For decades now, mortgage borrowers have had it easy. Each time the economy struggled, they were handed more money to pump it back up again.
Well, less money was taken away from them. That’s because central bankers would lower interest rates to stimulate the economy. And this cut meant less in mortgage repayments.
What economists call the “monetary policy transmission mechanism” isn’t interest rates themselves, but mortgaged households and how much of their income they’re allowed to keep. If you think about it, the Bank of England has control of their discretionary income!
That meant mortgaged households were the first to receive the benefits of looser monetary policy. They had an advantage over everyone else in the economy.
This was especially true for savers and investors who had their incomes reduced by lower interest rates. That is something which monetarypolicy makers don’t seem to factor into their equations when they cut rates to stimulate growth…
Unfortunately, this doesn’t only work one way, as @AvidCommentator pointed out on Twitter:
I think it needs to be understood that when you sign up for a mortgage you are effectively signing up to be a tool of monetary policy.
Rates are cut you have more money in your pocket.
Rates rise, you have less.
But it seems the latter was all but forgotten in recent years.
Some economists have long claimed that money is neutral and inflation affects everyone equally. But this is nonsense. And, until I read that tweet above, explaining why it is nonsense has been a pain in the neck.
I used to use metaphors about bath water (don’t ask) to explain how injecting money actually caused a lot of inequality and other problems including housing bubbles.
But the idea that the mortgage-paying class of society is the funnel for stimulating the economy makes it so simple and intuitive. It makes people realise that the levers which central banks are pulling and pushing, with increasing amounts of panic these days, are actually plugged into you, not some distant part of a machine called “the economy”. The rates control households’ discretionary income.
Mortgage payers are so used to being on the favourable side of this equation after decades of falling interest rates that this level of power and control is taken for granted without much chagrin or concern.
Whenever the economy struggled, central bankers would lower interest rates, banks would pass this on to borrowers and discretionary income was freed up for those by paying less on their mortgage.
Nice, isn’t it? What’s not to like? These fellows at the Bank of England are great!
Well, the opposite happens too, like now. And then it’s not so great. And central bankers are not so wonderful.
Interest rates are rising at the fastest pace in a mortgage’s lifetime in some places. And close to it elsewhere, including the UK.
My uncle was telling me at the weekend about the days when his monthly mortgage payments were so high, that they would’ve paid off the house in a few years if it wasn’t for the whopping interest. Back then, monetary policy was an unfair enemy too. (He had to put up with Piers Morgan at work to pay the bills.)
When inflation strikes and central bankers change focus from stimulus to restraint, suddenly, being a policy transmission mechanism isn’t so nice for mortgage payers. In fact, it feels a bit dystopian. Like something that’d happen in China, not here. Still, we have an unelected bunch of bureaucrats on a committee deciding how much of your income you get to keep each month and how much goes to the banks…
The idea of stealing more of your income and giving it to the banks is to rein in inflation. But few seem to consider how unfair this is. How unevenly the pressures are distributed. And what the redistribution of wealth really means for society.
Yes, wealthy households have the ability to get into debt. And doing so has served them well while rates fell for 40 years. Borrowing to generate wealth has worked wonders.
But what does the world look like if inflation sticks around and interest rates begin an uptrend for some time? Suddenly, squeezing those in debt becomes the tendency of monetary policy.
Somehow, I don’t think it’ll be the wealthy that are badly hurt by this shift. They will just stop borrowing, repay debts with their wealth and avoid leverage. If debt doesn’t pay, they won’t borrow it as much.
Those who bought houses out of necessity are the ones who will be left getting squeezed. The ones who borrow to get by will be left as the policy transmission mechanism.
This also makes monetary policy less effective. If borrowers who are already struggling are facing a spike in mortgage costs, there’s not much consumption to cut before financial disaster strikes the household.
Higher interest rates will push people into default, not just less consumption.
Put all this together and you can see how our current cycle of tighter monetary policy, much like those which preceded it, will end in some sort of financial crisis rather than just less consumption to bring down prices.
As 2008 financial crisis predictor Nouriel Roubini recently put it, “There are many reasons why we are going to have a severe recession and a severe debt and financial crisis. The idea that this is going to be short and shallow is totally delusional.”
His key concern was debt – there’s a lot more of it around than in the 70s, when inflation last spiked out of control. Which means monetary policy will trigger a debt crisis much earlier in an interest rate hiking cycle.
Crucially, the level of interest rates at which a debt crisis begins is likely to be much lower than the level of interest rates needed to bring down inflation without a crisis.
I mean, do you think double-digit inflation can be brought under control with 3% interest rates?
More on that tomorrow.
Editor, Fortune & Freedom