When it comes to one of the areas that will be hardest hit by the Coronavirus recession, you must look at the consumer. And one area of the consumer that we know can lead to a larger recession and possibly a depression is the effect a consumer has on their most significant asset: their home.
The U.S. Housing Market: 2020 Vs 2008
The Financial Crisis of 2008 exposed what a system based on high leverage and rising prices do when those home prices do not increase any longer.
Thankfully, the consumer is less leveraged than back then. U.S. household debt to GDP, a reliable indicator of how risky the amount of debt is, was still a contained 75.2% back in the third quarter of 2019. The trend was going to be about 79% in 2021 until the Coronavirus hit. Here’s the problem.
Back in February, U.S. household debt topped $14 trillion. Which wouldn’t be a problem, except we have this pesky expectation that the Coronavirus will knock GDP down a significant amount over the next few quarters, and we’ve already seen millions of people lose their jobs from the unemployment claims during the recent 2 months.
Without jobs for income, how many of those millions will be unable to service their debt, and with GDP falling while the debt level maintains or grows, how will the nation service its debt? This is going to be a huge problem if not dealt with.
Fiscal and Monetary Policy Will Help, But Can Only Do So Much
This is the time for governments and central banks to act, and they certainly are. The Fed already lowered interest rates to zero and is providing liquidity. The lower interest rates will help people with floating-rate mortgages, as they will have to pay less than before. And refinancing will likely increase if possible. However, the Fed’s influence over mortgage rates is complicated, at best.
Mortgage rates do not respond quickly to rate adjustments by the Fed. Those are more closely tied to the 10- and 30-year Treasury rates. Of course, the Fed rate and
Treasury rates are correlated because of what they mean for economic expectations. Treasury rates will rise when there is higher expected inflation and growth in the future, and fall when the opposite is true, especially during a recession. So while the Fed can lower rates in this situation, it could take more time for those to show up in mortgage rates.
Refinancing would be a way for homeowners to save plenty of money right now, given the rates are much lower than when they likely secured their mortgages. However, given how badly battered the mortgage market is right now, on several fronts given employment and the economy are in shambles, it is likely not an option for many. Mortgage credit availability dropped to its lowest level in five years.
JPMorgan Chase changed its underwriting guidelines for new mortgage applicants, requiring a FICO score of 700 and requiring a 20% downpayment. Several nonbank lenders are also increasing the minimum credit scores. Just months ago, before the Coronavirus, refinancing demand was booming, and applications jumped dramatically.
Unfortunately, the situation now is that some of those applications will be rejected, either due to timing or because borrowers no longer qualify.
How does the Coronavirus affect your ability to take advantage of lower rates? Well, if you don’t have employment, it’s going to be a lot harder for you to refinance that mortgage. Or pay it.
Borrowers Having Problems Paying Their Mortgage
We are starting to see just how difficult it is for mortgages to pay in April. Around two million homeowners are skipping their monthly mortgage data, according to industry data released in April . That means that 3.74% of home loans are in forbearance as of April 5, up from 2.73% in the prior week, and is expected to get worse.
The $2 trillion stimulus package passed by congress helps with this, as it allows homeowners who face hardships from the pandemic to request forbearance from the companies that service their mortgage, which will enable them to suspend payments without penalty for up to 12 months. If that many people can’t pay their debt, the supply of mortgages is set to fall short along with demand.
How does the Fed Support the Mortgage Market?
The Fed is equally concerned about the mortgage market, especially the mortgage servicers that are acting as middlemen to investors and mortgage owners. There is immense pressure on them to help in the wake of this crisis, and Federal Reserve Chairman Jerome (Jay) Powell mentioned that he is “watching carefully the situation.”
The problem is that these middlemen, firms like Quicken Loans Inc. and Freedom Mortgage Corp, is still on the hook to pay investors even if the mortgage owners do not pay. The firms originate about 60% of all U.S. mortgages, according to the WSJ. The $2 trillion bailout package included no assistance to these companies.
There is hope, though, as housing-finance experts hypothesize that the Fed could support mortgage servicers eventually. They would likely do this through an emergency lending facility, which would help bridge the forbearance period. That contrasts with the Federal Housing Finance Agency Director Mark Calabria’s tone, who thinks there is not much wrong with the servicers.
This is important because Mr. Calabria oversees Fannie Mae and Freddie Mac, the two government-sponsored entities that guarantee nearly half of all mortgages. He claims they are unlikely to provide liquidity to these firms unless issues persist for over a year.
Two significant errors could be made in this situation, by both the Fed and Mr. Calabria.
They could overestimate how long mortgage services could remain solvent. This would lead to a collapse in the mortgage system, which would be a disaster for the housing market and would take years to fix. Mortgage Servicers are a crucial market that supports households and consumer spending, which make up about 70% of U.S. GDP, so this is important.
The other mistake could be underestimating the sheer number of homeowners who look to forbearance. Given the massive unemployment numbers (17 million jobless claims in 3 weeks) we are seeing and a sharp recession likely, economist models may come up short. The failure of many mortgage service firms would cause havoc on the market recovery once the economy reopens. That could have longer-term implications on the housing market.
Housing Bubble 2.0?
Some people who think we’re about to see the housing bubble 2.0 burst. The reasoning is that according to the Case-Shiller Home Price Index, housing prices had surged about 57% since their bottom in January 2012. This was due to massive price inflating by the Fed keeping interest rates as low as possible, even while the economy expanded throughout the cycle.
A look at average hourly earnings and inflation versus the price shows a massive disconnect. U.S. housing prices have risen much faster than both, which is precisely what happened during the financial crisis.
With the housing market grinding to a halt due to lack of viewings, extreme job market uncertainty, and a spike in unemployment, the U.S. housing market looks in for a reset.
Other analysts think that policymakers can help the housing market get through this period. But they must act fast. They can “step in now and address the massive cash-flow problem faced by mortgage servicers, either by advancing these payments directly to investors or by lending servicers the money to do it themselves,” or risk the cost of having to bail out the housing market later.
Policymakers could also wait, and see what happens, and hope that there isn’t a lot of damage done. Kind of like how they waited to see if the Coronavirus would take hold in the U.S. and spread as fast as experts feared.
The Coronavirus Can Change The Housing Market?
The question is not will the Coronavirus change the housing market, but how it will change the housing market. Historically low inventory and rock-bottom mortgage rates would generally flow into much higher prices in the market.
In the long-term, however, things could recover. If we get a quick V-shaped recovery or even U-shaped, there could be a minimal shock to housing, especially as prices are stale-dated as they are not as liquid as say, the stock market.
If the damage to mortgage servicers is limited, and the Fed steps in to backstop bankruptcies in the short-term, the industry could rebound quickly.
Still, there is going to be a longer lag in the economy than people think, and the consequences of mass unemployment, even if transitory, could cause havoc on the housing market.
According to Payscale, it could take Americans up to five years to recover the hit to their wages from this pandemic.
That will almost certainly put a damper on demand, and potentially lead to fewer people in the market. Prospective buyers with cash on the sidelines will be in a good position for the first part of this decade, at a minimum.