[patientrenter]

Rustico,

You’re correct about the height. I think you were ribbing jg (whom I don’t know).

I thought it was a bit unfair of me to drag you through all that math and then leave it up to you and others to do the last step to get practical numbers you can use. So I went to that h.15 report I mentioned, which has daily closing data from 1962, and measured the historical variation in 10-year Treasury rates. Here are some results that might cut through the fog:

1. 90% of the time, the change in the 10-year Treasury rate since the last trading day (using closing prices) is 10bp or less, in either direction.

2. 99% of the time…. 25bp

To get variations over one month, just multiply by 5 (so changes are 50bp or less in either direction 90% of the time, and 125bp… 99% of the time).

If you’re looking at X months, multiply the monthly bp values above by sqrt(X).

At any one time, interest rate volatility can be higher or lower than the average from 1962 until now. Even our recent volatility in the bond markets is less than the average for 1962-2007, because the average includes lots of volatile years from the 1980’s. You could use 50-90% of the amount of variation quoted above in today’s environment. It’s been closer to 90% in the last few weeks, and was 50-60% for most of the last year.

SD R, I agree totally that the main point of all this is to have some awareness of this inability-to-lock-in risk (and thanks again for being the one to contribute that to us all).

Back to real estate, and over and out.

Patient renter in OC

[patientrenter]

Rustico,

You’re correct about the height. I think you were ribbing jg (whom I don’t know).

I thought it was a bit unfair of me to drag you through all that math and then leave it up to you and others to do the last step to get practical numbers you can use. So I went to that h.15 report I mentioned, which has daily closing data from 1962, and measured the historical variation in 10-year Treasury rates. Here are some results that might cut through the fog:

1. 90% of the time, the change in the 10-year Treasury rate since the last trading day (using closing prices) is 10bp or less, in either direction.

2. 99% of the time…. 25bp

To get variations over one month, just multiply by 5 (so changes are 50bp or less in either direction 90% of the time, and 125bp… 99% of the time).

If you’re looking at X months, multiply the monthly bp values above by sqrt(X).

At any one time, interest rate volatility can be higher or lower than the average from 1962 until now. Even our recent volatility in the bond markets is less than the average for 1962-2007, because the average includes lots of volatile years from the 1980’s. You could use 50-90% of the amount of variation quoted above in today’s environment. It’s been closer to 90% in the last few weeks, and was 50-60% for most of the last year.

SD R, I agree totally that the main point of all this is to have some awareness of this inability-to-lock-in risk (and thanks again for being the one to contribute that to us all).

Back to real estate, and over and out.

Patient renter in OC

[patientrenter]

Concho,

I think you’re making some assumptions about typical new Indian and Chinese and, to a lesser extent, Filippino, immigrants to the US that just may not be correct.

There’s a lot of evidence that incomes of Asians in the US are higher, on average, than incomes of average non-Asian Americans. It’s certainly true for Indians and Chinese, and the average Filipino income in the US is about the same as the average for all Americans.

For your reference, here is some public US Census Bureau data supporting this:

Page 15 of http://www.census.gov/prod/2004pubs/censr-17.pdf

Patient renter in OC

[patientrenter]

Concho,

I think you’re making some assumptions about typical new Indian and Chinese and, to a lesser extent, Filippino, immigrants to the US that just may not be correct.

There’s a lot of evidence that incomes of Asians in the US are higher, on average, than incomes of average non-Asian Americans. It’s certainly true for Indians and Chinese, and the average Filipino income in the US is about the same as the average for all Americans.

For your reference, here is some public US Census Bureau data supporting this:

Page 15 of http://www.census.gov/prod/2004pubs/censr-17.pdf

Patient renter in OC

[patientrenter]

Rustico,

What kind of nerd am I? 5’8″, blue eyes, insomniac….

I design and price retail financial products (that are not mortgages). I also initiate opportunistic wholesale purchases of bonds to support a portion of those retail sales. I strongly believe most people should not try to time the bond market for profit. Do it for amusement, but not if you expect to profit from it.

The two rules of thumb I gave for comparing levels of uncertainty about future long bond rates are, unfortunately, about as far as one can go without pulling in far more complex mathematical tools. And the rules of thumb are imperfect simplifications. Sorry.

Where does the square root come from? I said that the amount of unecertainty in a future long bond interest rate roughly varies with the square root of the time from now until that future time, if the time is short enough. Rather than pulling in the general theory, I’ll give a plausibility argument using a simple example. I hope it’s not too mysterious or mathematical. (For those familiar with stats, the key fact is that the standard deviation of the sum of N independent, identically distributed random variables is the square root of N times the standard deviation of one of the random variables.)

Here’s the illustrative example. The change in the long bond rate from now (June 16) to July 16 will be the sum of the daily changes on each of the 20 or so trading days from now until then. We don’t know the change next Monday, but we have some idea from experience how likely an increase or decrease of any amount is. A first approximation to the truth is to assume that the same likelihoods apply to Tuesday and all the other trading days. Another approximation to the truth is that the amount of change that occurs on one day has no impact on the amount of change that occurs on subsequent days (which is clearly not completely true, but look at the results before jumping to conclusions).

Next comes the mysterious math (statistics): The amount of variation in something uncertain that is itself the sum of N other uncertain pieces that all look alike, and that do not depend on each other, is equal to the square root of N times the amount of variation in any one of the pieces. (Read standard deviation for amount of variation, if you like stats)

Applying the math to the daily changes in the long bond rate from now until July 16, a first approximation to the truth is that the amount of possible variation in long bond rates from now until July 16 is the square root of 20 (about 4.5 according to my mental math) times the amount of possible variation we now expect to see on Monday.

So if you are considering a possible 10bp change on Monday, a change of 45bp is about as likely over the next month. I hope that sounds like a reasonable result to you, and it comes in spite of all the imperfections we had to paper over along the way.

How likely is a 10bp move either way on Monday? You can learn more about the likelihood of various amounts of daily change by looking at actual historical daily changes over the last year or longer. (If you’re really interested, a good internet source is the H.15 report updated daily by the Fed.)

OK, that’s probably more than enough technicality for you and 99% of the readers here. Hopefully it shed some light, or at least didn’t give you a headache.

Patient renter in OC

[patientrenter]

Rustico,

What kind of nerd am I? 5’8″, blue eyes, insomniac….

I design and price retail financial products (that are not mortgages). I also initiate opportunistic wholesale purchases of bonds to support a portion of those retail sales. I strongly believe most people should not try to time the bond market for profit. Do it for amusement, but not if you expect to profit from it.

The two rules of thumb I gave for comparing levels of uncertainty about future long bond rates are, unfortunately, about as far as one can go without pulling in far more complex mathematical tools. And the rules of thumb are imperfect simplifications. Sorry.

Where does the square root come from? I said that the amount of unecertainty in a future long bond interest rate roughly varies with the square root of the time from now until that future time, if the time is short enough. Rather than pulling in the general theory, I’ll give a plausibility argument using a simple example. I hope it’s not too mysterious or mathematical. (For those familiar with stats, the key fact is that the standard deviation of the sum of N independent, identically distributed random variables is the square root of N times the standard deviation of one of the random variables.)

Here’s the illustrative example. The change in the long bond rate from now (June 16) to July 16 will be the sum of the daily changes on each of the 20 or so trading days from now until then. We don’t know the change next Monday, but we have some idea from experience how likely an increase or decrease of any amount is. A first approximation to the truth is to assume that the same likelihoods apply to Tuesday and all the other trading days. Another approximation to the truth is that the amount of change that occurs on one day has no impact on the amount of change that occurs on subsequent days (which is clearly not completely true, but look at the results before jumping to conclusions).

Next comes the mysterious math (statistics): The amount of variation in something uncertain that is itself the sum of N other uncertain pieces that all look alike, and that do not depend on each other, is equal to the square root of N times the amount of variation in any one of the pieces. (Read standard deviation for amount of variation, if you like stats)

Applying the math to the daily changes in the long bond rate from now until July 16, a first approximation to the truth is that the amount of possible variation in long bond rates from now until July 16 is the square root of 20 (about 4.5 according to my mental math) times the amount of possible variation we now expect to see on Monday.

So if you are considering a possible 10bp change on Monday, a change of 45bp is about as likely over the next month. I hope that sounds like a reasonable result to you, and it comes in spite of all the imperfections we had to paper over along the way.

How likely is a 10bp move either way on Monday? You can learn more about the likelihood of various amounts of daily change by looking at actual historical daily changes over the last year or longer. (If you’re really interested, a good internet source is the H.15 report updated daily by the Fed.)

OK, that’s probably more than enough technicality for you and 99% of the readers here. Hopefully it shed some light, or at least didn’t give you a headache.

Patient renter in OC

[patientrenter]

SD Realtor

I have to disagree with you that you can see where rates are going in the future from the trend in the recent past. Or perhaps I should say that I can’t! If you can, then I suggest you should trade bonds and you could make many, many times your current earnings. (I’m not being sarcastic.)

I suspect you don’t actually advise your clients that rates are more likely to go up before lock-in, or vice versa. I think the consensus view amongst interest rate experts on what anyone can safely and accurately say about future long rates, and hence the lock-in (fixed) rate is that:

1. The best estimate of it is roughly the current rate

2. Rates will go up (or down) by an uncertain amount from now until lock-in

3. The degree of uncertainty increases with time to lock-in
(and for nerds, it’s approximately proportionate to the square root of the time to lock-in, if the time is short enough)

4. The degree of uncertainty varies with the amount of daily volatility in the rate today (and for nerds, it’s directly prportional over short enough times to lock-in)

Here’s a practical example:
Your buyer is trying to decide between two purchases. Home A can be locked in 1 month from now; B 4 months from now. Otherwise, they are equal. Current fixed rates are 6%. The buyer wants to compare the interest rate risk. He decides to look at the cost of home A at 6.5% as a reasonable worst-case, 50bp higher than today’s rate. Then it’s fair to look at home B at 7% [twice as much over today’s rate, because sqrt(4 months/1 month) = 2].

Here’s another:
Same buyer, but now the daily fluctuations in the rate have gone up by 50%, and the buyer is worried his 6.5% one month from now isn’t worst-case any more. How high should he go? 6.75%. Pretty obvious.

Sorry about all that math, and the absence of the excitement of making a bet on rates rising or falling. Maybe it’ll be of some practical use to you or someone else.

Patient renter in OC

[patientrenter]

SD Realtor

I have to disagree with you that you can see where rates are going in the future from the trend in the recent past. Or perhaps I should say that I can’t! If you can, then I suggest you should trade bonds and you could make many, many times your current earnings. (I’m not being sarcastic.)

I suspect you don’t actually advise your clients that rates are more likely to go up before lock-in, or vice versa. I think the consensus view amongst interest rate experts on what anyone can safely and accurately say about future long rates, and hence the lock-in (fixed) rate is that:

1. The best estimate of it is roughly the current rate

2. Rates will go up (or down) by an uncertain amount from now until lock-in

3. The degree of uncertainty increases with time to lock-in
(and for nerds, it’s approximately proportionate to the square root of the time to lock-in, if the time is short enough)

4. The degree of uncertainty varies with the amount of daily volatility in the rate today (and for nerds, it’s directly prportional over short enough times to lock-in)

Here’s a practical example:
Your buyer is trying to decide between two purchases. Home A can be locked in 1 month from now; B 4 months from now. Otherwise, they are equal. Current fixed rates are 6%. The buyer wants to compare the interest rate risk. He decides to look at the cost of home A at 6.5% as a reasonable worst-case, 50bp higher than today’s rate. Then it’s fair to look at home B at 7% [twice as much over today’s rate, because sqrt(4 months/1 month) = 2].

Here’s another:
Same buyer, but now the daily fluctuations in the rate have gone up by 50%, and the buyer is worried his 6.5% one month from now isn’t worst-case any more. How high should he go? 6.75%. Pretty obvious.

Sorry about all that math, and the absence of the excitement of making a bet on rates rising or falling. Maybe it’ll be of some practical use to you or someone else.

Patient renter in OC

[patientrenter]

Rustico,

I know 1992-1997 saw a lot of mortgage defaults and forced sales, but my suspicion is that this time around the efforts that will be made by banks, investors, state and federal agencies to save homeowners will be very different and much bigger. If the downward wave is too big, it may overwhelm them all, but I wouldn’t call a rout a sure bet quite yet.

Patient renter in OC

[patientrenter]

Rustico,

I know 1992-1997 saw a lot of mortgage defaults and forced sales, but my suspicion is that this time around the efforts that will be made by banks, investors, state and federal agencies to save homeowners will be very different and much bigger. If the downward wave is too big, it may overwhelm them all, but I wouldn’t call a rout a sure bet quite yet.

Patient renter in OC

[patientrenter]

Chris, I’m curious about your “big-picture patterns” causing a “major low in price” that’s coming “shortly”.

It sounds enticing and very mysterious, but it doesn’t give me much help in seeing what you’re thinking. What patterns do you have in mind? How high will the 10-T rate go? How soon is shortly?

Doubtless the 10-T rate will be higher at some time in the future than it is today, and that’s a big thing, so doubtless it will have a big reason, and the time it takes will be short on some time scale. But I know that kind of meaningless prediction is not what you’re saying.

Forgive me if you’ve already spelt all this out elsewhere on this blog, and please point me there.

PatientRenter in OC

[patientrenter]

Chris, I’m curious about your “big-picture patterns” causing a “major low in price” that’s coming “shortly”.

It sounds enticing and very mysterious, but it doesn’t give me much help in seeing what you’re thinking. What patterns do you have in mind? How high will the 10-T rate go? How soon is shortly?

Doubtless the 10-T rate will be higher at some time in the future than it is today, and that’s a big thing, so doubtless it will have a big reason, and the time it takes will be short on some time scale. But I know that kind of meaningless prediction is not what you’re saying.

Forgive me if you’ve already spelt all this out elsewhere on this blog, and please point me there.

PatientRenter in OC

[patientrenter]

cyphire, you threw raw meat to the pack!

I have sympathies for the point of view in your drunken rant (although I end up coming down on the opposite side on many of the issues you raise). Does that mean I’m drunk when I’m sober?

It’s amusing to see so many people compare averages in the UK or Albania with SD, and I often do it too. But the various members of my family live in many of the places that are being compared here and others (downtown London, Brussels, Stockholm, Nice, Dublin, Bermuda, Mumbai….) and they live lives remarkably similar to middle-class people here in OC, regardless of the incomes of the homeless or billionaires around them.

I’d be happy to live in any number of those places, and I prefer OC over Nice, for example, only because the weather here is slightly better and my professional qualifications cover the US only (and my French is terrible!)

A person who reflexively expresses the point of view that the country they grew up in is better than everywhere else is shedding more light on the shape of their own mind than on the merits of various places, and once you see that shape, there is no more useful information to be gained on that topic.

Patient renter in OC

[patientrenter]

cyphire, you threw raw meat to the pack!

I have sympathies for the point of view in your drunken rant (although I end up coming down on the opposite side on many of the issues you raise). Does that mean I’m drunk when I’m sober?

It’s amusing to see so many people compare averages in the UK or Albania with SD, and I often do it too. But the various members of my family live in many of the places that are being compared here and others (downtown London, Brussels, Stockholm, Nice, Dublin, Bermuda, Mumbai….) and they live lives remarkably similar to middle-class people here in OC, regardless of the incomes of the homeless or billionaires around them.

I’d be happy to live in any number of those places, and I prefer OC over Nice, for example, only because the weather here is slightly better and my professional qualifications cover the US only (and my French is terrible!)

A person who reflexively expresses the point of view that the country they grew up in is better than everywhere else is shedding more light on the shape of their own mind than on the merits of various places, and once you see that shape, there is no more useful information to be gained on that topic.

Patient renter in OC

[patientrenter]

2-year leases are not common in So Cal.

What’s the total savings from signing the 2-year lease? X

What’s the penalty for bailing? Y

So you get X if house prices decline slowly over 2 years (and you don’t buy), and lose Y if they drop very quickly and then start rising (and you buy). Only you know X and Y.

I doubt that prices will plummet very quickly and then start rising, all within 2 years. It’s possible, but then the $100,000’s you’ve saved on the house should easily cover the lease bail-out penalty (assuming it’s a few $1000).

Patient renter in OC

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