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