Lead Story…. Mortgage rates are now sitting at the highest that they have been in seven years. The standard knee-jerk reaction is that this uptick implies that home prices are on the cusp of falling across the board – which would actually be welcome economic news in some markets. However, I suspect that it won’t happen due to the impact of rising rates on supply. Via the Wall Street Journal (emphasis mine):
The concern among economists is that higher rates will prompt homeowners to keep their low-rate mortgages rather than trade up for better properties. As rates approach 5%, the risk of the phenomenon known as rate lock grows, economists said.
A one percentage point increase in rates can lead to a reduction in home sales of 7% to 8%, according to Lawrence Yun, chief economist at the National Association of Realtors. The recent increases in home prices and mortgage rates could especially hurt first-time and moderate-income borrowers, economists said.
So far, price gains have shown little sign of slowing. The S&P CoreLogic Case-Shiller National Home Price Index, which measures typical home prices across the nation, rose 6.3% in February, up from a 6.1% year-over-year increase in January.
Beyond supply-driven affordability issue, there is another concern that I’ve written about here but is not frequently talked about: the impact of rising rates on mortgage underwriting. It’s commonly believed that the past few years have been difficult ones for the mortgage industry but that really isn’t accurate. Yes, regulations got a lot tougher but the industry as a whole had a strong wind at it’s back for the past seven years or so thanks to:
- Falling interest rates
- Falling unemployment
- Rising (albeit slowly) wages
- Rising home prices
- Falling down payment requirements
The five conditions listed above are the sweet spot for mortgage lending. Falling interest rates and rising home prices made pitching refinances easy while rising wages, falling down payment requirements and declining unemployment meant that more people could afford to become home owners. If you have any doubts that the past few years have been good for lenders, check out the massive growth of non-bank lenders like Quicken Loans and Loan Depot, among others who managed to avoid the worst of the subprime debacle and emerge as the new leaders in the space when the market recovered.
Here’s the problem: mortgage lenders have geared up for growth in recent years and, as such are not really set up for a flat market in loan origination volume. Beyond that, they certainly are not set up for contraction in volume. The once-sleepy mortgage industry has become growth oriented in recent years but conditions are now anything but conducive to growth. Refinances have already fallen off a cliff, down 40% last year and expected to fall another 26% this year. In addition, purchase mortgage volume is likely to face a substantial headwind since people move less – meaning less inventory to sell – when rates rise as mentioned above. IMO, we are approaching a situation where mortgage lenders get painted into a corner where they are left with two options, assuming, of course that rates do not fall back near the prior lows:
- Accept that volume is going to be lower and scale back projections, budgets and staff accordingly.
- Ease underwriting standards and lower down-payment requirements in order to qualify more marginal first time buyers and entice cash out refinances (despite higher costs)
The first choice would not be great for the economy but would probably be more stable over the longer term and allow for the industry to be sized correctly moving forward. The second choice would throw some rocket fuel on the market and the economy for a period of time but would likely cause plenty of problems down the road as it makes the possibility of an asset bubble more likely. Liar loans, pick a payment negative amortization time bombs and no-doc underwriting are a thing of the past due to better regulation (THANK GOD) but that doesn’t mean that lenders – especially in the non-bank category – couldn’t start to get much more aggressive in lowering down payment qualifications and underwriting standards in an effort to prop volume up. In a market with tight supply, creating more demand through easing underwriting standards would be like dousing a slowly burning fire with gasoline. This would have been welcome news a couple of years ago when affordability was much better but potential buyers were stymied by the inability to qualify for a mortgage on a home that they could otherwise afford. Today, rising home prices and mortgage rates have reduced affordability to the point where too much easing of credit standards could lead to relatively weak marginal borrowers. There is still room to loosen standards a bit without causing a problem, to be sure. The question is how far things will go if lenders choose this path.
If this sounds familiar it’s because it has happened before. It’s easy to forget that the most egregious financial offenses during the housing bubble of the mid-aughts happened after the Federal Reserve began aggressively hiking rates in 2004 as lenders came up with ever-riskier products with more relaxed underwriting in an effort to keep feeding the machine long after rates had bottomed. We are in a position today where underwriting could ease quite a bit without really jeopardizing the market. Hopefully, lenders have long enough memories to recall what happens when they take things too far though.
Contrarian: A new BIS paper by Mikael Juselius and Elod Takats came to a surprising conclusion – inflation typically rises as the share of dependents (elderly) increases. If true, this has profound impact on future inflation expectations with our graying demographics (emphasis mine):
Demographic shifts, such as population ageing, have been suggested as possible explanations for the past decade’s low inflation. We exploit cross-country variation in a long panel to identify age structure effects in inflation, controlling for standard monetary factors. A robust relationship emerges that accords with the lifecycle hypothesis. That is, inflationary pressure rises when the share of dependents increases and, conversely, subsides when the share of working age population increases. This relationship accounts for the bulk of trend inflation, for instance, about 7 percentage points of US disinflation since the 1980s. It predicts rising inflation over the coming decades.
Out of Whack: The yield on the US 5-year Treasury is now higher than any available 10-year yield in other G10 countries.
Drivers Wanted: America doesn’t have nearly enough truckers and even rising salaries don’ seem to be attracting more. As a result, shipping costs are rising quickly. IMO, this could be paving the way for self driving trucks sooner rather than later.
Not To Be Outdone: Last week I wrote about how the CA solar mandate was going to drive up housing costs substantially at a time when we can ill afford it. Today, I give you the new Multnomah County Courthouse in Oregon that comes with a solar energy system that will take more than a century – possibly more than the effective life of the building – to pay for itself. (h/t Eric Knopf) As previously stated, I’m all for making buildings as green as possible but a 109 year break even is obscene.
Shots Fired: A new report from Moody’s found that brick-and-mortar retail’s recent struggles has a lot more to do with poor population growth and weak economies in certain regions than with added competition from eCommerce.
Whatever it Takes: Only in California could a run-down 1940s era gas station be designated as a historical structure just because neighbors are opposed to the owner’s plan to build housing on the site.
Ramping Up: CRE crowd funding companies are scaling up their platforms rapidly.
Overstated: The concept of downsizing gets a lot of press as baby boomers continue to age. However, it is a lot less common than people think.
Sweet Spot: 2018 could be a banner year for the Inland Empire’s housing market as the long-beleaguered region finally regains it’s footing.
In a Hole: Southern California’s housing plans must grow by 80% just to get on par with the national average hire-to-permit ratio and keep prices under control.
Get in Line: Sports betting in the US is likely to be fairly chaotic for a while as states, leagues and the federal government attempt to digest the recent Supreme Court decision. However, it is also likely to be lucrative for those who move early.
Gold Rush: Lithium mining is the modern equivalent of a gold rush as everyone from tech companies to auto makers rushes to secure future supplies of the key battery component.
A Sucker Born Every Minute: A Wall Street Journal analysis of 1,450 cryptocurrency offerings reveals rampant plagiarism, identity theft and promises of improbable returns.
Chart of the Day
American’s are in no rush to take equity out of their homes:
One explanation for this is that housing wealth is becoming increasingly becoming concentrated among older home owners who have less borrowing needs:
Source: The Daily Shot
Shocking if True: A new study (that someone actually funded) confirmed that Adolf Hitler is in fact dead and not living on the moon.
What a Way to Go: An Oklahoma woman was mauled to death by a pack of six wiener dogs, which is the dog mauling equivalent of drowning in 2 inches of water. (h/t Trevor Albrecht)
Bonnie and Clyde: A couple stole a Walmart motorized grocery cart and went on a joyride to a nearby dive bar before being arrested because Florida.
Gotta Hear Both Sides: An Indiana woman who was sentenced to 65 years in prison after admitting to killing her husband is now suspected of killing another lover and serving his remains to unsuspecting neighbors at a barbecue.
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