Negative Bond Rates May Cause A Second Housing Bubble

[None of this is any kind of advice. At all.]

Joshua Brown has a new post on his blog, The Reformed Broker, which can be read here. If you don’t want to read the whole thing, Brown basically suggests that Real Estate Investment Trusts have performed better than any other asset class since 2000. I don’t doubt that he’s right. Included in his post is a graph with Vanguard’s REIT ETF. The ETF is seen skyrocketing. It’s “performance against the yield on the 10-year Treasury bond” shows a mirror image. While bond yields go negative, investors pour their money into REITs.

He gives more information on the REIT asset class itself, but I want to discuss the effects of negative bond yields on the greater economy. Policymakers wanted investments to increase, and they have. Lowering the interest rates on Treasury bonds until they are negative will make investors focus on stocks and REITs. Put bluntly, if you loan the government money, you will get back less than you gave them. By making interest rates go negative, the Federal Reserve can be sure that people will invest in other assets. But driving people towards REITs should not have been their goal, at least not to this extent. People looking for a safe place to put their money have lost their best option, and are pressured to buy riskier assets instead. After a financial collapse largely caused by overinvestment in housing, policymakers have created negative yield bonds which lead investors to… overinvestment in housing.

Some caveats apply. REITs are not highly leveraged, toxic assets. They don’t have all the problems associated with the housing crisis. REITs include commercial properties, not just mortgages. A housing bubble would not bode well for them, but it wouldn’t necessarily destroy the value from commercial properties. I’m not forecasting a recession, at least not on the scale that we witnessed in 2007-08.

The bigger problem is that the Federal Reserve is not acting wisely. By making interest rates go negative, the Fed effectively made safe treasury bonds useless to any long-term investor. The price of REITs has increased in the short run, but this is not because they have improved as financial assets. REITs aren’t better, their competition is worse. At these rates, bonds are no longer worth holding. More people investing in riskier REITs rather than in safe bonds means the total risk in the economy has increased. As REITs continue to attract investors escaping from negative bonds, the problem gets worse. The infamous quote rings true, that the Federal Reserve’s job is “to take away the punch bowl just as the party gets going.” The punch bowl is still here. Eventually, we may realize we drank too much.

As with anything I write, feel free to let me know how wrong I am.

Update (July 16, 2016): On July 11th, the 10-Year inflation adjusted Treasury bond rate rose back above zero. It is currently hovering at 0.08%, barely above the zero-bound. Although the more extreme consequences of negative yields will not occur in these cicumstances, low yields still result in many investors choosing higher-yielding REITs over Treasuries.

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