October 19, 2023 • 41 mins
Mortgage rates have surged over the last couple of years. But surprisingly to some, actual home prices in the US have been resilient. This has created a historic shock to affordability, with a typical monthly payment on a home purchase soaring. But how long can this go on? Particularly as rates continue to rise, with a 30-year fixed rate mortgage near 8% now, we speak with Morgan Stanley housing strategist, and past Odd Lots guest, Jim Egan, about the impact of this rate environment. He explains why we may be at the limit to how far house prices can rise, and why at this point, the key variable is whether more supply comes onto the market.
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Episode Transcript
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Speaker 1 (00:11):
Hello, and welcome to another episode of the Odd Lots Podcast.
I'm Tracy Alloway.
Speaker 2 (00:15):
And I'm Joe Wisenthal.
Speaker 1 (00:17):
Joe, did you see that National Association of Homebuilders survey?
Speaker 2 (00:22):
Uh?
Speaker 3 (00:22):
It was bad.
Speaker 2 (00:23):
I actually didn't see the number, but I think it
was bad.
Speaker 1 (00:25):
Right, Yeah, it wasn't great. So the sentiment of the
homebuilders is falling, which is kind of noteworthy because towards
the beginning of the year we saw a little bit
of a pick up, a little bit of optimism, and
we did see some new construction and that started to
feed into overall housing supply. But fast forward to October
(00:49):
twenty twenty three, rates are going up again, and it
seems like this is finally starting to have something of
a negative impact on how home builders are actually feeling.
Speaker 2 (01:00):
Are recording this, as you say, rates going up, We
were recording this on October seventeenth. Just today, we have
the ten year yield back over four point eight percent
right at the time we're talking. That is basically at
the highs of the cycle. We had dipped for a
little while. And yeah, you mentioned that home builder sentiment number,
and that was like the interesting story with housing has
(01:20):
been resilience, right, resilience and prices, et cetera. Even the
homebuilders had like picked up a bid in the second
in the first half of the year, but we were
actually really heading back down, not far off those lows
that we saw at the end of twenty twenty two.
Speaker 1 (01:34):
Yeah, and meanwhile, mortgage rates, which of course are sort
of priced off of treasuries, are getting close to eight percent.
That's the highest level I think since something like two thousand.
So we have to discuss this. And you know, the
last couple times we dug into the housing market, we
spoke with Morgan Stanley's US housing strategist Jim Egan. In fact,
(01:54):
we spoke to him for the first time in October
of last year in an episode that we call well,
here's what seven percent mortgage rates will do to the
housing market. So now twelve months later, we're just gonna
do here's what eight percent mortgage rates will do to
the housing market.
Speaker 2 (02:08):
Here we got, Yeah, we just don't one percent at
a time. We'll just keep having Jim back.
Speaker 1 (02:11):
On that's right. But actually, on a serious note, one
of the reasons we like talking to Jim Egan is
that he was a bit of an outlier when we
first had him on. You know, when mortgage rates were
shooting up, a lot of people were predicting this really
big housing crash, and meanwhile Jim was forecasting a slight
dip basically followed by a rise, which is exactly what
(02:34):
we saw happen. And he was kind of early to
that whole lock in idea that you see everywhere now,
So the notion that people who are lucky enough to
have locked in mortgages when rates were at essentially zero
are now going to be very reluctant to move and
take on a higher mortgage cost, and so that basically
helped provide a floor on prices. So we liked talking
(02:57):
to Jim, and we thought, even though we spoke to
him one over the summer, given that rates are shooting
up even more, we should definitely do it again.
Speaker 2 (03:04):
I'm excited about it.
Speaker 1 (03:05):
Let's do it all right, Jim, welcome back to the show.
Speaker 3 (03:08):
Thank you so much for having me. It is an
honor to be asked back.
Speaker 1 (03:12):
Third time's the best time. Okay. So, you know, we've
spoken a lot to you about what higher rates mean
for housing in the short term, and as I said
in the intro, you were early to that whole lock
in idea. But I guess let's just jump into it.
If we assume that higher for longer is here to
stay for the foreseeable future, what does that mean for
(03:34):
housing over a longer term horizon?
Speaker 3 (03:37):
Sure, And I think that the way that you're characterizing
this is important, right We have to disaggregate the short
term impact of this most recent increase in rates versus
a longer term impact here. Now, what I will caveat
some of these comments by saying is that currently we're
not forecasting rates to remain at these elevated levels for
(03:59):
the law longer term. We do think that the tenure
will come down through the middle of next year, and
we think that mortgage rates will come down as part
of that. But given what's happened to rates, that is
a very important question right now. And I think this
starts with affordability, right We talked about affordability on this
podcast when I was able to visit previous to this,
and one of the things that characterized twenty twenty two
(04:23):
was just an historic, at least through the history of
our data, a decline or a deterioration and affordability that
we hadn't seen year over year changes were three times
worse than what we witnessed during the Great Financial Crisis
and earlier this year, affordability stopped deteriorating at those paces
some shorter term affordability metrics. If we look at it
(04:43):
over three months, over six months, affordability was actually improving.
That's no longer the case, right.
Speaker 1 (04:49):
It was a blit basically along with the like tiny,
tiny dip in house prices.
Speaker 3 (04:54):
Exactly, and if mortgage rates were to stay at eight
percent for a longer period of time, affordability deterioration would
return back to a place that we haven't seen in
decades in the twenty twenty two period. Notwithstanding, it's pretty incredible,
just you know, tugget percentage points can sometimes be abstract.
But our colleague Michael McDonough regularly posts this chart, and
(05:18):
this was about a month ago so or even higher
than we were before. But he posted this chart showing
like a median house with a thirty year mortgage just
sort of really standard. You know, a few years ago,
a monthly payment might be like about one thousand. It
is up to twenty three hundred as of according to
a typical thirty year mortgage rate. But there versus March
twenty twenty when we were at the lows and probably
(05:38):
not a lot of people got mortgages. Nonetheless, like when
you put those numbers in, I mean, it's just an
extraordinary affordability shock. It's incredible, Like one of the numbers
that we were looking at recently, not relative to March
twenty twenty. But to put it into context, the extent
to which we've seen mortgage rates increase, the payments up
over one hundred and twenty percent since the lows and
mortgage rates that we saw in the early part of
(06:00):
twenty twenty two. And you've mentioned the lock and effect
that is kind of a well discussed topic at this
point in time, and yes it's still present. But when
we think about the longer term impacts of this move,
the move from twenty twenty two saw almost a four
hundred basis point increase from three percent to seven percent.
When first time you invited Yeah onto this podcast. That
(06:22):
took a lot of homeowners, a lot of mortgaged homeowners,
from sort of at the money around the prevailing mortgage
rate to deeply out of the money locked into their
mortgage payment. The move now up to eight percent mortgage rates,
it's not capturing the same quantum of marginal homeowner and
so the impact on things like supply, the impact on demand,
(06:44):
especially that the rate of change is not going to
be the same this time around than it was in
twenty twenty two.
Speaker 1 (06:52):
Sorry, can you explain that a little bit further?
Speaker 3 (06:54):
Right? So, as borrowers were moving further and further out
of the money in twenty twenty two, we saw specifically
the listings of homes available for sale fall to right,
far and away the lowest level we have on record,
right where we have that data going back over forty years,
never lower by our metrics. Hit a low in May
of twenty twenty two. Right now, as rates kind of
(07:14):
held flat, maybe improved a little bit at those levels,
you started to see inventory pick up a little bit.
As rates have gone back to eight percent. We're testing
those lows again, but it's going to be difficult given
that you're not moving hundreds of thousands or millions of
homeowners out of the money.
Speaker 2 (07:29):
So the lock in effect is just like there, It
still exists, It worsens it, but the change is not
as dramatic and as significant as supply curtailing. Is that
initial move.
Speaker 1 (07:39):
It's like reverse convex exactly.
Speaker 3 (07:43):
And I would also say the lock and effect. While
it's enormous spigger than we've seen in a long time,
and it's still with us, it is going to be
slowly eroding as we move forward. Right, mortgagees pay down
at right now about every year two to two and
a half percentage points of these low rate mortgages are
paying off their amortizing. And some of these low coupon borrowers,
(08:05):
for reasons other than economic incentives, would call it turnover
like they are refinancing, right, so they're coming down.
Speaker 2 (08:11):
This is a point tracy that like Connor Sen has
been making in some Bloomberg opinion columns, etc. Which is
that like every year we get, even if it's marginal,
we do get a little bit further away from that
sort of peak refinancing period, and so do have a
little bit of marginal pressure. So you know that supply
constraining pressure. It does fade adventure.
Speaker 1 (08:34):
But I mean just on the actual mortgage rate. Jim,
you have a great chart in your research report, your
latest one. I don't have it directly in front of me,
but I'll try to describe it. Where you show the
effective mortgage rate versus I guess the rate of new
mortgages being made, and there's just a huge gap at
the moment. So most people who have a mortgage in
(08:55):
the US are not paying eight percent currently or anywhere
near it. Really, I mean, that seems like a pretty
big gap. And even if some of those mortgages are
rolling off eventually, it just seems really really slow.
Speaker 3 (09:11):
Correct the effective rate of mortgages in the United States,
the outstanding balance is somewhere between three point six three
point seven percent right now, as we've said in this podcast,
the prevailing rate is approaching eight percent. That is a
gigantic gap that we haven't seen in decades, over forty
years at this point in time. And so even though
it's eroding, you're right, Tracy, it's eroding on the margins.
(09:32):
We don't think that what you're going to see is
an increase in inventory. You're certainly not going to see
a significant increase in inventory. But the rise in rates
in twenty twenty two led to a significant pullback in inventory.
Right now, what we think you're going to see is
much more of a marginal pullback that is one of
the shorter term impacts that we're seeing right now. The
(09:54):
shorter term reaction to this. You mentioned the homebuilder's confidence
index this morning. There was a lot of weakness there.
Supply has pulled back a little bit after easing in
the later parts of twenty two the early parts of
twenty three. We do think in the very short term
that provides a little bit of upward pressure on home prices.
Our base case for the end of the year was
zero percent. Our bual case was plus five. We're moving
(10:14):
towards that bowl case. That's where we think we're going
to end up. But that's just the short term. That's
not the longer term rates we're to stay.
Speaker 2 (10:19):
Here, So I want to obviously we want to get
into the longer term, but just one more sort of
question on the short term. So on the supply side,
the move from seven to eight percent is not nearly
as dramatic as say the move from three percent to
seven percent. We are maybe moving for every day we
get a little bit further away from the low and yield.
What is the short term demand side impact? And you know,
(10:41):
just right now today October seventeenth, twenty twenty three, what
does eight percent mortgage mean for demand.
Speaker 3 (10:49):
It's going to mean that demand is weaker.
Speaker 1 (10:52):
Right.
Speaker 3 (10:52):
We just talked about the percentage increase in the monthly
payment on those mortgages, right, But the question is how
much weaker can demand get. In the same way that
the increase in mortgage rates isn't going to have the
same marginal impact on supply, we also think that it
will be hard for it to have the same marginal
impact on demand. There is a modicum of people that
(11:15):
will need to buy homes even at this challenged level
of affordability. When we look at again kind of the
turnover rates of the housing market, one way that we
estimated that in recent research was existing home sales versus
the total ownership stock of the housing market. That rate
has already fallen to the lows that we experienced during
the Great Financial Crisis. The existing home sales are higher
(11:36):
than that low point, but the housing stock is also larger, right,
And so while that doesn't mean that sales can't fall
further from here, we think that the sharp declines that
we witnessed in twenty twenty two, those are behind us.
Speaker 1 (12:04):
So maybe just from a longer term perspective, if we
could zoom in a little bit on the supply question,
because I feel like this is probably at this point
the lynchpin around which a lot of the prices are
going to sort of revolve. But you know, mortgage rates
clearly starting to have a negative impact on home builder sentiment.
But on the other hand, if we have higher rates
(12:27):
for a longer time, is there the potential for home
builders and people in general, I guess, just to get
used to it and to you know, have confidence that
they can start building again. Like I guess another way
of asking this is what sort of decisions go into
home builders on whether they decide to ramp up construction
(12:51):
and supply.
Speaker 3 (12:52):
So I think that one thing that we're going to need,
I think you're alluding to this is just less volatile
in the rate and market overall. We need more certainty
and where this is going to be on a go
forward basis. And I think when we think about single
unit starts, housing starts in general, but single unit starts
(13:13):
kind of home building in particular, I think we're dealing
with kind of a big headwind and a big tailwind
at the same time, and we're trying to figure out
how those two opposing forces are going to move forward.
We've been talking about the headwind affordability is incredibly challenged.
The tailwind piece of this is that there is a
pretty significant shortage of housing in the United States. That's
(13:34):
more than just the listing of homes for sale. We
don't believe that we've been building enough homes over the
course of the past fifteen years. I can be conservative
with my assumptions and get to roughly a two million
unit shortage. I can be more aggressive and say that
we might be six million units. Shy, we think that
the truth lies somewhere in that range. And by the way,
(13:54):
that's a total of single unit and multi unit housing.
But that shortage should theory be a tailwind in a
world in which maybe not affordability starts improving, but at
least the marginal volatility in that metric comes right.
Speaker 1 (14:10):
Or maybe it stabilizes so that people can at least make,
you know, decisions about their longer term finances.
Speaker 3 (14:16):
That's a good way to put it.
Speaker 2 (14:17):
What what what are the factors in your model that
would you know determine say, like, okay, it could be
two million, six million, Like what are the variables that
did go to that range?
Speaker 3 (14:29):
So if I started on the higher end of yes, right,
we think a lot about the marginal demand for shelter.
We forecast household formations. We've discussed the kind of dynamics
of that in the past.
Speaker 2 (14:38):
You've taught me what these words mean, headship rates, head
ship rates in household. Do we need a headship I
learned from Jim Egan. Now, people got to go back
and listen to the last time, which is when he
explained to me what he explained also on the first time.
We're going to make it. Go back and listen.
Speaker 3 (14:55):
But so we have that marginal demand, okay, and then
we have marginal supply.
Speaker 1 (14:58):
Right.
Speaker 3 (14:58):
It's the addition of both single unit multi unit housing,
all new units that come on on an annual basis.
You control a little bit for the obsolescence of old housing.
And the difficulty with an equilibrium calculation is I could
cherry pick and start in two thousand and nine at
the bottom of the GFC when home builders were really
pulling back and said that the shortage is enormous. Or
I could go back to two thousand, I could go
(15:19):
back to nineteen ninety. I don't know exactly where to
start that calculation, but going back over several decades you
get to a roughly a six million number. But on
the shorter end of this, if we're saying that the
marginal demand for shelter has exceeded the marginal supply of shelter,
one way to prove that would be our vacancy rates
coming down. People are living somewhere, the households are forming,
(15:39):
and so vacancy rates have both owner vacancy rates and
rental vacancy rates have come down significantly throughout this But
if I were to look at that and say, well,
what would it take how much shelter would it take
for us to get back to a long run equilibrium
vacancy rate or a long run average vacancy rate if
you will, And that's more like two million units across
(15:59):
the board. And so we think that the truth lies
somewhere in that range. We know it's a pretty big range,
but they're both pretty big numbers for an overall supply shortage.
Speaker 1 (16:10):
Actually, this reminds me since you mentioned vacancy rates. You know,
one of the interesting things that happened over the past
year or two was this idea that maybe buying a
house is an inflation hedge. So if you can lock
in your cost you know that your landlord isn't going
to send you a letter once a year and say
I'm raising rent by five or ten percent or whatever.
(16:31):
And so that was said to be driving some of
the demand. As mortgage rates continue to go up, would
you expect people to maybe start to go back to renting,
although I realized that like rent itself might not necessarily
be a great option. But you know, if inflation is
starting to cool a little bit, then maybe some of
(16:52):
that dynamic begins to reverse.
Speaker 3 (16:54):
I like the way that you kind of phrased that
juxtaposition from the household or the consumers perspective, and I
do think that as rates go up, Look, even as
rents have climbed in most places, most geographies across the country,
it's still more affordable to rent than it is to
own a home. And the climb in mortgage rates is
contributing to that as well, And so could on the margins,
(17:20):
you see more households elect to remain renters than buy
into the as you put it, the inflation hedge, the
locking in of that shelter payment as opposed to receiving
those every twelve or twenty four months. Rent increases. Sure,
on the margins that that would make sense, but anecdotally.
Speaker 1 (17:41):
Is probably a small percentage.
Speaker 2 (17:43):
Yeah, but it is true that right now, like the
rent versus by calculators, like at various times in some
market like oh you should rent, or sometimes by like
they're over, there's way in the dial towards rent right now, right, yes, okay,
So what else? I mean, what changes the dynamic? I mean,
I mean the other thing that of course could change,
(18:04):
but none of us really know. I mean, there could
be like the sort of miraculous disinflation, right and suddenly
it's like, oh, it's all transitory and everything's fine, and
then the FED like cuts rates and then mortgages. But
let's just say, you know, we can all dream that
that would be the scenario. But outside of that, like
what gives.
Speaker 3 (18:24):
So so the soft landing scenario, yeah, off the table
rates coming down in an other healthy economy. Right, What
we're trying to figure out is just where could supply
come from?
Speaker 1 (18:38):
Yes?
Speaker 3 (18:38):
Right, I think we've referenced the longer term impact of
eight percent mortgage rates, and I haven't spoken to any
potential impacts from a quantitative perspective. But if we think
that it's going to keep demand capped right, the drops
can't be as significant as they were in twenty twenty two,
or at least we don't think they will be. But
we do think that you can talk about a higher
(18:59):
for longer rate and environment in terms of just kind
of preventing sales from really climbing. Then we have to
become super focused on this low inventory, this low supply environment,
because a growth and supply for any reason will lead
to weakness in home prices. If we look at our
models and just put in a five percent increase for
(19:20):
next year, and we were increasing by more than five
percent in that period after May twenty twenty two that
I mentioned, just a five percent increase, if we assume
no growth in sales or no growth in transaction volumes,
our models would say that home prices are down five
percent by the end of next year. That's not our forecast.
As I stated, higher for longer is not our base case,
or mortgage rates at eight percent for the entirety of
next year is not our base case. But that means
(19:42):
that we're That means that that inventory becomes something that
we have to be hyper focused on. And so where
could that come from? Could it come from potentially the
erosion of the lock and effect that we discussed, maybe
on the margins, Tracy, as you pointed out, we're still very,
very fun away from prevailing mortgage, right, so that would
just be on the margins. I believe I've discussed older
(20:04):
homeowners on this podcast before. One out of every three
homes is owned by somebody over sixty five. Over fifty
percent of those homeowners bought their home before the year
two thousand. They have a lot of equity there. Perhaps
they could be listing. The general trend has been more
towards aging in place, so we don't think it's going
to come from there, but that's what we're trying to
figure out. If rates are going to stay elevated, we
think that demand will remain tepid, and if that's the case,
(20:28):
any marginal supply would weigh on home prices.
Speaker 1 (20:31):
Oh yeah, that reminds me. There was Actually there was
a very interesting Barkley's note, so from one of your competitors.
I'm sorry, we're cheating on you with other banks, but
the headline was basically, oh this was this is my headline. Okay,
well whatever, it captured the thrust of the note. The
headline of the summary that I wrote was Barkley says,
(20:54):
blame the boomers for surging house prices. And the idea
here was that you have a lot of this generation
who are choosing to stay in place, they don't want
to move in to nursing homes, and then that is
also affecting Joe headship rates and helping provide a floor
on house prices. I don't want to, you know, ask
(21:16):
you to talk about a competitor's research, but like, maybe
you can talk a little bit more about that dynamic,
like how much of the current resilience in housing is
coming from a large generation of people who want to
stay where they are, and it might even be you know,
downsizing but still moving into new houses.
Speaker 3 (21:36):
I think it is an incredibly important point. We talked
so much about headship rates and household formations, and it
drives the conversation towards millennials and Gen Z because they're
the ones that are moving through their late twenties, their
early to mid thirties, and those age cohorts that have
been so significant in driving the marginal demand for shelter.
(21:58):
I think the reason that we haven't been as focused
on older age cohorts as an industry is because historically
they just haven't been that large. The boomer generation moving
into this age cohort is really driving kind of differentiated
housing dynamics. If we look at the percentage of homes
that are owned by people over sixty five from nineteen
(22:20):
eighty to twenty twelve, it is a very consistent twenty
five percent. The oscillations are really small. As I mentioned
a little bit earlier, it's gone up to thirty three
percent from twenty twelve to today. Given some of the
demographic forecasts from our economics team, it's only going to
move higher right now. And that trend has been aging
(22:42):
in place. While older homeowners do move from time to time,
when they do move, they tend to move to very
similar places Florida, Arizona, South Carolina. For the most part,
they do stay where they are. They age in place.
They are the least mobile age cohort in our population.
I talked about listings being at the lowest levels we've
seen in forty years. The truth is in twenty eighteen
(23:03):
twenty nineteen they were close to forty year lows. And
one of the reasons behind that, we think is this
aging boomer population. What share of housing they're taking up
now from twenty twenty to now, it has dramatically fallen
in and very much reset those lows. But this was
a conversation that we're having pre code Chase.
Speaker 2 (23:39):
You know what I just thought about, maybe it's kind
of tenuous. You know, we had that conversation with Julia
Coronado about like inelastic demand as a big aspect of
this economy these days, and so it's interesting. This is
obviously sort of different than we were talking about the
energy and the energy transition and public spending, but it's
interesting to think about these inelastic forces in the econom
(24:00):
me and so to the extent that there is this
sort of large and growing share of homeowners who's would
the likes of which we've never seen, or getting older,
it's like another aspect of this economy that's sort of inelastic,
this function that's like not part of the cycle totally.
Speaker 1 (24:17):
It also reminds me of the idea that a lot
of economics is about looking at the aggregate data, see
a single number, but within that number you can have
a bunch of disparate groups. And it feels and I
think Julia made this point too, it feels like the
disparity between some of those groups has really been growing.
So you have younger people who absolutely cannot get on
(24:38):
the housing ladder at the moment due to affordability, and
then you have basically completely priced insensitive baby boomers.
Speaker 2 (24:45):
Right many have either they owned their home outright or
they're you know, completely you know, have a three percent
mortgage that's locked in for a long time. So the
thing that I'm taking away from your view on the
sort of like higher for longer rate scenario, and I
get you see Rach maybe coming down at some point
a little bit next year, is that there's not a
(25:06):
lot of upside with price at this point. Like we're
sort of like even under like the sort of benign scenario,
we're really sort of like hitting up against the ceiling
of price potential for housing here.
Speaker 3 (25:17):
If rates stay at these elevated levels. I would agree
with that statement. Yeah, shorter term, I think from now
till the end of the year, a little bit more upside.
Speaker 2 (25:25):
Yeah, but that's probably like a month and a half,
a couple months there. But then but in terms of
like the medium term, there's really like we just can't keep.
Speaker 3 (25:33):
Pushing from here over the medium term. If rates stay
at these levels, we think the demand will remain pretty tepid,
which means that we are reliant upon supply remaining near
historic loths to keep home prices at these levels. And
if you start to get any little bit of give there,
and we were already seeing that from May of twenty
twenty two through the beginning part of this year, if
(25:54):
you start to see that again, that's going to the
rate of change moving off of these lows. We do
think that's going to have a negative implication for home
prices next year.
Speaker 1 (26:05):
There was one other bit of analyst research that I
was reading ahead of this. This one was from Goldman
Sachs and they were commemorating the it's been sixteen years
since the housing crash, I guess. But one thing they
pointed out about the current market is that it seems
like borrowers homeowners are stretching on their mortgage payments relative
(26:27):
to income. So if you look at debt to income
ratios for people who have mortgages, they've been deteriorating for
a while. Now, you know, no one is really concerned
as far as I know, about a repeat of two
thousand and seven, two thousand and eight. I think. The
common argument is that the leverage is simply not there.
Mortgage standards are a lot higher, there's a lot more
(26:49):
scrutiny of borrowers. But does it matter if things like
debt to income ratios start to get stretched? I mean
going back to the affordability point, like, does affordability matter
and how does it play out?
Speaker 3 (27:04):
Yes, debt to income matters when we look at things
like delinquency rates looking at performance on an underlying mortgage basis,
the higher that debt to income is, the more likely
it is that you're going to see higher levels of delinquency.
Of course, controlling for all these other factors, when we
think of mortgage credit availability and our housing framework, we
try to distill all this information that comes in through
(27:26):
our four pillar lens that demands supply, the affordability as
housing market and mortgage credit availability. It's important enough to
be one of those pillars. We like to think of
it through two lenses, borrower risk and product risk. Both
of them are important. Borrow or risk, I think, is
how we typically default to thinking about lending standards, credit scores,
loan to value ratios, debt to income ratios. If debt
(27:48):
income ratios are increasing, that borrow or risk is picking up. Now.
Credit overlays are important. Who are you giving the high
DTI mortgage?
Speaker 1 (27:54):
Two?
Speaker 3 (27:55):
Is it a high credit score borrower? Is it on
a lower LTV loan? All of those things matter, But
I think we also have to focus on the product
risk piece of this. And by product risk, we're talking
about the difference between kind of your thirty year fixed
rate mortgage and some of the products that proliferated a
little bit more in the early two thousands. Talk about
the difference.
Speaker 1 (28:13):
Floating rates, option arms, that sort of thing.
Speaker 3 (28:16):
Option arms those negatively amortizing mortgages that really don't exist anymore,
and the qualifying mortgage definition has kind of labeled them
almost a toxic mortgage product. Short reset arms, so arms
that had a two or three year fixed period with
a low teaser rate that stepped up to a much
higher payment. I think overlaying those easing borrower lending standards
like the TTI that you talked about with some of
(28:37):
those product risks was one of the things that was
kind of endemic of what happened in the early two thousands,
and that product risk has been more or less completely
eliminated from the market this time around, and so that's
one of the reasons why we think we're on much
healthier footing there, why you won't see as much kind
of true distress or defaults in this cycle. One of
the things that keeps kind of home prices a lot
(28:59):
more tected. One of the things that underpinned our view
the first time I came on this in October of
last year, as well, the fact that you weren't going
to see these forced transactions.
Speaker 2 (29:08):
Yeah, well, so I'm gonna just sort of ask Tracy's
question even more like on this force transaction, because that's
where my head went, Like, you know, two thousand and seven,
two thousand and eight, this financial crisis, but we also
just had a lot of a big recession. A lot
of people lost their jobs, and when people lose their jobs,
you know, they can't make their mortgage payment, et cetera.
And then you have the foreclosure sales. Let's say we
(29:29):
actually get this recession that everyone has been missed correctly
forecasting for however, for long eventually.
Speaker 1 (29:36):
Say miss correctly is that a that's a.
Speaker 2 (29:38):
Word right, incorrectly, incorrectly, incorrectly mis forecasting.
Speaker 1 (29:42):
There we go incorrectly, I like it, I think we
should use it.
Speaker 2 (29:45):
Everyone's been missed correctly forecasting. Let's say we get some
kind of recession and unemployment goes from you know, just
some four percent to like five and a half or
six percent something like. Let's say we get a normal recession.
What does that do to supply given the other dynamic
of how many houses are not owned by people who
(30:05):
have a mortgage.
Speaker 3 (30:06):
So it wouldn't be good. And if I could give
a quick shout out to our US economist Hell Center,
who has been calling for a soft landing for quite
some time now, not everyone got a missing correctly, Okay,
but I think that there are two things we have
to keep in mind when thinking about what that could
mean for supply and for this involuntary supply, if you will.
(30:28):
One is consumer's payment priority. One of the axioms that
kind of came out of the last crisis was well,
you can sleep in your car, but you can't drive
your house to work.
Speaker 1 (30:38):
To kind of speak to the idea, I remember that.
I also remember there were these securitization bankers post two
thousand and eight who were making the same argument for
securitizations of phones, and they were saying of like phone loans,
and they're basically saying like, well, you know, you can
sleep in your car, but you definitely like need your phone.
You're never going to give up your phone, and so
(30:59):
it's completely safe. Sorry that was a tangent, but.
Speaker 2 (31:01):
No, that's a good point.
Speaker 1 (31:02):
Reminded me of it.
Speaker 3 (31:03):
I think we would agree if we had the data
to prove it, the cell phone payments should be at
the top of the consumer payment priority waterfall. Just walking
here trying to avoid people that are just staring at
their phone, it has to be up there. Sorry that
was me, But one of the things we're seeing in
the data now, so looking at the abs side of
the world, we saw a pick up in subprime auto
(31:25):
delinquencies last year, okay, And one of the things that
we were saying from our team in Securitized Products research
was that we didn't think you were going to see
the same transmission from subprime delinquencies to prime delinquencies because
a lot of your prime borrowers tend to be homeowners,
and their shelter costs aren't increasing because of everything we've
talked about here. Flash forward to this year, prime delinquencies
start increasing a little bit much more than we certainly
(31:46):
expected them to. And if you look at the way
in which they're increasing, it's not this straight current thirty
sixty ninety day delinquency. It's maybe inflation's higher. Miss one payment,
but stay at thirty days delinquency for a while, miss
another payment, stay at sixty days delinquency for a while.
When we analyze transition rates, we're seeing that, and we
think one thing that could be happening here is these
(32:07):
borrowers are looking to protect the equity they have in
their home. They're looking to protect the very low cost
of shelter, the cost of financing of their home that
they have, and those things that might be leading to
a payment priority shift back towards mortgages, which we think
could protect us a little bit in the environment you're
talking about. But the second piece is the service or
(32:28):
toolkit is what we're calling it. Back in two thousand
and eight, the government, the government introduced the Home Affordable
Modification Program hamp hamp right.
Speaker 1 (32:36):
I used to draw comics about hamp.
Speaker 3 (32:38):
And it was really the first time that servicers had
to implement this big modification program across all these distress
and delinquent borrowers. Foreclosure mitigation options. If you will, borrowers
themselves weren't used to or weren't expecting kind of somebody
they owed money to to give them other options for
paying that. Flash forward fifteen years now, this servicers are
(33:00):
much more practiced at implementing these foreclosure mitigation options. Borrowers,
we believe, are much more likely to know they are
available to them. And so when we're actually looking at
some of our distress scenarios, when we look at like
non agency mortgage backed securities, we're taking delinquency and yes,
we're thinking about the rate at which those delinquent loans
can become distressed and foreclosures and that involuntary supply on
(33:22):
the market that shadow inventory. But we're also a little
bit more focused on the rate at which they become
modifications and what that means the cash flows too. But
if they become modifications, means they don't become supply on
the housing market.
Speaker 1 (33:33):
I mean, it would be incredibly depressing if we had
experienced two thousand and eight and hadn't learned anything from
it in terms of mortgage modifications or actual risk management
for loaning money to would be homeowners. Jim, I just
have one last question, and I'm going to ask you
to I guess, like pretend to be an economist for
(33:55):
a second. But there is there is this open question
about the resilience of the housing market and what it
means for monetary policy, in the sense that with rates
going up, you might have expected to see more of
an impact on home prices and we haven't seen that.
And we've seen various FED speakers sort of scratching their
(34:15):
heads about this. The Richmond Fed's Tom Barkin was on
this podcast recently saying that it's been surprising to him
and maybe if it isn't and maybe if we aren't
seeing more of an impact on housing, maybe that means
the FED has to lean harder on other parts of
the economy. But I guess, you know, try to sum
it up for us, like what does it mean for
(34:36):
monetary policy, for inflation, for the economy in general that
housing has been this resilient.
Speaker 3 (34:43):
So I think we have to take that through again
two different lenses. One, home prices have been very resilient, right,
Other pieces of the housing market have reacted to the
increase that we've seen in mortgage rates. Existing home sales
have fallen more than twice as quickly if we control
(35:04):
for affordability deterioration, more than twice as quickly as they
did during the Great Financial Crisis. Housing starts from their
peak in this cycle, in kind of April May of
twenty twenty two, single unit housing starts are down over
twenty percent. When we think about how the housing market
impacts the economy more broadly, when I work with our
economists at Morgan Stanley, they're just as if not more,
(35:25):
interested in how we're thinking about housing starts and how
we're thinking about sales volumes going forward. If you think
about the job creation from a housing start perspective, especially
a single unit housing start perspective, which creates more than
two times as many jobs as a multi unit housing
start does, and when you think about the amount of
money people spend, either when they just buy a home
or if they're preparing their home to sell like both
of those things have a real impact on the economy
(35:47):
that aren't necessarily as visible as the home price piece
of this, and the home price piece can certainly support
the consumer, especially the homeowning consumer, which is two thirds
of the market. The home ownership rate is still sixty
five to sixty six percent so there are certainly a
lot of different ways to think about this, and keeping
rates higher for longer will continue to weigh on those
(36:09):
sales and starts pieces of the market, and as we've discussed,
if we stay here, could actually start to weigh on
home prices too.
Speaker 1 (36:16):
Yeah, this is a very good reminder that the housing
market is not a monolith and it's not just price.
Jim Egan, thank you so much for coming back on
all thoughts for the third time. Really appreciate it. We'll
have you back on again when mortgage rates hit nine
percent or.
Speaker 2 (36:30):
Seven or seven either direction, either direction. For ever from
here on out.
Speaker 1 (36:36):
We.
Speaker 2 (36:38):
Chat with Jim.
Speaker 3 (36:39):
Thank you so much for having me.
Speaker 1 (36:55):
So Joe. Always great to catch up with Jim. There
were so many interesting things to pull out there. I mean,
one one thing that stuck out to me was that
baby boomer dynamic, which was kind of apparent even before
twenty twenty. So the idea that you could see some
of it in the data in twenty eighteen twenty nineteen,
so more of a structural or secular shift than a
(37:15):
cyclical one. I thought that was really interesting. And also
the point at the end about like, yes, we talk
about housing market resilience, but actually it's basically just price
at this point, and a lot of the activity that
you would associate with housing has been fairly weak, except
for you know, maybe there were a couple months earlier
in the year when it felt like things were starting
(37:36):
to improve, but other than that, it feels like things
have been deteriorating.
Speaker 2 (37:40):
Yeah, I guess absolutely. I think the two takeaways for
me is that, you know, the move from three point
three percent or whatever it was to seven percent, like
that was the big move and moved higher from here, Yeah,
are going to the effect is going to be only marginal.
But also this idea that like, okay, home prices were
able to rie is during the first leg of this
(38:02):
affordability shock, but this idea that it can't really go
any further from here from a price perspective, and that
the only therefore variable that really is going to matter
is supply. And if supply starts to loosen a little bit,
and it might you know, at the margin, then that
starts to create the possibility at least of downside pressure
(38:22):
on prices.
Speaker 1 (38:23):
Yeah, that was a stunning statistic that Jim had that
I think it was like, if there's a five percent
growth in inventory next year that would lead to a
five percent drop in home prices. Yeah, which it gives
you a pretty good idea of like how so much
of it currently rests on the lynchpin of unlocking inventory.
Speaker 2 (38:43):
Yep, that's it. And however we get there so right,
so whether it's there's some marginal impact in theory if
there are layoffs, but even there, he noted, probably for
good that layoffs don't equal liquidations or foreclosures the way
they did in the pre Great Financial Crisis period, which
is a good thing. Whether it's obviously baby boomer, although
he does not see like some imminent demographic shift because
(39:06):
then there's not going to be some imminent change. So
you know, then there's the home builder component the new supply,
but we know they're pulling back. But it really does
seem to me it's like the supply variables are where
it's at from here, because we're sort of tapped out
on the demand variables totally.
Speaker 1 (39:20):
The other thing that was really interesting was the idea
that maybe subordination of mortgages in people's like oh yeah,
references has kind of changed.
Speaker 2 (39:28):
Right, I had right there. It's like, oh, you really
want to. I mean, no one wants to like before
closed up, of course, but if you have a three
percent more or three and a half percent more.
Speaker 1 (39:37):
They really don't want to be exactly that.
Speaker 2 (39:39):
You really don't because so I did think that was
an interesting point to see.
Speaker 1 (39:42):
Yeah, so many things to pull out there. Shall we
leave it there for now?
Speaker 3 (39:46):
Though?
Speaker 2 (39:46):
Let's leave it there?
Speaker 1 (39:47):
Okay. This has been another episode of the All Thoughts podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway
and I'm Joe Wisenthal.
Speaker 2 (39:54):
You can follow me at the Stalwart. Follow our producers
Carmen Rodriguez at Carman Arman and Dashiel Bennett at Dashbot.
And thank you to our producer Moses Ondam. For more
Oddlots content, go to Bloomberg dot com slash odd Lots,
where we have a blog, transcripts and a newsletter and
you can chat twenty four to seven with fellow odd
Lots listeners about all these topics, including in our real
(40:17):
estate channel in the Discord Discord dot gg. Slash odd
Lots really fun place to hang out.
Speaker 1 (40:23):
And if you enjoy Adlots, if you want us to
bring on Jim Egan for a fourth time, when morgat
rates inevitably go up or down, then please leave us
a positive review on your favorite podcast platform. Thanks for listening.
(41:00):
Was an E.
Hello, and welcome to another episode of the Odd Lots Podcast.
I'm Tracy Alloway.
Speaker 2 (00:15):
And I'm Joe Wisenthal.
Speaker 1 (00:17):
Joe, did you see that National Association of Homebuilders survey?
Speaker 2 (00:22):
Uh?
Speaker 3 (00:22):
It was bad.
Speaker 2 (00:23):
I actually didn't see the number, but I think it
was bad.
Speaker 1 (00:25):
Right, Yeah, it wasn't great. So the sentiment of the
homebuilders is falling, which is kind of noteworthy because towards
the beginning of the year we saw a little bit
of a pick up, a little bit of optimism, and
we did see some new construction and that started to
feed into overall housing supply. But fast forward to October
(00:49):
twenty twenty three, rates are going up again, and it
seems like this is finally starting to have something of
a negative impact on how home builders are actually feeling.
Speaker 2 (01:00):
Are recording this, as you say, rates going up, We
were recording this on October seventeenth. Just today, we have
the ten year yield back over four point eight percent
right at the time we're talking. That is basically at
the highs of the cycle. We had dipped for a
little while. And yeah, you mentioned that home builder sentiment number,
and that was like the interesting story with housing has
(01:20):
been resilience, right, resilience and prices, et cetera. Even the
homebuilders had like picked up a bid in the second
in the first half of the year, but we were
actually really heading back down, not far off those lows
that we saw at the end of twenty twenty two.
Speaker 1 (01:34):
Yeah, and meanwhile, mortgage rates, which of course are sort
of priced off of treasuries, are getting close to eight percent.
That's the highest level I think since something like two thousand.
So we have to discuss this. And you know, the
last couple times we dug into the housing market, we
spoke with Morgan Stanley's US housing strategist Jim Egan. In fact,
(01:54):
we spoke to him for the first time in October
of last year in an episode that we call well,
here's what seven percent mortgage rates will do to the
housing market. So now twelve months later, we're just gonna
do here's what eight percent mortgage rates will do to
the housing market.
Speaker 2 (02:08):
Here we got, Yeah, we just don't one percent at
a time. We'll just keep having Jim back.
Speaker 1 (02:11):
On that's right. But actually, on a serious note, one
of the reasons we like talking to Jim Egan is
that he was a bit of an outlier when we
first had him on. You know, when mortgage rates were
shooting up, a lot of people were predicting this really
big housing crash, and meanwhile Jim was forecasting a slight
dip basically followed by a rise, which is exactly what
(02:34):
we saw happen. And he was kind of early to
that whole lock in idea that you see everywhere now,
So the notion that people who are lucky enough to
have locked in mortgages when rates were at essentially zero
are now going to be very reluctant to move and
take on a higher mortgage cost, and so that basically
helped provide a floor on prices. So we liked talking
(02:57):
to Jim, and we thought, even though we spoke to
him one over the summer, given that rates are shooting
up even more, we should definitely do it again.
Speaker 2 (03:04):
I'm excited about it.
Speaker 1 (03:05):
Let's do it all right, Jim, welcome back to the show.
Speaker 3 (03:08):
Thank you so much for having me. It is an
honor to be asked back.
Speaker 1 (03:12):
Third time's the best time. Okay. So, you know, we've
spoken a lot to you about what higher rates mean
for housing in the short term, and as I said
in the intro, you were early to that whole lock
in idea. But I guess let's just jump into it.
If we assume that higher for longer is here to
stay for the foreseeable future, what does that mean for
(03:34):
housing over a longer term horizon?
Speaker 3 (03:37):
Sure, And I think that the way that you're characterizing
this is important, right We have to disaggregate the short
term impact of this most recent increase in rates versus
a longer term impact here. Now, what I will caveat
some of these comments by saying is that currently we're
not forecasting rates to remain at these elevated levels for
(03:59):
the law longer term. We do think that the tenure
will come down through the middle of next year, and
we think that mortgage rates will come down as part
of that. But given what's happened to rates, that is
a very important question right now. And I think this
starts with affordability, right We talked about affordability on this
podcast when I was able to visit previous to this,
and one of the things that characterized twenty twenty two
(04:23):
was just an historic, at least through the history of
our data, a decline or a deterioration and affordability that
we hadn't seen year over year changes were three times
worse than what we witnessed during the Great Financial Crisis
and earlier this year, affordability stopped deteriorating at those paces
some shorter term affordability metrics. If we look at it
(04:43):
over three months, over six months, affordability was actually improving.
That's no longer the case, right.
Speaker 1 (04:49):
It was a blit basically along with the like tiny,
tiny dip in house prices.
Speaker 3 (04:54):
Exactly, and if mortgage rates were to stay at eight
percent for a longer period of time, affordability deterioration would
return back to a place that we haven't seen in
decades in the twenty twenty two period. Notwithstanding, it's pretty incredible,
just you know, tugget percentage points can sometimes be abstract.
But our colleague Michael McDonough regularly posts this chart, and
(05:18):
this was about a month ago so or even higher
than we were before. But he posted this chart showing
like a median house with a thirty year mortgage just
sort of really standard. You know, a few years ago,
a monthly payment might be like about one thousand. It
is up to twenty three hundred as of according to
a typical thirty year mortgage rate. But there versus March
twenty twenty when we were at the lows and probably
(05:38):
not a lot of people got mortgages. Nonetheless, like when
you put those numbers in, I mean, it's just an
extraordinary affordability shock. It's incredible, Like one of the numbers
that we were looking at recently, not relative to March
twenty twenty. But to put it into context, the extent
to which we've seen mortgage rates increase, the payments up
over one hundred and twenty percent since the lows and
mortgage rates that we saw in the early part of
(06:00):
twenty twenty two. And you've mentioned the lock and effect
that is kind of a well discussed topic at this
point in time, and yes it's still present. But when
we think about the longer term impacts of this move,
the move from twenty twenty two saw almost a four
hundred basis point increase from three percent to seven percent.
When first time you invited Yeah onto this podcast. That
(06:22):
took a lot of homeowners, a lot of mortgaged homeowners,
from sort of at the money around the prevailing mortgage
rate to deeply out of the money locked into their
mortgage payment. The move now up to eight percent mortgage rates,
it's not capturing the same quantum of marginal homeowner and
so the impact on things like supply, the impact on demand,
(06:44):
especially that the rate of change is not going to
be the same this time around than it was in
twenty twenty two.
Speaker 1 (06:52):
Sorry, can you explain that a little bit further?
Speaker 3 (06:54):
Right? So, as borrowers were moving further and further out
of the money in twenty twenty two, we saw specifically
the listings of homes available for sale fall to right,
far and away the lowest level we have on record,
right where we have that data going back over forty years,
never lower by our metrics. Hit a low in May
of twenty twenty two. Right now, as rates kind of
(07:14):
held flat, maybe improved a little bit at those levels,
you started to see inventory pick up a little bit.
As rates have gone back to eight percent. We're testing
those lows again, but it's going to be difficult given
that you're not moving hundreds of thousands or millions of
homeowners out of the money.
Speaker 2 (07:29):
So the lock in effect is just like there, It
still exists, It worsens it, but the change is not
as dramatic and as significant as supply curtailing. Is that
initial move.
Speaker 1 (07:39):
It's like reverse convex exactly.
Speaker 3 (07:43):
And I would also say the lock and effect. While
it's enormous spigger than we've seen in a long time,
and it's still with us, it is going to be
slowly eroding as we move forward. Right, mortgagees pay down
at right now about every year two to two and
a half percentage points of these low rate mortgages are
paying off their amortizing. And some of these low coupon borrowers,
(08:05):
for reasons other than economic incentives, would call it turnover
like they are refinancing, right, so they're coming down.
Speaker 2 (08:11):
This is a point tracy that like Connor Sen has
been making in some Bloomberg opinion columns, etc. Which is
that like every year we get, even if it's marginal,
we do get a little bit further away from that
sort of peak refinancing period, and so do have a
little bit of marginal pressure. So you know that supply
constraining pressure. It does fade adventure.
Speaker 1 (08:34):
But I mean just on the actual mortgage rate. Jim,
you have a great chart in your research report, your
latest one. I don't have it directly in front of me,
but I'll try to describe it. Where you show the
effective mortgage rate versus I guess the rate of new
mortgages being made, and there's just a huge gap at
the moment. So most people who have a mortgage in
(08:55):
the US are not paying eight percent currently or anywhere
near it. Really, I mean, that seems like a pretty
big gap. And even if some of those mortgages are
rolling off eventually, it just seems really really slow.
Speaker 3 (09:11):
Correct the effective rate of mortgages in the United States,
the outstanding balance is somewhere between three point six three
point seven percent right now, as we've said in this podcast,
the prevailing rate is approaching eight percent. That is a
gigantic gap that we haven't seen in decades, over forty
years at this point in time. And so even though
it's eroding, you're right, Tracy, it's eroding on the margins.
(09:32):
We don't think that what you're going to see is
an increase in inventory. You're certainly not going to see
a significant increase in inventory. But the rise in rates
in twenty twenty two led to a significant pullback in inventory.
Right now, what we think you're going to see is
much more of a marginal pullback that is one of
the shorter term impacts that we're seeing right now. The
(09:54):
shorter term reaction to this. You mentioned the homebuilder's confidence
index this morning. There was a lot of weakness there.
Supply has pulled back a little bit after easing in
the later parts of twenty two the early parts of
twenty three. We do think in the very short term
that provides a little bit of upward pressure on home prices.
Our base case for the end of the year was
zero percent. Our bual case was plus five. We're moving
(10:14):
towards that bowl case. That's where we think we're going
to end up. But that's just the short term. That's
not the longer term rates we're to stay.
Speaker 2 (10:19):
Here, So I want to obviously we want to get
into the longer term, but just one more sort of
question on the short term. So on the supply side,
the move from seven to eight percent is not nearly
as dramatic as say the move from three percent to
seven percent. We are maybe moving for every day we
get a little bit further away from the low and yield.
What is the short term demand side impact? And you know,
(10:41):
just right now today October seventeenth, twenty twenty three, what
does eight percent mortgage mean for demand.
Speaker 3 (10:49):
It's going to mean that demand is weaker.
Speaker 1 (10:52):
Right.
Speaker 3 (10:52):
We just talked about the percentage increase in the monthly
payment on those mortgages, right, But the question is how
much weaker can demand get. In the same way that
the increase in mortgage rates isn't going to have the
same marginal impact on supply, we also think that it
will be hard for it to have the same marginal
impact on demand. There is a modicum of people that
(11:15):
will need to buy homes even at this challenged level
of affordability. When we look at again kind of the
turnover rates of the housing market, one way that we
estimated that in recent research was existing home sales versus
the total ownership stock of the housing market. That rate
has already fallen to the lows that we experienced during
the Great Financial Crisis. The existing home sales are higher
(11:36):
than that low point, but the housing stock is also larger, right,
And so while that doesn't mean that sales can't fall
further from here, we think that the sharp declines that
we witnessed in twenty twenty two, those are behind us.
Speaker 1 (12:04):
So maybe just from a longer term perspective, if we
could zoom in a little bit on the supply question,
because I feel like this is probably at this point
the lynchpin around which a lot of the prices are
going to sort of revolve. But you know, mortgage rates
clearly starting to have a negative impact on home builder sentiment.
But on the other hand, if we have higher rates
(12:27):
for a longer time, is there the potential for home
builders and people in general, I guess, just to get
used to it and to you know, have confidence that
they can start building again. Like I guess another way
of asking this is what sort of decisions go into
home builders on whether they decide to ramp up construction
(12:51):
and supply.
Speaker 3 (12:52):
So I think that one thing that we're going to need,
I think you're alluding to this is just less volatile
in the rate and market overall. We need more certainty
and where this is going to be on a go
forward basis. And I think when we think about single
unit starts, housing starts in general, but single unit starts
(13:13):
kind of home building in particular, I think we're dealing
with kind of a big headwind and a big tailwind
at the same time, and we're trying to figure out
how those two opposing forces are going to move forward.
We've been talking about the headwind affordability is incredibly challenged.
The tailwind piece of this is that there is a
pretty significant shortage of housing in the United States. That's
(13:34):
more than just the listing of homes for sale. We
don't believe that we've been building enough homes over the
course of the past fifteen years. I can be conservative
with my assumptions and get to roughly a two million
unit shortage. I can be more aggressive and say that
we might be six million units. Shy, we think that
the truth lies somewhere in that range. And by the way,
(13:54):
that's a total of single unit and multi unit housing.
But that shortage should theory be a tailwind in a
world in which maybe not affordability starts improving, but at
least the marginal volatility in that metric comes right.
Speaker 1 (14:10):
Or maybe it stabilizes so that people can at least make,
you know, decisions about their longer term finances.
Speaker 3 (14:16):
That's a good way to put it.
Speaker 2 (14:17):
What what what are the factors in your model that
would you know determine say, like, okay, it could be
two million, six million, Like what are the variables that
did go to that range?
Speaker 3 (14:29):
So if I started on the higher end of yes, right,
we think a lot about the marginal demand for shelter.
We forecast household formations. We've discussed the kind of dynamics
of that in the past.
Speaker 2 (14:38):
You've taught me what these words mean, headship rates, head
ship rates in household. Do we need a headship I
learned from Jim Egan. Now, people got to go back
and listen to the last time, which is when he
explained to me what he explained also on the first time.
We're going to make it. Go back and listen.
Speaker 3 (14:55):
But so we have that marginal demand, okay, and then
we have marginal supply.
Speaker 1 (14:58):
Right.
Speaker 3 (14:58):
It's the addition of both single unit multi unit housing,
all new units that come on on an annual basis.
You control a little bit for the obsolescence of old housing.
And the difficulty with an equilibrium calculation is I could
cherry pick and start in two thousand and nine at
the bottom of the GFC when home builders were really
pulling back and said that the shortage is enormous. Or
I could go back to two thousand, I could go
(15:19):
back to nineteen ninety. I don't know exactly where to
start that calculation, but going back over several decades you
get to a roughly a six million number. But on
the shorter end of this, if we're saying that the
marginal demand for shelter has exceeded the marginal supply of shelter,
one way to prove that would be our vacancy rates
coming down. People are living somewhere, the households are forming,
(15:39):
and so vacancy rates have both owner vacancy rates and
rental vacancy rates have come down significantly throughout this But
if I were to look at that and say, well,
what would it take how much shelter would it take
for us to get back to a long run equilibrium
vacancy rate or a long run average vacancy rate if
you will, And that's more like two million units across
(15:59):
the board. And so we think that the truth lies
somewhere in that range. We know it's a pretty big range,
but they're both pretty big numbers for an overall supply shortage.
Speaker 1 (16:10):
Actually, this reminds me since you mentioned vacancy rates. You know,
one of the interesting things that happened over the past
year or two was this idea that maybe buying a
house is an inflation hedge. So if you can lock
in your cost you know that your landlord isn't going
to send you a letter once a year and say
I'm raising rent by five or ten percent or whatever.
(16:31):
And so that was said to be driving some of
the demand. As mortgage rates continue to go up, would
you expect people to maybe start to go back to renting,
although I realized that like rent itself might not necessarily
be a great option. But you know, if inflation is
starting to cool a little bit, then maybe some of
(16:52):
that dynamic begins to reverse.
Speaker 3 (16:54):
I like the way that you kind of phrased that
juxtaposition from the household or the consumers perspective, and I
do think that as rates go up, Look, even as
rents have climbed in most places, most geographies across the country,
it's still more affordable to rent than it is to
own a home. And the climb in mortgage rates is
contributing to that as well, And so could on the margins,
(17:20):
you see more households elect to remain renters than buy
into the as you put it, the inflation hedge, the
locking in of that shelter payment as opposed to receiving
those every twelve or twenty four months. Rent increases. Sure,
on the margins that that would make sense, but anecdotally.
Speaker 1 (17:41):
Is probably a small percentage.
Speaker 2 (17:43):
Yeah, but it is true that right now, like the
rent versus by calculators, like at various times in some
market like oh you should rent, or sometimes by like
they're over, there's way in the dial towards rent right now, right, yes, okay,
So what else? I mean, what changes the dynamic? I mean,
I mean the other thing that of course could change,
(18:04):
but none of us really know. I mean, there could
be like the sort of miraculous disinflation, right and suddenly
it's like, oh, it's all transitory and everything's fine, and
then the FED like cuts rates and then mortgages. But
let's just say, you know, we can all dream that
that would be the scenario. But outside of that, like
what gives.
Speaker 3 (18:24):
So so the soft landing scenario, yeah, off the table
rates coming down in an other healthy economy. Right, What
we're trying to figure out is just where could supply
come from?
Speaker 1 (18:38):
Yes?
Speaker 3 (18:38):
Right, I think we've referenced the longer term impact of
eight percent mortgage rates, and I haven't spoken to any
potential impacts from a quantitative perspective. But if we think
that it's going to keep demand capped right, the drops
can't be as significant as they were in twenty twenty two,
or at least we don't think they will be. But
we do think that you can talk about a higher
(18:59):
for longer rate and environment in terms of just kind
of preventing sales from really climbing. Then we have to
become super focused on this low inventory, this low supply environment,
because a growth and supply for any reason will lead
to weakness in home prices. If we look at our
models and just put in a five percent increase for
(19:20):
next year, and we were increasing by more than five
percent in that period after May twenty twenty two that
I mentioned, just a five percent increase, if we assume
no growth in sales or no growth in transaction volumes,
our models would say that home prices are down five
percent by the end of next year. That's not our forecast.
As I stated, higher for longer is not our base case,
or mortgage rates at eight percent for the entirety of
next year is not our base case. But that means
(19:42):
that we're That means that that inventory becomes something that
we have to be hyper focused on. And so where
could that come from? Could it come from potentially the
erosion of the lock and effect that we discussed, maybe
on the margins, Tracy, as you pointed out, we're still very,
very fun away from prevailing mortgage, right, so that would
just be on the margins. I believe I've discussed older
(20:04):
homeowners on this podcast before. One out of every three
homes is owned by somebody over sixty five. Over fifty
percent of those homeowners bought their home before the year
two thousand. They have a lot of equity there. Perhaps
they could be listing. The general trend has been more
towards aging in place, so we don't think it's going
to come from there, but that's what we're trying to
figure out. If rates are going to stay elevated, we
think that demand will remain tepid, and if that's the case,
(20:28):
any marginal supply would weigh on home prices.
Speaker 1 (20:31):
Oh yeah, that reminds me. There was Actually there was
a very interesting Barkley's note, so from one of your competitors.
I'm sorry, we're cheating on you with other banks, but
the headline was basically, oh this was this is my headline. Okay,
well whatever, it captured the thrust of the note. The
headline of the summary that I wrote was Barkley says,
(20:54):
blame the boomers for surging house prices. And the idea
here was that you have a lot of this generation
who are choosing to stay in place, they don't want
to move in to nursing homes, and then that is
also affecting Joe headship rates and helping provide a floor
on house prices. I don't want to, you know, ask
(21:16):
you to talk about a competitor's research, but like, maybe
you can talk a little bit more about that dynamic,
like how much of the current resilience in housing is
coming from a large generation of people who want to
stay where they are, and it might even be you know,
downsizing but still moving into new houses.
Speaker 3 (21:36):
I think it is an incredibly important point. We talked
so much about headship rates and household formations, and it
drives the conversation towards millennials and Gen Z because they're
the ones that are moving through their late twenties, their
early to mid thirties, and those age cohorts that have
been so significant in driving the marginal demand for shelter.
(21:58):
I think the reason that we haven't been as focused
on older age cohorts as an industry is because historically
they just haven't been that large. The boomer generation moving
into this age cohort is really driving kind of differentiated
housing dynamics. If we look at the percentage of homes
that are owned by people over sixty five from nineteen
(22:20):
eighty to twenty twelve, it is a very consistent twenty
five percent. The oscillations are really small. As I mentioned
a little bit earlier, it's gone up to thirty three
percent from twenty twelve to today. Given some of the
demographic forecasts from our economics team, it's only going to
move higher right now. And that trend has been aging
(22:42):
in place. While older homeowners do move from time to time,
when they do move, they tend to move to very
similar places Florida, Arizona, South Carolina. For the most part,
they do stay where they are. They age in place.
They are the least mobile age cohort in our population.
I talked about listings being at the lowest levels we've
seen in forty years. The truth is in twenty eighteen
(23:03):
twenty nineteen they were close to forty year lows. And
one of the reasons behind that, we think is this
aging boomer population. What share of housing they're taking up
now from twenty twenty to now, it has dramatically fallen
in and very much reset those lows. But this was
a conversation that we're having pre code Chase.
Speaker 2 (23:39):
You know what I just thought about, maybe it's kind
of tenuous. You know, we had that conversation with Julia
Coronado about like inelastic demand as a big aspect of
this economy these days, and so it's interesting. This is
obviously sort of different than we were talking about the
energy and the energy transition and public spending, but it's
interesting to think about these inelastic forces in the econom
(24:00):
me and so to the extent that there is this
sort of large and growing share of homeowners who's would
the likes of which we've never seen, or getting older,
it's like another aspect of this economy that's sort of inelastic,
this function that's like not part of the cycle totally.
Speaker 1 (24:17):
It also reminds me of the idea that a lot
of economics is about looking at the aggregate data, see
a single number, but within that number you can have
a bunch of disparate groups. And it feels and I
think Julia made this point too, it feels like the
disparity between some of those groups has really been growing.
So you have younger people who absolutely cannot get on
(24:38):
the housing ladder at the moment due to affordability, and
then you have basically completely priced insensitive baby boomers.
Speaker 2 (24:45):
Right many have either they owned their home outright or
they're you know, completely you know, have a three percent
mortgage that's locked in for a long time. So the
thing that I'm taking away from your view on the
sort of like higher for longer rate scenario, and I
get you see Rach maybe coming down at some point
a little bit next year, is that there's not a
(25:06):
lot of upside with price at this point. Like we're
sort of like even under like the sort of benign scenario,
we're really sort of like hitting up against the ceiling
of price potential for housing here.
Speaker 3 (25:17):
If rates stay at these elevated levels. I would agree
with that statement. Yeah, shorter term, I think from now
till the end of the year, a little bit more upside.
Speaker 2 (25:25):
Yeah, but that's probably like a month and a half,
a couple months there. But then but in terms of
like the medium term, there's really like we just can't keep.
Speaker 3 (25:33):
Pushing from here over the medium term. If rates stay
at these levels, we think the demand will remain pretty tepid,
which means that we are reliant upon supply remaining near
historic loths to keep home prices at these levels. And
if you start to get any little bit of give there,
and we were already seeing that from May of twenty
twenty two through the beginning part of this year, if
(25:54):
you start to see that again, that's going to the
rate of change moving off of these lows. We do
think that's going to have a negative implication for home
prices next year.
Speaker 1 (26:05):
There was one other bit of analyst research that I
was reading ahead of this. This one was from Goldman
Sachs and they were commemorating the it's been sixteen years
since the housing crash, I guess. But one thing they
pointed out about the current market is that it seems
like borrowers homeowners are stretching on their mortgage payments relative
(26:27):
to income. So if you look at debt to income
ratios for people who have mortgages, they've been deteriorating for
a while. Now, you know, no one is really concerned
as far as I know, about a repeat of two
thousand and seven, two thousand and eight. I think. The
common argument is that the leverage is simply not there.
Mortgage standards are a lot higher, there's a lot more
(26:49):
scrutiny of borrowers. But does it matter if things like
debt to income ratios start to get stretched? I mean
going back to the affordability point, like, does affordability matter
and how does it play out?
Speaker 3 (27:04):
Yes, debt to income matters when we look at things
like delinquency rates looking at performance on an underlying mortgage basis,
the higher that debt to income is, the more likely
it is that you're going to see higher levels of delinquency.
Of course, controlling for all these other factors, when we
think of mortgage credit availability and our housing framework, we
try to distill all this information that comes in through
(27:26):
our four pillar lens that demands supply, the affordability as
housing market and mortgage credit availability. It's important enough to
be one of those pillars. We like to think of
it through two lenses, borrower risk and product risk. Both
of them are important. Borrow or risk, I think, is
how we typically default to thinking about lending standards, credit scores,
loan to value ratios, debt to income ratios. If debt
(27:48):
income ratios are increasing, that borrow or risk is picking up. Now.
Credit overlays are important. Who are you giving the high
DTI mortgage?
Speaker 1 (27:54):
Two?
Speaker 3 (27:55):
Is it a high credit score borrower? Is it on
a lower LTV loan? All of those things matter, But
I think we also have to focus on the product
risk piece of this. And by product risk, we're talking
about the difference between kind of your thirty year fixed
rate mortgage and some of the products that proliferated a
little bit more in the early two thousands. Talk about
the difference.
Speaker 1 (28:13):
Floating rates, option arms, that sort of thing.
Speaker 3 (28:16):
Option arms those negatively amortizing mortgages that really don't exist anymore,
and the qualifying mortgage definition has kind of labeled them
almost a toxic mortgage product. Short reset arms, so arms
that had a two or three year fixed period with
a low teaser rate that stepped up to a much
higher payment. I think overlaying those easing borrower lending standards
like the TTI that you talked about with some of
(28:37):
those product risks was one of the things that was
kind of endemic of what happened in the early two thousands,
and that product risk has been more or less completely
eliminated from the market this time around, and so that's
one of the reasons why we think we're on much
healthier footing there, why you won't see as much kind
of true distress or defaults in this cycle. One of
the things that keeps kind of home prices a lot
(28:59):
more tected. One of the things that underpinned our view
the first time I came on this in October of
last year, as well, the fact that you weren't going
to see these forced transactions.
Speaker 2 (29:08):
Yeah, well, so I'm gonna just sort of ask Tracy's
question even more like on this force transaction, because that's
where my head went, Like, you know, two thousand and seven,
two thousand and eight, this financial crisis, but we also
just had a lot of a big recession. A lot
of people lost their jobs, and when people lose their jobs,
you know, they can't make their mortgage payment, et cetera.
And then you have the foreclosure sales. Let's say we
(29:29):
actually get this recession that everyone has been missed correctly
forecasting for however, for long eventually.
Speaker 1 (29:36):
Say miss correctly is that a that's a.
Speaker 2 (29:38):
Word right, incorrectly, incorrectly, incorrectly mis forecasting.
Speaker 1 (29:42):
There we go incorrectly, I like it, I think we
should use it.
Speaker 2 (29:45):
Everyone's been missed correctly forecasting. Let's say we get some
kind of recession and unemployment goes from you know, just
some four percent to like five and a half or
six percent something like. Let's say we get a normal recession.
What does that do to supply given the other dynamic
of how many houses are not owned by people who
(30:05):
have a mortgage.
Speaker 3 (30:06):
So it wouldn't be good. And if I could give
a quick shout out to our US economist Hell Center,
who has been calling for a soft landing for quite
some time now, not everyone got a missing correctly, Okay,
but I think that there are two things we have
to keep in mind when thinking about what that could
mean for supply and for this involuntary supply, if you will.
(30:28):
One is consumer's payment priority. One of the axioms that
kind of came out of the last crisis was well,
you can sleep in your car, but you can't drive
your house to work.
Speaker 1 (30:38):
To kind of speak to the idea, I remember that.
I also remember there were these securitization bankers post two
thousand and eight who were making the same argument for
securitizations of phones, and they were saying of like phone loans,
and they're basically saying like, well, you know, you can
sleep in your car, but you definitely like need your phone.
You're never going to give up your phone, and so
(30:59):
it's completely safe. Sorry that was a tangent, but.
Speaker 2 (31:01):
No, that's a good point.
Speaker 1 (31:02):
Reminded me of it.
Speaker 3 (31:03):
I think we would agree if we had the data
to prove it, the cell phone payments should be at
the top of the consumer payment priority waterfall. Just walking
here trying to avoid people that are just staring at
their phone, it has to be up there. Sorry that
was me, But one of the things we're seeing in
the data now, so looking at the abs side of
the world, we saw a pick up in subprime auto
(31:25):
delinquencies last year, okay, And one of the things that
we were saying from our team in Securitized Products research
was that we didn't think you were going to see
the same transmission from subprime delinquencies to prime delinquencies because
a lot of your prime borrowers tend to be homeowners,
and their shelter costs aren't increasing because of everything we've
talked about here. Flash forward to this year, prime delinquencies
start increasing a little bit much more than we certainly
(31:46):
expected them to. And if you look at the way
in which they're increasing, it's not this straight current thirty
sixty ninety day delinquency. It's maybe inflation's higher. Miss one payment,
but stay at thirty days delinquency for a while, miss
another payment, stay at sixty days delinquency for a while.
When we analyze transition rates, we're seeing that, and we
think one thing that could be happening here is these
(32:07):
borrowers are looking to protect the equity they have in
their home. They're looking to protect the very low cost
of shelter, the cost of financing of their home that
they have, and those things that might be leading to
a payment priority shift back towards mortgages, which we think
could protect us a little bit in the environment you're
talking about. But the second piece is the service or
(32:28):
toolkit is what we're calling it. Back in two thousand
and eight, the government, the government introduced the Home Affordable
Modification Program hamp hamp right.
Speaker 1 (32:36):
I used to draw comics about hamp.
Speaker 3 (32:38):
And it was really the first time that servicers had
to implement this big modification program across all these distress
and delinquent borrowers. Foreclosure mitigation options. If you will, borrowers
themselves weren't used to or weren't expecting kind of somebody
they owed money to to give them other options for
paying that. Flash forward fifteen years now, this servicers are
(33:00):
much more practiced at implementing these foreclosure mitigation options. Borrowers,
we believe, are much more likely to know they are
available to them. And so when we're actually looking at
some of our distress scenarios, when we look at like
non agency mortgage backed securities, we're taking delinquency and yes,
we're thinking about the rate at which those delinquent loans
can become distressed and foreclosures and that involuntary supply on
(33:22):
the market that shadow inventory. But we're also a little
bit more focused on the rate at which they become
modifications and what that means the cash flows too. But
if they become modifications, means they don't become supply on
the housing market.
Speaker 1 (33:33):
I mean, it would be incredibly depressing if we had
experienced two thousand and eight and hadn't learned anything from
it in terms of mortgage modifications or actual risk management
for loaning money to would be homeowners. Jim, I just
have one last question, and I'm going to ask you
to I guess, like pretend to be an economist for
(33:55):
a second. But there is there is this open question
about the resilience of the housing market and what it
means for monetary policy, in the sense that with rates
going up, you might have expected to see more of
an impact on home prices and we haven't seen that.
And we've seen various FED speakers sort of scratching their
(34:15):
heads about this. The Richmond Fed's Tom Barkin was on
this podcast recently saying that it's been surprising to him
and maybe if it isn't and maybe if we aren't
seeing more of an impact on housing, maybe that means
the FED has to lean harder on other parts of
the economy. But I guess, you know, try to sum
it up for us, like what does it mean for
(34:36):
monetary policy, for inflation, for the economy in general that
housing has been this resilient.
Speaker 3 (34:43):
So I think we have to take that through again
two different lenses. One, home prices have been very resilient, right,
Other pieces of the housing market have reacted to the
increase that we've seen in mortgage rates. Existing home sales
have fallen more than twice as quickly if we control
(35:04):
for affordability deterioration, more than twice as quickly as they
did during the Great Financial Crisis. Housing starts from their
peak in this cycle, in kind of April May of
twenty twenty two, single unit housing starts are down over
twenty percent. When we think about how the housing market
impacts the economy more broadly, when I work with our
economists at Morgan Stanley, they're just as if not more,
(35:25):
interested in how we're thinking about housing starts and how
we're thinking about sales volumes going forward. If you think
about the job creation from a housing start perspective, especially
a single unit housing start perspective, which creates more than
two times as many jobs as a multi unit housing
start does, and when you think about the amount of
money people spend, either when they just buy a home
or if they're preparing their home to sell like both
of those things have a real impact on the economy
(35:47):
that aren't necessarily as visible as the home price piece
of this, and the home price piece can certainly support
the consumer, especially the homeowning consumer, which is two thirds
of the market. The home ownership rate is still sixty
five to sixty six percent so there are certainly a
lot of different ways to think about this, and keeping
rates higher for longer will continue to weigh on those
(36:09):
sales and starts pieces of the market, and as we've discussed,
if we stay here, could actually start to weigh on
home prices too.
Speaker 1 (36:16):
Yeah, this is a very good reminder that the housing
market is not a monolith and it's not just price.
Jim Egan, thank you so much for coming back on
all thoughts for the third time. Really appreciate it. We'll
have you back on again when mortgage rates hit nine
percent or.
Speaker 2 (36:30):
Seven or seven either direction, either direction. For ever from
here on out.
Speaker 1 (36:36):
We.
Speaker 2 (36:38):
Chat with Jim.
Speaker 3 (36:39):
Thank you so much for having me.
Speaker 1 (36:55):
So Joe. Always great to catch up with Jim. There
were so many interesting things to pull out there. I mean,
one one thing that stuck out to me was that
baby boomer dynamic, which was kind of apparent even before
twenty twenty. So the idea that you could see some
of it in the data in twenty eighteen twenty nineteen,
so more of a structural or secular shift than a
(37:15):
cyclical one. I thought that was really interesting. And also
the point at the end about like, yes, we talk
about housing market resilience, but actually it's basically just price
at this point, and a lot of the activity that
you would associate with housing has been fairly weak, except
for you know, maybe there were a couple months earlier
in the year when it felt like things were starting
(37:36):
to improve, but other than that, it feels like things
have been deteriorating.
Speaker 2 (37:40):
Yeah, I guess absolutely. I think the two takeaways for
me is that, you know, the move from three point
three percent or whatever it was to seven percent, like
that was the big move and moved higher from here, Yeah,
are going to the effect is going to be only marginal.
But also this idea that like, okay, home prices were
able to rie is during the first leg of this
(38:02):
affordability shock, but this idea that it can't really go
any further from here from a price perspective, and that
the only therefore variable that really is going to matter
is supply. And if supply starts to loosen a little bit,
and it might you know, at the margin, then that
starts to create the possibility at least of downside pressure
(38:22):
on prices.
Speaker 1 (38:23):
Yeah, that was a stunning statistic that Jim had that
I think it was like, if there's a five percent
growth in inventory next year that would lead to a
five percent drop in home prices. Yeah, which it gives
you a pretty good idea of like how so much
of it currently rests on the lynchpin of unlocking inventory.
Speaker 2 (38:43):
Yep, that's it. And however we get there so right,
so whether it's there's some marginal impact in theory if
there are layoffs, but even there, he noted, probably for
good that layoffs don't equal liquidations or foreclosures the way
they did in the pre Great Financial Crisis period, which
is a good thing. Whether it's obviously baby boomer, although
he does not see like some imminent demographic shift because
(39:06):
then there's not going to be some imminent change. So
you know, then there's the home builder component the new supply,
but we know they're pulling back. But it really does
seem to me it's like the supply variables are where
it's at from here, because we're sort of tapped out
on the demand variables totally.
Speaker 1 (39:20):
The other thing that was really interesting was the idea
that maybe subordination of mortgages in people's like oh yeah,
references has kind of changed.
Speaker 2 (39:28):
Right, I had right there. It's like, oh, you really
want to. I mean, no one wants to like before
closed up, of course, but if you have a three
percent more or three and a half percent more.
Speaker 1 (39:37):
They really don't want to be exactly that.
Speaker 2 (39:39):
You really don't because so I did think that was
an interesting point to see.
Speaker 1 (39:42):
Yeah, so many things to pull out there. Shall we
leave it there for now?
Speaker 3 (39:46):
Though?
Speaker 2 (39:46):
Let's leave it there?
Speaker 1 (39:47):
Okay. This has been another episode of the All Thoughts podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway
and I'm Joe Wisenthal.
Speaker 2 (39:54):
You can follow me at the Stalwart. Follow our producers
Carmen Rodriguez at Carman Arman and Dashiel Bennett at Dashbot.
And thank you to our producer Moses Ondam. For more
Oddlots content, go to Bloomberg dot com slash odd Lots,
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(40:17):
estate channel in the Discord Discord dot gg. Slash odd
Lots really fun place to hang out.
Speaker 1 (40:23):
And if you enjoy Adlots, if you want us to
bring on Jim Egan for a fourth time, when morgat
rates inevitably go up or down, then please leave us
a positive review on your favorite podcast platform. Thanks for listening.
(41:00):
Was an E.
Hosts And Creators
Joe Weisenthal
Tracy Alloway
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