Tuesday, December 16, 2008

Demand Destruction in Reverse

Demand Destruction is a process that causes us to make a change in the way in which we make decisions. This process can be both positive and negative depending on what the consumer is reacting to. When crude oil hit $147 a barrel and gasoline was $4.25 a gallon we experienced “Demand Destruction” in the consumption of oil. At $4.25 a gallon for gas, Americans were forced to change their habits about their consumption of gas. We all know that this shift (Demand Destruction) caused part of the decline in oil prices and in turn the price of gas to the price levels of today.

Today the Federal Reserve cut the Fed Funds interest rate to a range of zero to 25 basis points and they created a new “Demand Destruction” for investors and consumers alike. I wrote recently about two clients who were considering a home equity loan at the prime rate less 25 basis points and more. The prime rate tomorrow will be 3.25% so if you had a home equity line of credit priced at prime less 25 basis points your new rate would be 3%. For most people this will be the lowest rate to borrow in their lifetime.

This unprecedented reduction in interest rates will cause people to destroy their credit card balances. Some people think that all the equity is lost in most American homes. I do not think so. I believe there is still a great deal of equity available, but people have been afraid to borrow money. In difficult times people protect their savings just in case things change at their job. If people are paying 9,10, 11% or more on their credit cards and you can refi that loan for 3% and deduct the interest expense it becomes a no brainer. Look for an explosion of home equity lines of credit marketing from your local bank.

With Fed indication that they were going to start buying mortgages from the agencies along with buying longer dated Treasuries I would expect to see home mortgage interest rates fall through the floor. I think it is possible for 30 year conforming mortgage interest rates to be under 4% by the end of the first quarter 2009. If I am right then virtually every home mortgage is in play to be refinanced. I don’t not think everybody can refi because the banks will be stricter than in the past but millions of Americans will refi and most important of all we have made millions of unsold homes more affordable.

I think the actions announced today may bring us to a bottom in the real estate market sooner than I thought.

Dan Perkins

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