise homes that you buy with debt when the mortgage rate goes from 5% to 3%, which is what happened over the last decade, home prices rose. And so you did see significant increases in asset prices over the last decade.
I should note that there were predictions 10 years ago that all these debt purchases were going to lead to consumer price inflation too, which is what the Fed actually cares about. This was going to debase the currency. And you didn’t see that during the period before the pandemic, you never really saw inflation get up to the Fed’s 2% target. And so the Fed’s concern heading into 2019 and 2020 was actually gee, we raised interest rates to two and a half percent by 2018. And we were shrinking our balance sheet, shrinking our asset holdings because we thought as the unemployment rate fell, you would see more resource scarcity across the economy that would drive inflation up.
And that didn’t happen. So the Fed’s concern became something that sounds crazy today, which was, wow, we may not have enough inflation if we provided all this stimulus. And when we took it away, we still didn’t really get prices up to our 2% goal. The Fed became concerned that the same trap that appeared to have hit Japan 25 years ago and Europe over the past decade, those were economies with rates effectively stuck at zero or negative interest rates and large debt purchases by the bank of Japan, for example.
And so the concern was, while they’re stuck with of this liquidity trap, we really don’t want that to happen. The next time a downturn hits that could be us. And so let’s think about ways where we could actually change our policy framework to see if we could get even more inflation, not because inflation is a good thing, or we want inflation for inflation’s sake, but because we want to actually provide error on the side of providing more stimulus and then next downturn, so that we don’t end up in that low growth, low inflation trap that you see in Europe and Japan.

David:
James, I’m curious to hear how you lived through this, because you were an investor back in 2008, unfortunately. How did the impact of Fed policy and lowering of interest rates following the housing collapse impact your business since then?

James:
I guess I was unfortunate to be involved in real estate during that time, but I was actually really fortunate too, because I learned so many valuable lessons as a real estate investor in about banking in general. Like back before 2008, I was more of a deal guy. And then after the financial meltdown, I became more of a banker guy because I really realized that I had to pay attention to outside influences. But in 2008, I remember when subprime mortgage that product got taken away, when it stopped coming out, I think it was July of 2008 if I remember right.
And once that was notified what it was, it was more based on term than rate at that time. It was that people had to provide more income and not just stated and really put proof behind their qualification. And then that’s what caused the big bump in the crash. And then the recovery process, it felt a lot slower. And I had a question for Nick was rates were at zero or near zero at that time, but we didn’t see that asset inflation like we’re seeing now. And as a real estate investor, I’m always watching rates going, okay, where are they going to be at? How is that going to affect affordability?
What is that going to do to people’s payments and whether they can actually purchase this product. But what has thrown me off is back in the recovery stage, we were at next to zero and we saw steady growth and it was this very slow recovery from 2009 to ’11 to where a lot of things were stagnant in real estate. There was things starting to recover and move up, but it wasn’t jumping. And right now we’re seeing the complete opposite where we’re at zero and we’re seeing appreciation at 10, 20% in quarters in certain real estate sectors. And that’s what has thrown me off so much. We’ve done similar process besides I guess the amount of money that they got put into the market.
I think in the recession, what they put what? 100, or no, 500 billion, or it was around 500 billion. Whereas this time we’re actually five trillion. Is that the big difference in why we’re seeing that asset inflation too compared to… Because the recovery seems a lot different than it did in 2008.

Nick:
It’s a totally different recovery. I mean, it was a totally different crisis too. So before I covered the Fed, I covered the housing markets and the GSCs, Fannie Mae, Freddie Mac. And so I remember well that time and the big differences is, well, I’ll give you two of them. One is demographics. If you look at where we are today, the millennials, the children of the baby boomers are coming of age. These are 30 year olds who are buying their first homes or even trading up and you didn’t have that 12 years ago. Instead, you were at a different place demographically, so you didn’t have the same demand tailwinds.
And then you just 2009, ’10, ’11, the Fed cuts interest rates and interest rates are very low. You have mortgage rates falling below 5% for really the first time since the 1950s mortgage rates falling below 4% at one point and people are going, “Oh, my goodness, we’ve never seen…” I mean, we were having to look up. When was the last time you could get 30 year mortgage money for below 4%. And you’re going back to like the 1950s and some of those FHA programs, but you had a boatload of foreclosed properties, real estate owned properties being released by the mortgage service.
And you had people that had… They were underwater on their properties. They owed more than their homes were worth. And so it had frozen people in place. You had high unemployment, 10% unemployment when people are losing their jobs, they’re not paying their mortgages. And so the demand side was completely different and supply side was different too. You had an overhang of properties, especially in Phoenix, Tampa, Las Vegas, Inland Empire of Southern California. Let’s fast forward to the downturn that we had in 2020. And we go into the lockdowns and all of a sudden people decide, “Hey, I want a bigger house.
I want a house that has an extra office, because my kids are downstairs making so much noise and I’m working from home.” So we’ve gone through potentially a change in lifestyle preferences before the downturn in 2020 people who were living in cities, you heard all about this, sharing economy, people weren’t going to buy cars. They were going to Uber everywhere and they didn’t want to own a house. They were going to rent an Airbnb. And now you go through the downturn and you have millennials coming of age and deciding, “Hey, you know what? Actually home ownership doesn’t seem like a terrible thing after all.”
And so yeah, now we’re talking about 20% annual home price growth. And you look at the case chiller home price charts and it makes the 2006, ’07 boom, look like a little blip now because what we’ve gone through over the last two years is just so much home price appreciation.

James:
Yeah. And then one question I do have is, so in our recovery back in 2009, like I remember we were getting rates around, like for investment property, we’re like four and a half percent to 4.75. That was where we were getting our refis done at. So the Fed’s at zero now too, but then we were starting to lock rates in the low fours or high threes. So why is there such a huge swing in the interest now versus the recovery rate of 2011? Because the Fed was still at zero, but the rates were about a point higher back in 2011 when we were at least locking at rates.

Nick:
Are those for investment properties?

James:
It’s for investment, but even on owner occupied, I think back then it was still high threes for… If you got really lucky, you were getting high threes and then in this last recovery, we were, I mean, people are locking rates at 2.75 or even lower. And that’s what I don’t really understand, where’s the movement of a point in that, because that makes a huge difference and the Fed still remains at zero.

Nick:
Well, so that’s true. I mean, I think you had interest rates fall into the high twos in 2020 and may have hung out there in 2021. What you’re seeing now though, I mean, if you’ve been in the mortgage market in the last few weeks, you see how things are changing. And so the Fed, one argument is well with inflation at 8%, why is the Fed only raising rates by 25 basis points, by a quarter percentage point? That doesn’t add up. But if you look at their communications since January, where they’ve said, we’re going to raise rates and we’re going to raise rates rapidly, Lael Brainard, the incoming vice chair of the Fed says, “We’re going to raise rates expeditiously and we’re going to shrink the balance sheet rapidly.”
All of that communication is intentional and it’s because the Feds policy, they don’t just raise interest rates when they meet, they raise interest rates when they talk. And this is a very clear example of that. They are telling the market, they are telling bond investors, we plan to take interest rates up this year, maybe to 2%, maybe above 2%. And the bond market is already pricing that in. And so that’s why you’ve seen mortgage rates, the 30 or fixed rate mortgage. You look at the MBA weekly survey, we’re closing in on a 5% mortgage rate and we were at three and a half percent just three months ago.
So that is a huge change. You have not seen that kind of a movement in a 30 year mortgage rate since maybe 2004, maybe 1994. And that dramatic repricing of the interest rate curve is directly because what Fed officials are saying they’re planning to do right now, even though, if you look up the Fed funds rate, it’s sitting in that range between a quarter and a half percentage point.

David:
That’s a great point, Nick. And I just want to jump in and provide a point of clarity for our listeners, because as you said earlier, the Fed Reserves, one of their main tools is controlling the short-term overnight interest rates, basically their target fund rate. They don’t actually control mortgage rates. What has a stronger correlation to mortgage rates than even the Feds interest rates is the yield on the 10 Year U.S. Treasury.
And although the Federal Reserves activity does impact the bond markets, I think the difference, James, when we talk about what was happening in the last recovery in this recovery is that bond yields were actually in a very different place. And bond yields were a lot lower in this recovery than they were and is probably why we’re seeing that big difference in mortgage rates.

Nick:
That’s absolutely right. And when the Fed launched their third round of bond buying in 2012, it was called QE3. It was the third round of quantitative easing. You saw the 10 Year Treasury sitting at 3%, 4%. And Fed officials are saying, looking there saying that’s too high. We want to get that down. The whole idea behind the bond purchases was to really bring that down. And I think what happened by 2019, 2020, when the pandemic hit, bond investors had priced in that new Fed, it’s called a reaction function. It’s really how you expect the Fed to react to changes in the market. And people now knew what the Fed’s emergency reaction function was.
It was to try to get the 10 year yield down. And so even before the Fed began to buy by treasury securities with their asset purchases in March of 2020, you saw the 10 year yield drop to 0.5% record low. And that also helped bring down mortgage rates. And then the Fed in this crisis, they were also buying much larger quantities of mortgage-backed securities. So even though mortgages tend to price off of the 10 Year Treasury the Fed was actively buying MBS. They now own 31% of all of Fannie, Freddie, Jenny May paper. Those are government backed MBSs. They own 31% of that’s much higher than was the case after the 2008 crisis.

David:
So can we fast forward Nick to where we are today? We just hinted at it a little bit. The Fed has started raising their target rate and has signaled that they’re going to continue to do that, but can you just give us a backdrop about what the Fed is thinking right now and where you think they’re going over the next couple of months?

Nick:
It’s pretty simple. The Fed thinks inflation is too high. And some people might say, “Well, duh, where were you last year Federal Reserve? Where were JJ Powell last year?” But what happened last year was we were coming out of the pandemic and there was a view that the prices that were rising the most were in these supply constrained categories, airfares, used cars, the rental car fleets have liquidated during the pandemic. And then they had to go replenish last year. And so they bought used cars at auction that sent used car prices up. You have chip shortages. So new car production can’t keep up, prices go even higher.
And so for a while, of course, the Fed infamously said, and a lot of private sector economists agreed that this was transitory. The idea behind that was that inflation was really driven by the pandemic. And assuming the pandemic was over with quickly, inflation would be too. Where we are today, that hasn’t been what happened you saw, especially in the last part of 2021, the labor market tied in rapidly. And the Fed pays a lot of attention to that because what they really are focused on is underlying inflation. They call it the persistence of inflation. And the most persistent inflation items are labor intensive services.
Think about getting your haircut or going to the bar where the main price of what you’re paying for is labor. So if wages are rising because the labor market’s tight, that is not transitory inflation. And that is inflation that is very hard to reverse once it starts. And then course rents are another big example of persistent inflation. When the economy’s booming, when people have jobs, they’re forming households, they’re willing to pay more for housing. And housing’s obviously, badly supply constraint in a lot of the places where people want to live. So what happened last year was the Fed decides, “We think this is transitory, we’re going to ride this out. We’re going to be patient.”
By the end of the year, Powell, abandons that he says, “We still think prices are going to come down. You don’t think prices of used cars can continue to go up 40% year after year, but the labor market’s probably getting really tight.” And now he says, he thinks the labor market is overheating. He at the last Fed press conference in March said the labor market is tight to an unhealthy level, which my jaw was on the floor when he said that, because this is somebody who all through 2021 was talking about having a really strong labor market recovery and saying that you think the market is now unhealthy to sign that maybe we’ve gone past the point of full employment.
And the Fed doesn’t want to be in a place where they’re having to raise interest rates to create unemployment. The way you create slack in the market is you actually throw people out of work. And that almost always actually strike almost that always has led to a recession. Whenever the unemployment rate rises by a little bit, it goes up by a lot. So where we are now is the Fed is worried. They’re worried that one year of high inflation is okay, but if we have a second year of that, people are going to begin to build expectations of higher prices into their wage setting and price setting behaviors. And that psychology is something the Fed really strongly wants to avoid.
And that was where we were up until February war in Ukraine, energy prices going up, commodity prices going up, supply chain, which you thought was going to get better by maybe the spring not going to get better this spring. And so that’s why you now see a Fed that is very determined as signal, let’s get to a neutral interest rate. A neutral interest rate is the level the Fed thinks isn’t providing any stimulus to the economy. If you think of the economy as a car and the Fed is the driver, they’re taking their foot off the gas. They’re not pushing on the brake, but they’re trying to find that place where they’re no longer pushing on the gas, not necessarily stepping on the brake.
And the big question for interest rates over the next 12 to 18 months is, does the Fed decide we need interest rates above neutral because we need to step on the brake. We need to slow this thing down because it’s just going too fast.

James:
Do you think that as the Fed starts to change the rates and slow this down, which I do think needs to happen. I mean, assets are going up. Costs are out of control right now. At least I know like for us we do a lot of renovation. We do a lot of home improvements. Those costs are at least at 20% above where it was before. And a lot of that isn’t just materials, it is labor. Like guys want more money. They have to pay more for fuel. There’s more demand. And so they can charge more. Do you think that these reactionary things, there’s two things that are going to come out of this as rates go up, affordability’s going to come down. And like you said, slow down the economy in the wages, but how high do you think they need to go to slow this down?
Because if I’m looking at this as an investor, like even the other day I was buying a property less than 30 days ago, I locked in a rate that was like 4.45. I had to switch the structure and go to a reverse. And now I have to refi it. And now my new rate in 30 days is at 5.6, which is a difference of $800 in that rental property I was buying, which is a huge compression on your margins in a very short amount of time. I mean, just doing that on that one specific example, that can be painful. And if it keeps going up quickly and if they’re going to keep rising this, I mean, do you think they have to keep compressing these things to slow down the labor market? And how hard do you think they have to go?

Nick:
I mean, that’s the million $64,000, whatever you want to call it question right now. How high does the Fed have to go? So, let’s step back. What is inflation? Inflation is supply and demand out of balance. That’s what we have here or supply and demand are just out of balance. Last year, the Fed thought it was mostly supply, supply chain bottlenecks, people not wanting to work because they are concerned about COVID or they have a lot of money socked away. So they’ll retire early. Now, it’s clear that, that isn’t the case. It is strong demand. You have a lot of demand. You have more people working, making more money, spending money on things. You have had a shift of spending towards goods away from services and the supply chain couldn’t handle that. So you had extreme price, increases.
To get to your question, now how high will interest rates have to go? The Fed can’t do a lot in the near term about the supply side of the economy. They can’t create more oil, they can’t create more houses, their tools just don’t do that. So when they talk about bringing supply and demand into balance, they either need to get lucky, they need to get supply chains moving again. People who are not in the labor force coming back to work, those are not things they can control. So they are hoping to get help from the supply side of the economy. But if they do not, then they have to throttle back demand. They will have to reduce demand to bring supply into balance.
So how high will interest rates have to go? It really depends on how much help do they get in the next two quarters from the supply side. If they do get that help, if used car prices come down and you begin to see inflation come down, because that was such a big contributor to inflation last year, then maybe they won’t have to raise interest rates very much above again, an estimate of neutral. There’s another question there about what is a neutral interest rate? The Fed, when they submit their projections every quarter, this is called the dot plot. It’s a grid that shows where all of the participants at the Fed meetings think interest rates are going to be at the end of this year or the end of next year, the year after that.
They also project where they think interest rates should be over the long run. And that interest rate has been between two and 3%. So we could take that as the estimate of neutral, but that estimate assumes that inflation is at 2%. So a nominal neutral rate of two to 3%, assuming inflation’s at 2%, if inflation ends up at a higher level, let’s say 3%, then to get that neutral rate, you’re actually talking about a higher interest rate. You have to get interest rates up to three or 4%. And so, this depends on a lot of things that are out of the Fed’s control. How far does inflation come down?
How quickly does inflation come down and do you see expectations of future inflation becoming, the Fed calls us [inaudible 00:31:01] where people expect per prices to be higher. If they get the good story, the positive story, people come back to the labor force, wages come off the boil, the supply chain heals, you don’t see inflation spreading out into the service sector, then they may not have to raise interest rates very much. Maybe they get up to their most recent projection so they’d get interest rates up to just below 3% by the end of next year. And then hang out there for a while. That’s the optimistic scenario.
The other scenario is interest rates go much higher than markets are expecting much higher than we’ve seen since before the 2008 financial crisis. The Fed fund rate in 2006, peaked at five and a quarter percent. So, that’s much higher than anybody has on their radar screen right now. And there’s a risk. The Fed will go there because I’m not saying 5%, but above the 3%, high end estimate of neutral because either they have to chase inflation down or they can’t actually tide in policy because they would want to raise interest rates above the inflation rate to actually slow down demand.

David:
That’s super helpful. And just to clarify for everyone, the way that the Fed slows down demand is by raising interest rates, but people are less likely to borrow, their less incentivized to borrow. It’s not as easy for them to go out and buy a new car or a new house, for example. And so fewer people are getting into those markets for those goods and services, just to make sure everyone understands that.

Nick:
And also businesses hire fewer workers. And so people have less overall income. And so they don’t spend as much money.

David:
Nick, one thing I wanted to ask you about is asset prices because when we talk about inflation in the way that the Federal Reserve defines it is the most common is consumer pricing index, which measures things like energy prices and food and rent. What it does not factor in are prices of homes for example, and stock prices or cryptocurrencies. And I personally believe that a lot of the reasons all three of those markets are taking off is because interest rates are so low and people can borrow to buy a house or people are even borrowing to buy stock or crypto right now.
How much does the Fed care about asset inflation? Is that factored into this tight rope walk that they’re doing right now between a recession and lowering inflation, or is this something that is out of their purview?

Nick:
It’s definitely something they pay attention to and you’re right, it isn’t something that goes into the consumer price basket. So they’re not measuring, if the price to buy a house goes up by 20% where you live in, say Las Vegas, that isn’t getting factored into their inflation radar screen. The statistical agencies that measure prices and the Fed relies on these agencies, they look at the caring cost of a house, the monthly payment you would pay either to rent the house that you own, or if you’re renting a house from a landlord, how much do you pay in rent? Because that’s how much you’re actually spend out of pocket for the consumption of that housing service.
Now, the main way in which asset prices are on their radar screen, I said that there are two mandates the Fed has, which is price stability, or inflation and employment. But they also have a silent third mandate, which is the stability of the financial system. And it’s through their supervision of that stable financial system where asset prices come to bear. Now, there’s been a big debate over the last 10 years, which is, should the Fed raise interest rates even if inflations contained and even if they’re meeting their mandate unemployment, but to prick a bubble? Because an asset bubble could jeopardize their ability to achieve both of their other goals. And the argument has generally been, no, we shouldn’t use interest rates. We shouldn’t raise interest rates to prick asset bubbles.
We should use other tools, primarily regulatory tools to do that. The Fed can do that by issuing guidance to banks, for example, saying, “If you’re going to make leveraged loans to corporate borrowers, you have to hold more capital.” But there aren’t that many of these regulatory tools available to them. It’s not like they can go say to the regulator that oversees Fannie Mae and Freddie Mac, “Hey, charge more for mortgages right now. Raise the loan level prices that Fannie Mae and Freddie Mac charge in the secondary market because we think there’s a housing bubble.” They can’t do that. So, if we were in an environment where inflation was low, but asset prices were booming, I think we would be hearing a lot more about, “Well, gee, shouldn’t the Fed be raising interest rates to deal with this asset price boom?”
It’s a moot issue here in 2022, because inflation is a problem. And the Fed has said that. I mean, if you look at the title of J Powell’s last speech, it was, restoring price stability. That’s a pretty bold title. He’s basically saying we do not have price stability. And so when the Fed is saying, they’re going to raise interest rates to get inflation down, there’s a happy coincidence that’s also going to go after an asset price boom, if we’re having one, but to your point, Dave, if we were in the environment we were in say 2018 or 2019 before the pandemic hit, where the Feds saying, “Gee, we don’t really think we need to raise interest rates anymore because inflations contained, but you saw crypto and housing and all these other things off for the races then you’d probably have a bigger debate right now over how to deal with that.”

David:
Thank you. That’s a super helpful explanation because I think so many people I talk to say like real inflation is higher than even 7% or 8%. And it really just depends on how you measure it. The Fed, as we’ve learned today, their mandate is to control price stability or, how did you say it? It was price stability?

Nick:
Yeah. To have stable prices.

David:
Yeah. So they want to do that for goods and services. It is not officially in their purview to control asset prices, but thank you for explaining that. It sounds like they do have this debate at least internally about how they should do that. Sounds like interest rates aren’t the right way to do that. But perhaps their regulatory means they can try and control that. Before we wrap this up, Nick, for any real estate investors. Investors, anyone listening to this who like, I think James and I love paying attention to this stuff.
What should they be paying attention to over the next couple months in terms of Fed policy and how can they read into the news that’s coming out to help plan their own investing and financial decisions?

Nick:
Before this crisis, the big data point that everybody watched to see is the Fed going to raise interest rates at the next meeting was the jobs report. So the first Friday of every month at 8:30, the labor department issues the job support and people would say, “Oh, if hiring’s really strong, the Fed will feel like they can raise interest rates.” If you want to understand over the next few months what’s going to happen, then pay attention to the monthly inflation report. The CPI report, which comes out usually around the 10th day of every month. And the reason that’s important is because the Fed is looking to see whether the month over month pays of inflation slows. They measure this, looking at the 12 month figure the year over year, but pretty soon here, beginning next month, a year ago, inflation began to rise.
So the comparisons are going to get flattered because you’d have to have much higher inflation to have the year over year number go up. So the year over year number probably after this next report, which will be a high one because of the energy increase from the war in Ukraine. The year over year number may not be as important. But look at the month over month number, for the Fed to be hitting a 2% inflation target, or even getting inflation down to 3%, they would want to see something closer to a two tenths to three tenths of a point increase in inflation, or less than that. Less than that would be great if it was 0% for a month that would be very reassuring to the Fed. They would want to see that. If on the other hand, you continue to see where it’s been a five tenths, six tenths of a percentage point month over month increase in inflation, that is not at all consistent with what they want.
That’s consistent with a 6% annual inflation rate or even higher. And so if you really want to understand what’s happening for the Fed for the next few months, I would say, obviously pay attention to what they say. They mean what they say. When the Fed chair and the vice chair in waiting say that they plan to expeditiously raise interest rates, when they say that they want to get interest rates as fast as they can back to a neutral level, that means they’re going to 2%, at least unless something in the economy breaks and something in the financial markets break and then they’d have to decide how they manage that. So listen to that, but also look at the monthly inflation numbers, because I think that’s going to be where the most near term information is going to come on how comfortable or panicked they feel about where the economy is right now.

James:
Curious to know, what do you mean by something in the economy breaks? Is that like a housing bubble pop or is that a stock market or-

Nick:
Yeah. It would be, if you saw signs of dysfunction in the financial markets, then that would be… I don’t know how they would address that, but that’s what they’re trying to avoid. What they’re trying to do right now is they refer to as tightening financial conditions, which means they want to see the cost of borrowing increase. That means stock prices coming down. It takes some of the froth out of the economy, but they don’t want that to happen in a disorderly manner. So sometimes you think about going up the stairs, going down by the elevator. Well, they like to go down by the stairs here. If you have big discontinuous drops then that would be concerning. And I’m not at all suggesting that would be enough to throw them off their track right now of raising interest rates.
But so long as that doesn’t happen, they will feel like they have a green light to raise interest rates. And remember, many interest rate increases this year. So the market is already pricing in a half point increase at the May meeting. The market is already pricing in a half point increase at the June meeting. As we get closer to those meetings, if the market is saying, we’re expecting this, then that’s an open door and the Fed will take it. They will walk through that door. All of this is happening in a way that isn’t really disrupting economic growth. Yes, you’re seeing the housing market slow and you’ll probably continue to see the housing more slow, but that’s what the Fed wants when they raise interest rates.
They want activity to cool, they want to remove some of that excess demand that you have right now. And so if you’re in situations where homes that used to be getting 10 or 30 offers are now getting three or four, for the Fed, that’s probably a healthy development.

David:
Nick, this has been an incredible interview and you are such a wealth of information. And I’m so grateful to have you on, I’m already dreaming about inviting you back on sometime in the near future, but we do have to go, this is-

Nick:
Thank you.

David:
We can’t do it all day as much as I would probably love to. But before we do, I’d love to hear about your book. I know you just released book recently called Trillion Dollar Triage. Can you tell us about it?

Nick:
Yeah. Trillion Dollar Triage is about how the Fed managed through the pandemic. And so if you want to understand J Powell and how he operates, if you want to understand better what the Fed did and why they did it, you should check out this book. Basically, in the second and the third weeks of March of 2020, we had a financial crisis, a full blown crisis. There was a run on the treasury market. This is the most important market in all of global finance. And it was melting down. It was melting down because there was a dash for dollars, businesses didn’t know how to manage through a pandemic, everybody in the world wanted to get their hands on dollars.
And so the Feds stepped in a very big way, and they avoided another 2008 episode. Of course, 2021 ended up being a very different story. And they were reluctant to pull back on their support. There was much more fiscal stimulus than they anticipated. And so that’s where we are now with high inflation. But if you will want to understand the Fed and how they think and why they made the decisions they made, then you should check out Trillion Dollar Triage.

David:
I know James bought it already. And I started reading it too, because we’re both nerds and love this stuff, but it’s not just being a nerd. Honestly, if you want to be a informed investor, understanding the Fed, which controls one of the, if not the single most important financial lever in the global economy is a wise thing to understand how they operate, what their mandate is, and how they’re thinking about fiscal policy in the current day and age.
Nick, before we get out of here, is there anywhere if our listeners want to reach out to you or connect with you anywhere they can do that?

Nick:
Well, you can follow me on Twitter @NickTimiraos. I tweet fairly often. You can also email me at nick.timiraos, T-I-M-I-R-A-O-S @wsj.com. I’m always happy to respond to readers and then you can check out the book on my website, nicktimiraos.com.

David:
All right. Thank you. I think I’m going to be emailing you a lot.

Nick:
Thanks so much for having me, Dave and James. I really appreciate your time.

James:
Yeah. You might be getting some late night questions.

Nick:
I’ll take them at all hours.

James:
All right. 1:00 AM it is.

David:
All right. Thanks, Nick. I mean, whoa, that was awesome, right?

James:
Yeah. I think that guy is on a whole nother level of understanding money.

David:
I mean, I have a lot of thoughts about how what this means for the housing market and for real estate investors, but I’m curious to hear your take. What are you thinking right now?

James:
Well, when I was listening to him talk and what he was saying is… How I got the summary was that we have some stuff coming our way and we need to get really lucky. When he said, we need to get a little bit lucky to make this pull off right, I started to get and very concerned because right now what I’m seeing in the world it’s not really the best climate for luck. We got a war going on, we got supply chain issues. And so, I think how I took that was we need to anticipate as investors to make some changes and anticipate more expensive money.
And as a real estate investor, it doesn’t really matter how much money costs. You just have to make the adjustments for it. Whether it’s 3% or 5%, I still need to make sure my cashflow numbers work the same way. And if it’s at 5%, I just need to buy a little bit different and look at different products. But I mean, that definitely, he gave a lot of signs of what you should be preparing and for as a real estate investor.

David:
Yeah, man. That part worried me a lot too. He just put it in a really simple way that made me realize that we don’t have a good line of sight on the end of this thing. I was originally thinking, you look at the dot plot and Fed reserve notes. You’re like, okay, mortgage rates will top out at 5%. And now I’m saying, okay, five and a half percent. Now it might be 6% at the end of the year. And unless things start turning around in terms of inflation soon, I don’t think we’re going above like seven or 8% anytime soon, but I think we have to recognize that we might be in for a long ride with rising interest rates here, which is concerning in some regard.
But again, like you said, I don’t think it necessarily would make me stop investing in real estate. It just changes Europe approach. So, I mean, I know that we just had this interview, but how would you think about adjusting your approach given this information?

James:
Yeah, I mean, there’s lots of things that you need to prepare for when you have a volatile market and money. I mean, because what I did learn from the 2008 crash was access to money is the, I mean that is the difference maker in everything, housing, stocks, economy growth, and as they slow the access to money or make it more expensive, you have to just make sure that you’re running your numbers off today’s numbers and anticipate that your performer numbers are going to change. So as I’m looking at buying even value ad there’s two major value ads that we do, it’s a fix and flip and then it’s also a burst style or holdings where we’re going out or buying it and then refining into a conforming loan after we add the value.
So what we’ve done is for preparing and we started doing this about a month ago, because I was getting really concerned with rates rising is we’re just adjusting our exit rates. So if we’re going and looking at a property, we’re not looking at the now rate of going, okay, this is at 4.65. We’re naturally adding a point to our exit on everything. We’re adding 10% to our construction budgets because as costs keep soaring up and everything that the Fed and even that Nick were saying was, they’re not anticipating this to slow down and it’s going to need more of a harder reaction, which is going to cause a jolt in the market, but you just have to adjust as long as your backend numbers are where it needs to be, then that’s where it’s okay.
And so like on a fix and flip, we’re not going to the high end of the comps anymore, or we’re targeting areas that have more liquidity of money in the market to where it’s less impactful to have interest rates or the interest rates will impact those buyers less. But I think the last 24 months have been unreal for investors. People have gotten really used to winning 100% of the time. And what you have to do is slow down, go back to our 2010 to 2012 model and just go off the numbers. Does this return make sense for what I’m trying to achieve? Does it make sense with the high money? And don’t forget to build these costs in. Build in inflation in your construction, build in higher rates as you look at acquiring and stabilizing that asset.

David:
That’s super good advice. I think we’ve seen for years the mantra at bigger pockets and a lot of people I hear was about cashflow and not focusing on appreciation. And personally, I always thought that at least over the last five years, that was a little misguided because appreciation has just been so strong that you could basically count on appreciation for the last couple of years. That to me now has changed. And I think it sounds like you assume the same thing is that I’ve been one of the biggest proponents of investing for inflation of the last couple years, but with all of this rising interest rates, it seems like demand is really going to start falling off.
I mean, I think that we’ll start to see first time home buyers who are, especially, you said this in our first episode, especially the lower end around the median home price are probably very interest rates sensitive and price sensitive, and we’re probably going to see some demand start falling off. And to me that means we might see housing prices start to flatten out in the next couple of months. Do you think that’s possible?

James:
Yeah, no. I think it’s definitely coming and it’s actually happening right now. We’re seeing that. We do a lot of transactions up in Washington, so we’re in all different markets. We’re in the median home pricing, we’re in the luxury market and we can see where the movement is. We do about three to 400 listings a year. So I can always gauge it. And the number one thing that I’m always looking at is what’s the showing activity. How many bodies are coming through these price points because that’s telling me the demand. Not the pending on, it’s not the so comps. I want to know who’s coming through. And I mean, there’s an area in Washington, it’s a city Bethel. It’s just north of Bellevue.
It’s gotten a lot of appreciation because of how expensive Bellevue went. Bellevue appreciated at 72% last year. And so it’s naturally sent Bethel to the roof as well. But in the last two weeks we had four listings. Four weeks ago, we were averaging about 30 to 40 showings a weekend on that property. This last week, we’re down to four. That is a huge, huge follow up-

David:
Wow. Oh, my God. Jesus.

James:
But we’re still selling the homes. And so what I don’t think in certain markets, we’re going to see much depreciation. I think we’re going to see flattening out, which for an investor, that’s actually a good thing. Investing in highly erratic markets can be very risky. You get a lot of reward, but there’s also a lot of risk. And so now, as you’re looking at any kind of potential investment, at least when I’m looking at, I’m going, where’s the money at? Where’s this stability? Where’s the good paying jobs? Because those jobs are not going to be paying them less inflation could make it feel like it’s less, but the affordability should still be in that kind of factor range.
And we’re still selling those product. But in that first time home buyer range or the median home price range, those buyers are drastically affected by interest rates. Like even what we were talking about earlier, I had a loan that went up a point that cost me $800 a month. That’s a huge expense on that loan that I just completed. And so I do think you got cost of inflation energy’s up, and it’s really going to beat up that first time home buyer where they’re really constraint on their pricing already because they’re getting eaten by fuel, energy cost in general. Now housing costs is up and now the money is getting more expensive.
It’s going to bring that market down a little bit. And the general is one point equals 10% affordability. As you’re looking at any kind of investment, if you think it’s going to go up a point and you’re looking at the analysis, you can bring your value down five, 10% to offset that a little bit.

David:
Yeah. It’s a super interesting point that about the flattening out and that being actually potentially a good thing for investors, because I think a lot of people generally believe investors love this runaway housing market. Personally, I don’t. I would much rather see a market where we see three or 4% annual appreciation. It’s just a healthier market in my mind. It’s more predictable. I have a hard time, I think everyone does figuring out what’s going to happen in this market where we’re seeing unprecedented levels of growth. And for me, one of the things that could be a positive benefit of this and listen, there aren’t many right now. The there’s a lot of crazy things going on in the economy.
But the prospects of cashflow could improve nationwide in this type of scenario. Like if housing prices flatten out, but rent prices keep growing because wages are going up. And because generally because of inflation that could create a better cashflow market for investors, because they’re going to be getting more, the rent to price ratios, I should say, could potentially increase nationwide.

James:
Yeah. And I think it will, I mean, home pricing has gotten so high and I mean, we’ve seen pretty major rent growth. I mean, I think our rent portfolio is like up 25% from last year on rent hikes. It was just this set because rent were also so low for so long in our local area compared to what people the income bracket that they’re in. And so we saw this massive jump and I still think it’s going to climb pretty high towards the end of the year. But again, I think that’s going to flatten now too towards the end of the year, because we’ve had these sudden hockey sticks in appreciation, rent growth. And in my opinion, anytime there’s a hockey stick, there’s something coming down the backside.
Like there’s going to be some sort of correction and that’s okay to work in inside that model, especially… I mean, I agree with what you’re saying, like a more consistent market is a much better place for you to invest in. This last two years I think have been great for income. Everybody’s been making more income especially on their fix and flip, they’re getting more fees and generation, but where I’ve always done well with wealth is in a normal market. We obtain more real estate wealth during 2010 to ’14, not just because pricing was low it’s because we could act logically like, is this the right thing to buy? I don’t have 40 other offers coming in. I can think about it.
I can put the right plan on it and then really choose whether you can put it in your portfolio rather than just taking whatever’s there. And a lot of us are just taking whatever’s there right now because there’s nothing around. And so it really allows you to buy what you want, know your numbers and walk in and put together a good plan on it. So I’m looking forward to the market cooling down, if it does.

David:
All right. Well, this has been an awesome conversation. I have been very eagerly awaited talking to Nick and really appreciate your opinion and context here James, on the housing market. So if anyone has any other thoughts, you can hit up Nick, you can find me on Instagram @thedatadeli. James, where should people reach out to you if they want to talk to you about this?

James:
The best place probably Instagram, check me out @jdainflips. And we’re always putting now more and more information just to stay ahead of the curve.

David:
Dude your content has been great recently.

James:
I know. We got a great team and we got a lot of things going on. Yeah. Now, especially with all the inflation battling that’s been easy content to create.

David:
Good. Well, check it out on Instagram. Thank you guys so much for watching this episode of On The Market. We will be back next week where we’re going to be talking all about in inflation. So definitely check that out, because real estate investing one of the best ways out there to hedge against inflation. And we’re going to be talking about strategies to help you do just that. We’ll see you next week.
On The Market is created by Dave Meyer and Kalin Bennett produced by Kalin Bennett edited by Joel [inaudible 00:58:01] copywriting by Nate wine trout special thanks to Lisa Sawyer, Eric Knutson, Danielle Daley and Nathan Winston. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.

 




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