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

Episode Date: October 19, 2023

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.See omnystudio.com/listener for privacy information.

Hi, I'm PJ Vote. My podcast Search Engine has a new two-part series for you. Of all the new technologies coming out of AI, the most transformative one might be driverless cars. They're already on the road in 10 American cities, and they're quickly coming to more. We tell the story of how we got here. The secret team at Google that spent 15 years building what might be the safest vehicle on the road, and we cover the fights brewing in blue cities, where unions and politicians are working to keep those cars off the streets. Listen to search engine wherever you get your podcasts. Hello and welcome to another episode of the Oddlots podcast. I'm Tracy Alloway.

And I'm Joe Wisenthal. Joe, did you see that National Association of Home Builders Survey? 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 home builders is falling, which is kind of noteworthy because towards the beginning of the year, we saw a little bit of a pickup, 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, 23, 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.

Well, we are recording this, as you say, rates going up. We are recording this on October 17th. just today we have the 10-year yield back over 4.8% right at the time we're talking. That is basically at the highs of the cycle. We had dip 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 home builders 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 2022. Yeah, and meanwhile, mortgage rates, which of course are sort of priced off of treasuries, are getting close to 8%. That's the highest level, I think, since something like 2000. So we have to discuss this. And, you know, the last couple of times we dug into the housing market, we spoke with Morgan Stanley's U.S. housing strategist Jim Egan. In fact, we spoke to him for the first time in October of last year in an episode that we called, Here's what 7% mortgage rates will do to the housing market. So now 12 months later, we're just going to do, here's what 8% mortgage rates will do to the housing market.

Here we go. 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 like talking to Jim and we thought even though we spoke to him once 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 hire 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 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 2022 was just an historic, at least through the history of our data, a decline or 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 blip, basically, along with the like tiny, tiny dip in house prices.

Exactly. And if mortgage rates were to stay at 8% for a loan, period of time, affordability deterioration would return back to a place that we haven't seen in decades the 2022 period notwithstanding. It's pretty incredible. Just, you know, talking percentage points can sometimes be abstract. But our colleague, Michael McDonough, regularly post this chart. And this was about a month ago, so we're even higher than we were before. But he posed this chart showing like a median house with a 30-year mortgage, just sort of

really standard. You know, a few years ago, a monthly payment might be like about 1,000. It's up to 2,300, as of according to typical 30-year mortgage rate. Or this versus March 2020 when we were at the lows and probably not a lot of people who got mortgages. Nonetheless, like when you put those numbers in, I mean, it's just extraordinary affordability shock. It's incredible. Like, one of the numbers that we were looking at recently, not relative to March 2020, but to put it into context, the extent to which we've seen mortgage rates increase, the payments up over 120 percent. since the lows and mortgage rates that we saw in the early part of 2022.

And you've mentioned the lock-in 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 2022 saw almost a 400 basis point increase from 3% to 7% when the first time you invited me 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. Right. The move now up to 8% 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 the rate of change is not going to be the same this time around than it was in 2022. Hmm. Sorry, can you explain that a little bit further? Right. So as borrowers were moving further and further out of the money in 2022, we saw specifically the listings of homes available for sale fall to far and away the lowest level we have on record, right? Where we have that data going back over 40 years, never lower, by our metrics hit a low in May of 2022, 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,

to 8% 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 still exists, it worsens it, but the change is not as dramatic and as significant as supply curtailing as that initial move. It's like reverse convex. Exactly. And I would also say the lock-in effect, while it's enormous, it's bigger 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? Mortgages pay down. Right now about every year two to two and a half percentage points of these low rate mortgages are paying off. They're amortizing.

And some of these low coupon borrowers for reasons other than economic incentives, we call it turnover. They are refinancing. Right. So they're coming down. This is a point, Tracy, that like a Conner Sen has been making in some Bloomberg opinion columns and said that, 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 you do have a little bit of marginal pressure. So, you know, that supply-constraining pressure, it does fade eventually. 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 U.S. are not paying 8% 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 3.6, 3.7% right now. As we've said in this, podcast, the prevailing rate is approaching 8%. Yeah. That is a gigantic gap that we haven't seen in decades, over 40 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 2022 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 home builders 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 22, the early

parts of 23. 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 0%. Our bull case was plus 5. We're moving towards that bull case. That's what we think we're going to end up. But that's just the short term. That's not the longer term. Right. It's where 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 7 to 8% is not nearly as dramatic as say the move from 3% to 7%. 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 17th, 2023, what does 8% 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 rate to 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 2022. Those are behind us. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Rafini. We'll bring you the latest headlines, in-depth analysis, and big interviews. All the stories that hit home on your days off. And I'm Lisa Mateo. Watch and listen to Bloomberg this weekend for thoughtful, enlightening conversations about business, lifestyle, people, and culture. On Saturday mornings, we put the past week's events into context, examining what happened

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Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts. 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 linchpin 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, and I think you're alluding to this, is just less volatility in the rate and market overall.

We need more certainty in where this is going to be on a go forward basis. And I think when we 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 15 years.

I can be conservative with my assumptions and get to roughly a 2 million unit shortage. I can be more aggressive and say that we might be six months. 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 theoretically be a tailwind in a world in which maybe not affordability starts improving, but at least the marginal volatility in that metric comes down. 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 a, what goes, what are the facts? In the vectors in your model that would, you know,

that say like, okay, it could be $2 million, $6 million. Like what are the variables that go to that range? So if I started on the higher end of this, 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.

Headship rates and household formations. Do we need a headship rate primer? I learned from Jim Egan. No, 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 you 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 and multi-unit housing, all new units that come on on an annual basis. You control a little bit for the obsolescence of old housing. Yeah. And the difficulty with an equilibrium calculation is I could cherry pick and start in 2009 at the bottom of the GFC when home builders were really pulling back and say that the shortage is enormous. Or I could go back to 2000, I could go back to 1990. I don't know exactly where to start that calculation. But going back over several decades, you get to a roughly a $6 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 are 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. I 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 10 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 realize 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 consumer's 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 12 or 24 month rent increases?

Sure, on the margins, that would make sense. But anecdotally... It's probably a small. percentage, yeah. But it is true that right now, like the rent versus buy calculators, like in various times in some market, like, oh, you should rent or sometimes buy. 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, 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 was all transitory. and everything's fine and then the Fed 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 the soft landing scenario off the table, rates coming down and otherwise 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 8% 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 2022, or at least we don't think they will be.

But we do think that you can talk about a higher for longer rate 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 in supply for any reason will. will lead to weakness in home prices. If we look at our models and just put in a 5% increase for next year, and we were increasing by more than 5% in that period after May 22 that I mentioned, just a 5% increase. If we assume no growth in sales or no growth in transaction volumes, our models would say that home prices are down 5% 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 8% 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-in effect that we discussed? Maybe on the margins. Tracy, as you pointed out, we're still very, very far away from bailing mortgage rates. 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 65, over 40. 50% of those homeowners bought their home before the year 2000. 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 a very interesting Barclays note, so from one of your competitors. I'm sorry, we're cheating on you with other banks. But the headline was basically, well, this was the headline. This is your headline. This is my headline. Okay, whatever.

It captured the thrust of the note. The headline of the summary that I wrote was Barclay says blame the boomers for surging house prices. And the idea here was that you have a lot of this older 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 ask you to talk about a competitor's research, but 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 might even be 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 20s,

they're early to mid-30s, 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 65 from 1980 to 2012, it is a very consistent 25%.

The oscillations are really small. As I mentioned a little bit earlier, it's gone up to 33% from 2012 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 40 years. the truth is in 2018, 2019, they were close to 40-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 2020 to now, it has dramatically fallen in and very much reset those lows.

But this was a conversation we were having pre-co. I'm Francine Lacquois, an award-winning journalist, and I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from heads of state to fashion icons about the news of the moment. But I've always been curious who are these people as leaders. I don't think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday.

Follow leaders with Francine Lacroix wherever you get your podcasts. Chase, you know what I just thought about? Maybe it's kind of tenuous. You know what? We had that conversation with Julia Coronado about like, inelastic demand is a big aspect of like this economy these days. And so it's interesting, this is obviously sort of different that 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 economy. And so to the extent that there is this sort of large and growing share of homeowners who's the likes of which we've never seen are 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. So you 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 price insensitive baby boomers. Right. Many of you. Either they own their home outright or they're completely, you know, have a 3% 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 rates 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 even 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, think from now until the end of the year,

a little bit more upside. Yeah, but that's... We're just talking 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. Yeah. Which means that we are reliant upon supply remaining near historic lows 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 2022 through the beginning part of this year, if you start to see that again, that's going to the rate of change, the 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 16 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 2007, 2008. 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's demand, supply,

the affordability of the U.S. 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. But borrower risk, I think, is how we typically default to thinking about lending standards. Credit scores, loan to value ratios, debt to income ratios. Right. If debt to income ratios are increasing, that borrower risk is picking up.

Now, credit overlays are important. Who are you giving the high DTI mortgage to? 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 30-year fixed-rate mortgage. and some of the products that proliferated a little bit more in the early 2000s.

Talk about the difference between now. So floating rates, option arms, that sort of thing. Option arms, those negatively amortizing mortgages that really don't exist anymore. And the qualified 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 2000s, 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, while 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 protected. 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 going to just sort of ask Tracy's question even more like on this forced

transaction because that's where my head went. Like, you know, 2007, 2008, we had this financial crisis. But we also just had a lot of risk, 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 correctly forecasting for however for long.

Did you just say miscorrectly? Is that a, that's a word, right? Incorrectly. Incorrectly. Misforecasting. There we go. Incorrectly. I like it.

I think we should use it. Everyone's been miscorrectly forecasting. Let's say we get some kind of recession and unemployment goes from, you know, just some 4% to like 5.5 or 6%. Something like a, let's say we get a normal recession. What is that due 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 U.S. economist, Helensettner, who has been calling for a soft landing for quite some time now.

Not everyone got it miscorrectly. 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 consumers' 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. Oh, I remember that. I also remember there were these securitization bankers post 2008 who were making the same argument for securitizations of phones. They were saying of like phone loans and they were 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 that 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 pickup in subprime auto delinquencies last year. 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 30, 60, 90 day delinquency. It's maybe inflation's higher, miss one payment, but stay at 30 days delinquency for a while. miss another payment, stay at 60 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 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 2008, 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 distressed 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, to give them other options for paying that. Flash forward 15 years, now the 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 in 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 to cash flows too. But if they become modifications, it means they don't become supply on the housing market. I mean, it would be incredibly depressing if we had experienced 2008 and hadn't learned anything from it in terms of mortgage modifications or actual risk management for loaning money to would-be home owners. 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 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 2022, single unit housing starts are down over 20%. When we think about how the housing market impacts the economy more broadly, when I work with our economists at more, 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. 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 homeownering consumer, which is two-thirds of the market. The home ownership rate is still 65 to 66%. 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 9%. Or 7? Or 7. Either direction. Either direction. Up or down. Every 1% from here on now, 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 thing that stuck out to me was that baby boomer dynamic, which was kind of apparent even before 2020. So the idea that you could see some of it in the data in 2018, 2019. 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 3% or whatever it was to 7%.

Like that was the big move and moves higher from here are going to, the effect is going to be only marginal. But also this idea that like, okay, home prices were able to rise 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 5% growth in inventory next year, that would lead to a 5% drop in home prices, which gives you a pretty good idea of like how so much of it currently rests on the linchpin 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 were layoffs, but even there he noted, probably for good, that that, that, you know, that. that layoffs don't equal liquidations or foreclosures the way they did in the pre-grade financial crisis period, which is a good thing, whether it's obviously baby boomer, although he does not see some imminent demographic shift because, you know, 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 be 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 own preferences has kind of changed. Right. I had right. There's like, oh, you really want to. I mean, no one wants to like be foreclosed out. No, of course not. But if you have a three percent more or three and a half percent mortgages, then you really don't want to be foreclosed on.

Exactly. Then you really don't because, uh, so I did think that was an interesting point. Yeah. So many things to pull out there. Um, shall we leave it there for now, though? Let's leave it there. Okay. This has been another episode of the Allpots podcast.

I'm Tracy Alloway. You can follow me at Tracy. And I'm Joe Wisenthal. You can follow me at the stalwart. Fellow our producers, Carmen Rodriguez at Carmen Armin and Dashel Bennett at Dashbot. And thank you to our producer, Moses Andam. For more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have a blog, transcripts, and a newsletter. And you can chat 24-7 with fellow Odd Lots listeners about all these topics, including in our real estate channel in the Discord.org.g.g.

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