Flashback to February, 2020… On paper, the US economic picture was at historic highs with the top economic indicators of inflation, low unemployment, strong housing demand, consumer spending, and high consumer confidence all seemingly to be “unstoppable forces”. How then, with what seemed like a blink of an eye, did the Coronavirus which we will deem as the global “immovable object” cause the economy to drop to its knees; and more specifically, did this break the housing and mortgage market and how can it be fixed?
Let’s gain a better understanding of how the economy and the business cycle works. The business cycle is the term used to describe the expanding and contracting pattern of the US economy. Throughout history, wars and plagues have been blamed for economic swings. In 1819, the French economist named Jean Sismondi proposed the idea that economies go in cycles based in production and consumption. When business activity is strong, the output of business known as GDP, or Gross Domestic Product, rises and the economy expands until it reaches a peak where people are not as willing to spend, thus leading to a surplus of goods and services. When this outweighing of production of goods and services continues to outpace consumption, a downward contraction in the economy begins. This downturn is classified as a recession if it lasts two consecutive quarters. When this downturn continues for a sustained period, economists define this as a depression. At this point, economists disagree on the best course of action – whether government should intervene as in the bailout of 2008, or if the market should be left to work through the rough times until ingenuity, invention, and commerce can cause a balance between production and consumption. This process has been documented in 11 cycles since World War II where the average period of time for the business cycle to go from peak to peak has been just under 6 years.
How is the Mortgage and Housing Market Being Impacted?
In response to the news that the Coronavirus was infiltrating the country, the housing and mortgage market began seeing loan programs disappearing, severe volatility with interest rates and more than a few independent lenders closing for business indefinitely. As an answer, the Federal Reserve began buying $100 billion per week of mortgage debt. This sounded very familiar to the 2008 economic meltdown, although the inherent wrongdoing and mismanagement from 2008 was absent. The Coronavirus response has been the most abrupt and unexpected economic adjustment that the world has ever seen. The consequences of this disruption have fueled the bond market (which loves unrest in the world) to the point where mortgage rates dropped to all-time lows – perhaps too low. “How could low mortgage rates be bad?” you ask. Well, investors who buy mortgages are planning to make money on interest paid over time. They pay more than the principal loan amount up front for the right to collect that interest and calculate what they are willing to pay based on how long they think people will remain with their loan before refinancing or selling. When rates drop faster than the investor expected, lenders begin to collect their principal back without earning a profitable amount of interest. If this rate reduction persists, then investors pay less and less for their mortgages, which in turn means they will not be in the market. This means that lenders do not have the liquidity needed to continue lending.
Here is an easier way to explain what was happening. Imagine that you remodeled your home with a credit card with the hope to quickly refinance to pay off your debt, but do to the unavailability of cash in the bond market, your loan approval was delayed, or suddenly not possible. You now have to pay a few high interest payments – possibly a lot more than you expected. Now, you could potentially handle this for a few months, but imagine that on a broad scale for multiple people and businesses across the country, and the amount of debt adds exponentially. This is the reason that the Federal Reserve stepped in and began purchasing $100 billion per week of bond/mortgage debt. Again, there was differences from 2008 in that these purchases were not bail outs, but rather they were repurchase agreements (aka “repos”) that allow banks to quickly sell non-cash assets to the Federal Reserve and agree to buy them back later when the flow of cash has opened back to them.
At the same time the Federal Reserve was working to free up cash for lenders, the government stepped in and offered:
The Disaster Relief Bill to provide small businesses through the SBA, PPP loans (Paycheck Protection Program) so they could keep their workers on payroll.
The CARES Act (Coronavirus Aid, Relief, and Economic Security) provided an injection of money to households to provide for lost wages while businesses were directed to be closed.
Fannie Mae, Freddie Mac, and Ginnie Mae offered homeowners affected by the Coronavirus to seek a forbearance on their mortgages (3-12 months of no payments), to assist while their incomes may have been impacted.
The impact on the mortgage market for this program is yet to be seen as this could place a never before seen strain on lending. Ultimately, what this means is that investors who purchase mortgages have a guarantee to receive timely payments. If the homeowners cannot pay their monthly bill, Fannie Mae and Freddie Mac will cover the bill. If these agencies cannot pay, then taxpayers will because the Treasury is the guarantor for these agencies.
Can you see the potential issues here? The financial markets could see the largest and fastest surge of forbearances (non-payments) that the mortgage market has ever seen if businesses do no open quickly and people do not return to work.
How Does The 2008 Housing Market Compare to the 2020 Housing Market?
Does all this dire news mean the country is worse off than in the 2008 meltdown? I propose that no, in many ways 2020 is much better than 2008 because the market did not cause the coronavirus pandemic. The average mortgage being made up to 2020 was much more regulated and of higher quality than those being made from 2004-2008. Incomes, documentation, employment verification, improvements in home valuations, and underwriting standards that were put into place by financial institutions mean that whatever economic issues could arise, will not be blamed on the housing and mortgage market. We are not facing the same behemoth that destroyed the confidence in the system from 2008. We are facing a crisis that can be slayed by taking health precautions, building strong relationships with customers, and overcoming the effects of a pandemic that can be handled much more quickly than in decades past where news and information could not be attained within seconds over the phone, satellite, or the internet.
This is not to say the road ahead will not have obstacles and get worse before it gets better, but the mortgage and housing market is in a position to be able to swiftly recover as America gets back to work. In fact, according to Redfin, 41% of offers over the past month were subject to a bidding war even amidst the Coronavirus pandemic. This suggests that demand is still outpacing supply, just as it was before the pandemic. In Utah, we are seeing the same type of data s as we compare the inventory vs. sales from the same time period of April 2019 vs April 2020.
I would love to hear your thoughts or have a discussion with you about this topic and how it is affecting your decision to buy or sell your property in Utah County, Salt Lake County, or Heber City, please reach out to me with any questions. Please reach out to me at (801) 885-2558 or by email at brandonrwood19@gmail.com.