“I do believe in the American Dream,” said President Bush in 2002. “Owning a home is a part of that dream, it just is. Right here in America, if you own your own home, you’re realizing the American dream.”

Bush was echoing a theme that reaches back at least to Herbert Hoover: When the government encourages homeownership, the story goes, it strengthens individuals and communities and thereby fosters the American Dream.

Fast forward to 2010, and yesterday home sales in the U.S. broke a new record, plunging by 27% in July.

The U.S. housing market is at a point where it seems to be dragging the United States down as if the country were some hapless satellite of the old Soviet Union that refuses to face the facts. The game is over, the old regime is technically dead.

American home ownership, artificially created over decades by trillion-dollar government-backed loans, guarantees and regulation, continues to operate under the old rules. Somehow, the mess that Washington created is still thought of as the mess that Washington can still fix.

Millions of Americans face foreclosure, the value of their homes below the value of their nominal mortgages. Lenders are carrying mortgages that have little or no value, or writing them off. Foreclosures accounted for 22% of total house purchases in July.

The only real hope for a revival in the market is a return of buyers with confidence in the economy and in an environment where prices reflect the market rather than more government flim-flam support.

The American Dream, that has lured tens of millions of all nations to our shores in the past century has not been a dream of material plenty, though that has doubtlessly counted heavily. It has been a dream of being able to grow to fullest development as a man and woman, unhampered by the barriers which had slowly been erected in the older civilizations, unrepressed by social orders which had developed for the benefit of classes rather than for the simple human being of any and every class.

James Truslow Adams
“Epic of America”

Read more:
http://www.financialpost.com

http://www.marketoracle.co.uk

by Mark Jasayko and Neil McIver
The Vancouver Sun

Interest rate policy is often divisive, pitting borrowers against savers and investors against speculators.

On Tuesday, the Bank of Canada raised its key lending rate from 0.50 per cent to 0.75 per cent. On balance, this rate increase will be good for Canada, whose economy has reached a level that is the envy of others, judging by the accolades received in the international press.

However, using low rates to stimulate our economy towards an even higher trajectory could create imbalances that will eventually risk our new global economic standing.

To some, such as politicians, speculators and profligate consumers, a juiced-up economy sounds like a fantastic proposition. Unfortunately, most Canadians don’t fall into any of these categories. If interest rates are kept too low for too long, economic resources begin to flow rapidly to relatively unproductive uses. In the end, disasters such as real estate bubbles pose the greatest risk.

We only have to look south to see what an era of “easy money” interest rate policies have achieved: a real estate meltdown and an economy that has remained flat for a decade when the effects of financial engineering and over-borrowing are netted out. Apart from some lucky real estate speculators who timed things perfectly, is the U.S. better off?

Higher rates would have played an important role in bringing balance to the U.S. economy. Instead, there were some stunning side effects of low rates that included the statistic that 40 per cent of all job creation was related in some way to real estate (agents, bankers, mortgage brokers, construction firms, etc.) before the bubble burst.

Higher rates would have helped other service and manufacturing industries to compete for the labour that was otherwise attracted to real estate with its fevered speculation and promises of unending growth.

In a concerning development, real estate prices in Canada are back at record levels and in many cities prices exceed afford-ability indices. If the bank rate is kept too low for much longer, Canada risks the potential of becoming an economy that is too dependent on maintaining real estate price trends, inhibiting our ability to grow beyond the currently hot economic industries of construction and resources. The future of our economy will be on more solid ground with more diversification and job growth in other areas, and interest rate policy will have an effect on this.

Another benefit of higher rates is to provide savers with a yield. Recently, savings rates in Canada have plummeted as Canadians are being induced to borrow and spend while employment remains strong and rates remain low. In addition, there is reduced incentive to save and invest when yields are so low.

Even worse, for those who are saving or who depend on current investment income, there is the temptation to invest in lower quality investments in order to pick up a little more yield.

The asset-backed commercial paper catastrophe illustrated the hazards of this strategy for income-seeking investors who did not have the resources to assess the true underlying quality.

Finally, being able to cut rates in a time of crisis is crucial. However, this tool is drastically compromised when rates are already severely low, tantamount to “pushing on a string.” If the anemic global economy begins to impact Canada through trade flows, we are going to need all the policy ammunition we can muster.

Increased rates now will ensure that we are able to fight that battle if it arrives, thereby protecting our newly acquired, and envied, economic advantages.

Mark Jasayko and Neil McIver are portfolios managers with McIver Wealth Management Consulting Group at Richardson GMP Ltd.

Boyd Erman
Globe and Mail Update

After a year of making it easy by telling the market exactly what the Bank of Canada would do with borrowing costs by giving a commitment to keep them at emergency lows, Governor Mark Carney has rapidly switched tacks. The country’s top central banker is now confounding those who would try to predict exactly how fast interest rates will rise by refusing to give explicit guidance.

Yesterday’s quarter-point increase in the benchmark central bank rate and the accompanying statement show that the kind of transparency markets get from Mr. Carney as borrowing costs go up in coming months is going to be very different than what they have become used to over the first part of his tenure, when rates dropped to record lows and stayed there.

In this statement, Mr. Carney is being open but not predictable. He is laying out the parameters he is watching and leaving it to markets to try to figure out what that will mean for rates. It’s an education for investors and analysts, because this is the first time they have seen Mr. Carney raising borrowing costs.

“It’s going to be more fun being the central banker in this environment than being a forecaster,” said Mark Chandler, a rates strategist at RBC Dominion Securities who predicts “a whole bunch of angst” before every Bank of Canada rate announcement in coming months.

Just as the explicit commitment to keep rates low served a purpose by giving an uncertain economy some certainty, the new move to the other end of the predictability spectrum gives Mr. Carney the flexibility he needs to deal with a stop-and-go rebound in growth.

The economy posts a couple of hot quarters and inflation ticks up? Fine, a quarter point tighter it is. But then we wait and see.

This isn’t a normal recovery, so there’s no sign of the central bank’s normal language in a tightening cycle. Usually, there is wording foreshadowing a steady move higher, along the lines of “some further reduction of monetary stimulus will be required,” to quote a 2005 rate hike announcement. This time, the guidance is that “any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.”

With that, Mr. Carney has established himself as neither hawk nor dove, just a pragmatist who watches the data and the markets and reacts.

Already, there are signs that the new strategy is a success. The market is re-evaluating its belief that more rate cuts are a sure thing.

Read more at:
www.theglobeandmail.com

More about forecasting interest rates:

Economists use a variety of techniques to forecast interest rates. The most basic is to use economics and history as a guide and to make a judgement about what an appropriate level of interest rates and their future course given the state of the economy and important economic variables. Since most economists disagree on how the economy works or what economic history means, this is more difficult than it seems.
See Schools of Economic Thought.

Quantitative economic statistical techniques called “econometrics” attempts to model the economy using mathematical and statistical relationships. A comprehensive model of the economy might have hundreds of equations and many variables. The problem with these techniques is that while they might have a “high explanatory power” or be “robust” historically against “back-tested” data after the fact, they are very poor at explaining the future before the fact.
See Econometric Techniques.

The reason for this inaccuracy is simple. Interest rates reflect human behaviour which is highly complex. This complexity has been compounded by the internationalization of economies and the financial markets. The direction of Canadian and U.S. interest rates is partially set by those of other countries, particularly Germany and Japan. Even governments miss their interest rate forecasts and they have control over their countries’ monetary and fiscal policy.

More about forecasting interest rates