Variable Mortgages Waken Inflation Fears for Many
During the inflationary surge of the 1970s, Roger and Barbara Segrest of Columbus, Ga., were clear winners.
Income easily kept pace with prices and the value of their house rose while their mortgage payments held steady. “It was a secure feeling to know your payment was not going to jump,” Roger Segrest recalls.
Today, all that has changed. Fifteen months ago, the Segrests bought a new house with an adjustable-rate mortgage, one with an interest rate that rises and falls as general interest rates shift. Since late October, fixed mortgage rates have climbed half a percentage point, and the Segrests are paying $100 a month more now than in mid-1987.
As a result, the Segrests want the Bush Administration to dampen inflation pressures before they become so great that, to control them, the Federal Reserve Board has to push rates back into the range they reached in the early 1980s. “I’d be real concerned if I were looking at a 13% to 14% interest rate,” Roger Segrest says.
The Segrests may not be alone. William A. Galston, a Democratic political strategist now at the University of Maryland, said that the advent of adjustable-rate home mortgages--combined with the still-fresh memory of the frightening wage-price spiral of the late 1970s--may well have fundamentally transformed Americans’ attitudes toward inflation.
As late as a decade ago, Galston said, Americans took a moderate degree of inflation pretty much for granted. A substantial portion of the public still vividly remembered the Great Depression and the national economic bogey man was still recession.
With the double-digit inflation of the late 1970s, however, Americans finally felt the full fury of a price scourge.
“People felt the stability of their entire way of life was being called into question,” Galston said. Today, he added: “There’s no question that the politics of inflation-fighting has changed dramatically.”
Galston and many other political observers believe that the Fed now may be able to muster more political support for credit-tightening activities than it could in the late 1970s, provided that it couches them as a part of an anti-inflation program.
The public, in this view, has developed a sophisticated understanding of inflation and of what is necessary to stop it. Rising mortgage payments will trigger fears that 1970s-style inflation might be making a comeback and consumers will accept some short-term pain, in the form of higher mortgage rates, if they believe it will forestall a wage-price spiral that would send mortgage rates even higher.
Interest Rates Creeping Up
The Fed, resorting to its time-tested method of curbing inflation, has already begun pushing rates up in the expectation that higher interest costs will dampen economic activity. Interest rates on 90-day Treasury bills, just 5.69% as recently as last March, are now at about 8.25%, and many analysts expect further increases.
If they do, the public will notice. Before 1982, almost all consumer borrowing was done at fixed rates, but the advent of adjustable-rate mortgages in 1982--and the overhauling of the income tax law in 1986, which took away the deduction for interest paid on consumer loans and sent borrowers scurrying to home-equity loans for installment credit--changed all that.
According to estimates of Wall Street economist A. Gary Shilling, adjustable-rate arrangements account for 32.6% of all outstanding home mortgages, an overwhelming majority of home-equity loans and 10% of all credit-card borrowing and consumer installment debt.
“The political impact of variable-rate mortgages and home-equity loans is coming down the pipeline pretty fast,” Democratic economist Michael Barker said. “If inflation shoots up and people are suddenly forced to pay an extra 2% on their mortgages, there’ll be an enormous squeal. It’ll be very important politically.”
The theory has yet to be tested in practice.
Loan Rates Run Behind
Economist Lyle Gramley, a former Fed governor now with the Mortgage Bankers Assn., pointed out that holders of adjustable-rate mortgages have not yet felt the full brunt of the recent run-up in short-term interest rates. Most such mortgages are adjusted only once every six or 12 months, and some analysts say their rates could rise another 2 percentage points by year’s end.
Tommy Pease, a mortgage officer for Fairfield Financial Co., a Columbus, Ga., mortgage writer, added that most adjustable-rate mortgages issued today are far more user-friendly than those drawn in the early 1980s. Most of today’s mortgages, he said, limit how much the interest rate can climb within any one year and also have a “cap” on how high it can go altogether.
Unless rates soar in the next few months, “it’s possible that consumers will barely feel it,” said Pease, who himself holds a variable-rate mortgage.
David S. Levine, an economist with Sanford C. Bernstein & Co. in New York, said the impact of adjustable-rate mortgages has been overstated. The built-in caps, combined with the fact that mortgage interest payments are tax deductible, mean that a jump in rates of 2 percentage points would increase the debt burden on variable-rate mortgages by only $12.2 billion a year, or just 0.3% of disposable personal income, he said.
May Be Offset by Savings
What’s more, Levine added, the adjustable-rate economy also benefits consumers by boosting their investment income as well as their debt burden. Levine figures that a 2-point rise in short-term interest rates on savings and money market accounts would more than offset any drag from an increase in the interest rates on variable-rate mortgages.
As a result, there is serious debate of whether, at least for the present, the Fed’s modest moves to nudge up interest rates are having any economic impact. Although the credit-tightening began nine months ago, the economy is still steaming along. Businesses are opening an average of 275,000 new jobs a month, and consumer spending continues to be high.
The political impact of the new adjustable-rate economy on anti-inflation efforts is also a question mark.
Michael McCracken of Informetrica Ltd. in Ottawa said that polls in Canada, which went to adjustable-rate mortgages in the 1970s, found “wide support” for fighting inflation by raising interest rates. Mortgages with variable rates have sparked “a wider concern that inflation be kept under control,” McCracken said.
Test Yet to Come
But Greg Schneiders, former White House strategist in the Jimmy Carter Administration and now running a political consulting firm in Washington, said the real test in the United States is yet to come.
“Until now, people have sort of benefited from variable-rate mortgages,” he said. “We don’t know what the situation will be when homeowners experience a rise in rates.”
A small sampling indicated that the impact, when it hits, may be easy to measure. Pam Reid, a Rockford, Ill., white-collar worker who has an adjustable-rate mortgage, said the rise in rates so far “hasn’t hurt me yet” because it has not shown up in her mortgage interest rate. She is now paying a lower rate than in 1985, when she bought her current home.
Reid conceded, however, that she has begun to worry about reports that interest rates are rising, and she is apprehensive about where the economy is going. She figures that each 1-point rise in interest rates will cost her an additional $100 a month in her mortgage payment--”a lot of money” by her standards. “I’m a lot more concerned about inflation now,” she said.
Sees Public Support
Barry Bosworth, who served with some frustration as the Carter Administration’s chief inflation fighter, is optimistic. He said that if such attitudes hold up, the heightened public sensitivity to higher interest rates “will translate into new, broader public support for inflation fighting”--particularly for reducing the federal deficit.
In the meantime, Roger and Barbara Segrest are watching interest-rate developments closely, trying to discern how hard they’ll be hit if the Fed continues to push rates up. “We have one possible out,” Roger Segrest said. “I could convert this to a fixed-rate mortgage and lock everything in at 9 1/2%.”
Segrest conceded there is no magic formula to help him make the right decision. “I just kind of go with the gut feeling,” he said with a shrug.
