Byline: Allan Sloan; Sloan is NEWSWEEK's Wall Street editor. His e-mail is firstname.lastname@example.org.
One of Wall Street's favorite sayings is that you don't know who's swimming naked until the tide goes out. Now, thanks to Alan Greenspan and Ben Bernanke, we're starting to see some exposed butt. That's because the present and former chairmen of the Federal Reserve Board have boosted short-term interest rates by a whopping four points in the past two years, revealing body parts of folks ranging from financially stressed homeowners to zillionaire hedge-fund managers.
These higher short rates--combined with higher long-term rates,
which are set by financial markets rather than the Fed--are finally starting to ripple through the economy to the detriment of borrowers, but to the benefit of savers. Since all of us are borrowers or savers or both, herewith is a brief interest-rate primer. No, I'm not going to burden you with discussions of Fed policy or the supposed significance of an "inverted yield curve" (when short-term rates are higher than long-term rates) or other technical stuff that causes the average eyeball to glaze over. Instead, let's just talk about some aspects of how the world has changed, and what to make of it.
Housing first. For years, people warned about the dangers of financing houses with interest-only mortgages tied to short-term rates. But rates stayed down, prices rose, buyers were ahead. Even when rates headed up, housing prices in many markets kept right on rising. One reason is that ever-more-inventive mortgages requiring ever-smaller cash outlays put houses within reach of buyers who otherwise couldn't have remotely afforded them. The idea was that when the "teaser rate" on your loan expired, another lender would want to tease you, and all would be well. But teasing isn't working anymore.
People who reached farther than they could afford for low-cash mortgages-- which Minneapolis investment guru Steve Leuthold calls "financial death traps"-- now find themselves on the beach. "Rates on those loans were 4 percent two years ago, and now they're 8 percent," says Leuthold, "so your payment has doubled." Can higher foreclosures be far behind?
I expect house prices to drift down--but not to crash. Here's why. The Greenspans and Bernankes of the world don't …