Last week Arthur Laffer published an interesting opinion in the Wall Street Journal. (http://online.wsj.com/article/SB124458888993599879.html). He makes the case that inflation and higher rates are coming and I for one agree. However, he does miss the mark on a few points.
First, he is very caviler that banks will increase their lending to the point where reserve requirements limit them. In today’s market that is just not true.
First, banks are still not sure what future losses they will take on existing portfolios and therefore are uncertain of needed reserves in the future. So far their predictions of losses have been pretty poor and I think most banks are keeping excess cash on hand for expected, but unreported, future reserves. Until there is some job growth to give them hope that things are really getting better they will not be confident that their long term reserves are adequate.
Second, he misses the importance of lenders needing to find credit worthy borrowers. A bank can’t put our money if they don’t find good borrowers. With job growth and income down lending to consumers is tough and commercial lending depends on strong businesses which, in many cases, needs the consumer. As for real estate, lending today is an issue of values. With no solid knowledge of how much a house or commercial building is worth its hard to know how much you can lend. In the multifamily world this has led to lower advance rates (65%-75% today vs. 75%-85% a few years ago).
However, the expansion of bank lending is not necessary to make Mr. Laffer’s point. Government borrowing, for a variety of reasons, will lead to oversupply in the treasury market, forcing an increase in rates which will flow through to conventional loans. While the government can keep short term rates low, in the long run they can’t control long term rates which will increase.
Mr. Laffer points out how to deal with this is a Hobson ’s choice for the Fed. However, this is also a Hobson’s choice for how each of us. If rates are going up, what do you do today? For multifamily owners, do you refinance now before rates go up even if you are borrowing less loan funds than you would like or do you wait until markets recover and possible finance then, with better loan proceeds, but with higher rates. There is no easy answer, but if you want to discuss the issues, give me a call at 847-849-5006.
