This Is What an 8% Mortgage Means For the Housing Market

Published Oct 19, 2023, 2:16 PM

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.

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

And I'm Joe Wisenthal.

Joe, did you see that National Association of Homebuilders survey?

Uh?

It was bad.

I actually didn't see the number, but I think it was bad.

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 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.

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 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.

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, 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.

Here we got, Yeah, we just don't one percent at a time. We'll just keep having Jim back.

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 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 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.

I'm excited about it.

Let's do it all right, Jim, welcome back to the show.

Thank you so much for having me. It is an honor to be asked back.

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 housing over a longer term horizon?

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 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 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 over three months, over six months, affordability was actually improving. That's no longer the case, right.

It was a blit basically along with the like tiny, tiny dip in house prices.

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 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 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 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 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, especially that the rate of change is not going to be the same this time around than it was in twenty twenty two.

Sorry, can you explain that a little bit further?

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 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.

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.

It's like reverse convex exactly.

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, for reasons other than economic incentives, would call it turnover like they are refinancing, right, so they're coming down.

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.

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 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.

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. 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 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 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.

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, just right now today October seventeenth, twenty twenty three, what does eight percent mortgage mean for demand.

It's going to mean that demand is weaker.

Right.

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 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 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.

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 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 and supply.

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 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 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, 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.

Or maybe it stabilizes so that people can at least make, you know, decisions about their longer term finances.

That's a good way to put it.

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?

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.

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.

But so we have that marginal demand, okay, and then we have marginal supply.

Right.

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 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, 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 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.

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. 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 that dynamic begins to reverse.

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, 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.

Is probably a small percentage.

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, 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.

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?

Yes?

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 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 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 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 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, any marginal supply would weigh on home prices.

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, 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 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.

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. 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 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 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 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.

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 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.

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 the housing ladder at the moment due to affordability, and then you have basically completely priced insensitive baby boomers.

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 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.

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.

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.

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 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.

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 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 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?

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 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 income ratios are increasing, that borrow or risk is picking up. Now. Credit overlays are important. Who are you giving the high DTI mortgage?

Two?

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.

Floating rates, option arms, that sort of thing.

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 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 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.

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 actually get this recession that everyone has been missed correctly forecasting for however, for long eventually.

Say miss correctly is that a that's a.

Word right, incorrectly, incorrectly, incorrectly mis forecasting.

There we go incorrectly, I like it, I think we should use it.

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 have a mortgage.

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. 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.

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 it's completely safe. Sorry that was a tangent, but.

No, that's a good point.

Reminded me of it.

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 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 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 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 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.

I used to draw comics about hamp.

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 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 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.

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 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 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 monetary policy, for inflation, for the economy in general that housing has been this resilient.

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 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, 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 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 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.

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.

Seven or seven either direction, either direction. For ever from here on out.

We.

Chat with Jim.

Thank you so much for having me.

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 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 to improve, but other than that, it feels like things have been deteriorating.

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 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 on prices.

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.

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 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.

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.

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.

They really don't want to be exactly that.

You really don't because so I did think that was an interesting point to see.

Yeah, so many things to pull out there. Shall we leave it there for now?

Though?

Let's leave it there?

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.

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