This Is What 7% Mortgages Will Do To the Housing Market

the moment, given everything that's been happening with markets. I'm thinking in particular, you know, bond market volatility, what we saw with sterling and guilts very recently. But if you're looking for the most interesting charts at the moment, I gotta say, I really think the housing market and the mortgage market are where it's at. I completely agree with you.

And you know, like, look, the FED is raising rates to slow down the economy to beat inflation, but the number one sector of the economy that's most sensitive to rate very directly is housing. And so you just see some insane charts. We've been posting a bunch, but if you know, you know, look at the price of a new thirty year mortgage, just like through the roof compared to six months ago. So many things like that, And you know, housing is so crucial right to the overall economy.

Everyone wants to buy one or wants to live in one. And what does it mean when these numbers are moving so fast so hard? Right, Well, everyone also has an

opinion on warehousing is going. But you know, you mentioned a couple of those charts you can look at pretty much anything, Like the pure acceleration in mortgage rates has been unprecedented, The spread between mortgages and the tenure U S. Treasury is now at a record, Housing affordabilities at a record though, Like there are so many you can choose from, but it really feels like, given the unusual nous of the situation and what we're seeing in some of these charts,

it feels like there's a lot of uncertainties. So, yes, everyone would expect higher interest rates to have a negative impact on the housing market, but we've also been talking about how there's low inventory and you know, there's a structural need for more housing in the US, so maybe things are different this time. It's a really weird market because you know, I think everybody is still kind of scarred from the Great Financial crisis, and you see these

huge moves. You know, well, our house prices don't they have to fall off a cliff. And yet if no one is forced to sell, what's going to happen? Is the housing market just gonna go away, like no transactions except for people who like you know, get divorced or like have to prove or something like that. Like seriously, it seems like a possibility. So much weirdness. You know, pull up a chart of like how many people are

refined their mortgage. I mean it's basically the closest thing you find to like zero and a chart like no one is refined with mortgages that yeah at seven percent or whatever. I thought you were going to mention the reats, which is another good chart as well. So there are big questions about this market and it does. Yeah. And the other thing going on is you have a lot of people talking about market structure issues, so how mortgage rates are actually set, what's going on in the market

for mortgage backed securities. A lot of people have been saying, oh, there's you know, it's broken, there's something going on. So I am very pleased to say we are going to get into all of these issues, or at least try to, because there is a lot of uncertainty, and we really do have the perfect guest. Let's do it. I'm really excited. I have so many questions. Let's get god. Okay, we are going to be speaking with Jim Egan. He is Morgan Stanley's US housing strategist and does some great research

on all of these topics. So, Jim, thank you so much for coming on. Thank you so much for having me. It's an honor to be here. So maybe just to begin with, we should talk about is this environment that unusual? You know, you've been analyzing US housing for a very very long time. When you look at what's going on today,

how remarkable is it too? I would say that a lot of these statistics that we use to cast things like housing activity, and by that we mean home sales or housing starts, as well as home prices, are at levels that we either haven't seen before, or if we've seen them, we haven't seen them for decades. I think you've already mentioned a few of the pretty important aspects of this, like when we think about the housing market and taking a step back, we have a four pillared

view supply and demand, affordability and credit availability. Those first two we kind of think they're the larger structural, kind of underlying tides of the housing market. It's difficult to change them so much on a month to month or a year to year basis. Affordability and availability are those dials that determine kind of the shorter term changes to prices, to activity. And I think just to highlight one of them,

housing affordability. It's deteriorating. Not only is affordability itself at a level we haven't seen in at least the past thirty to forty years when we're comfortable with the data, but the pace with which it's deteriorating. If we look at it over the past three months, over the past six months, over the past twelve months, we've never seen affordability deteriorate this quickly in the housing market. So how

is it that housing prices are going to crash? Because if the price of a new thirty year mortgage in many cases, I mean, like I want to look it up because I wrote about it last week, but I think, like fifty a huge jump. Like what is would you? All right, let's start with that question, a what how do you? What is the jump or the decline and affordability like, how would you convey it what we've seen and how does how is like the market not going

to crash with such an affordability shock. I think that's an incredibly important question because it is something we get asked so frequently as people they're short, like their memories go back to the Great Financial Crisis and they're seeing not similar trends and affordability deterioration. But that's the last time things were this significant, right, And so I think first of all, you asked the tent to the affordability deterioration.

Home prices each of the past sixteen months would have been a record in year over year growth if we were comparing it to two thousand and four and two thousand five. We have significantly surpassed that. When you add mortgage rates up over three basis point since the beginning of the year, those things are going to combine to lead to the monthly mortgage payment on the median priced

home up over fifty year over year. If we include incomes the kind of third variable on that affordability calculation, we're only a forty six percent year over year. So we've deteriorated incredibly substantially. The GFC that year over year deterioration never exceeded thirty We capped out in the twenties. But why we think home prices aren't going to crash here, Why we do think this time is different is because the question we have to ask after affordability deterioration is

whose affordability just deteriorated. The structure of the mortgage market itself is very different today than when we compare it to two thousand four to two thousand and seven. If I were to just take one specific aspect of it, it's the overwhelming percentage of mortgages that are fixed rate. We think that over of the outstanding mortgage market is

fixed rate. We were much more heavily skewed towards adjustable rate mortgages in the early two thousand's, and so as mortgage rates went higher, the monthly payment for current homeowners was resetting higher as well this time around, especially when you consider the record amount of mortgage regination volumes, the fact that we broke that for a new record amount of mortgage reginations, most of these homeowners were able to either buy their home or we finance their mortgage at

historically low rates. Their affordability is locked in for thirty years. They're not seeing affordability deteriorate. This deterioration is coming for first time homebuyers perspective home buyers. That's where this sits. It's always the first time home buyers that seemed to be in the worst place, it feels like. But this

is actually something I wanted to ask you. So, given the preponderance of fixed rate do higher rates basically just mean that people who got a good deal are going to be reluctant to sell, especially at a time when you know prices might be softening, but definitely at a time when they know that if they're going to take out, you know, another mortgage, it's going to be at a higher rate. Absolutely, and it's something we refer to as the lock in effect. They're kind of locked in at

their current homes at these lower rates. And we mentioned housing activity versus home prices earlier. We do think this is going to lead to a different evolution of those two kind of paths of the housing market. Current homeowners in order to sell their home, and a lot of instances, would have to take out a mortgage that might be two dred fifty bases points higher than their current mortgage. That becomes prohibitively expensive when you combine it with how

much equity they have in their homes. They're just not going to be willing to sell their home at the lower price point that might be more affordable for the first time home buyer. So what we think we're already seeing, what we anticipate continuing to see going forward, is that the inventory, the listings of existing homes available for sale. We have that data going back for single unit homes to the early nineties. It was never lower than it

was in earlier this year. We've been increasing just a very little bit off the bottom for the past three months. But we think that they're going to keep listings tight,

which will keep home prices more supported. Like if we think about Kase Shiller probably the most frequently quoted home price index, it uses something called to repeat sales methodology, So when a home is transacted, it looks at the last time that home was transacted, and so if we're not going to be selling those homes at lower prices than they were purchased, that's going to help support home

price activity. But on the other side of this, it means that that existing homeowner is also not buying another home after they sell theirs, which we think is going to kind of exacerbate the decrease in sales volumes. So you can see a sharp drop in sales without necessarily that corresponding drop at home prices. So it's really I mean, obviously, if you're looking at the the first time home buyer, this is not a pleasant time. So it's a bad time to buy a home. It's a bad time to

sell a home. So just for renters too, for homeowners, for renters, for everyone really, and it seems like it's a really bad time to be a broker or realtor. It seems like that is the space that's going to sort of like bear the burden of adjustment. You know. It's just interesting, getting back to like the price question. The two things that it seems like, going back to the housing crash that really for sales were a these mortgage resets, So suddenly affordable affordable mortgage becomes a less

affordable mortgage and a deteriorating labor market. So if you get laid off and you don't have much equity in your home, you kind of have to sell it. It's neither of those are currently in place. We agree with that statement completely, right, I think that, And we've talked about affordability. The other pillar that was kind of the short term dial that we focus on is credit availability. Yeah.

I think when people hear credit availability, especially with the GFC, in your mind, you go towards the borrow or characteristic piece of that. You go towards FICO scores, loan to value ratios, debt to income ratios. Right, the kind of characteristics that we like to think of when we're thinking about the probability of a mortgage defaulting or something along those lines, right eether the likelihood that it will prepay.

On the other side of that, we don't capture the product aspect, the product risk aspect of credit availability as much. And that's what you just hit on. Right. You have this proliferation like the subprime mortgage back securities market, for instance, that got so large in two thousand four to two

thousand seven. First of all, that market doesn't exist anymore, but a big characteristic of that market where things we called or short reset arms that were fixed at lower rates for two or three years before adjusting for the final twenty seven or twenty eight years of that mortgage is life. Those products made up a significant chunk of the mortgage market back then. They almost effectively do not

exist today. And when you think about what that inherently asks owner to do, a mortgage to borrower to do is in month twenty five or thirty seven, when that payments about to change to a place that could be unaffordable, especially as the unemployment rate is creeping up and they may not have that income anymore. They need to be

able to refinance that mortgage. If credit standards are tightening at the same time, if home prices have flattened out, if they've started to come down a little bit, and all of a sudden there isn't excess equity in the house, all of a sudden, that refinance is not going to be feasible for that borrow where and they're effectively in a place where it's going to be very difficult for them to make that monthly payment. Because those products don't

exist anymore. You just do not have those resets. You don't have a homeowner that's reliance upon the credit availability environment going forward, and credit availability it tightened, we gave up six years worth of easing in the six months after the onset of COVID in March, where at the tightest levels we've been in effectively twenty years. And if anything, because of risk weighted asset stresses at large banks, we think the pathroom here might even be towards tighter lending standards.

So the equality of mortgage credit is incredibly healthy. UM, we don't think that because of the lack of reliance of homeowners on the ability to refinance, we don't know that's going to force them into defaults and foreclosures. But that also means that we think that the risk of a dramatic increase to defaults and foreclosures that could we think about what could bring home prices down. It's those distressed transactions, those forced sellers. UM. Divorce is very distressing.

I want to get into distress sellers. But just before we do. The other thing I think about when I think about pre two thousand eight housing and the subprime crisis is I think about inventory, and the housing market was so hot, credit, as you just described, was so ample. Everyone could get alone. You know, there are all those scenes from that big short movie about going down to Florida and everyone has like five properties. But the other thing I think about is just lots of homes getting

built in that environment. How are you viewing the inventor or question at the moment and how does that feed into your housing forecasts. We think it's one of, if not the most important statistic right now. When we think about inventories, we view it from from three angles. There's you mentioned homebuilding, there's the new inventory, there's the listing we talked about, the lack in effect existing inventories, and then there's what we call shadow inventory or distressed Those

are those defaults and foreclosures. That's what you would need to really provide kind of downward momentum for big year over year decreases and home prices. As I mentioned, because of credit availability, who we don't think that last piece is going to play a material role in this cycle. So you think about the other two existing inventories. We already mentioned the lack in effect. One statistic that we've been thrown or we've been discussing a lot recently is

months of supply. Now, months of supply has been despite how low inventories are, the fastest increasing piece of the inventory metric universe, if you will, And the reason for that is because it's it's an equation. The numerators inventories started to increase a little bit from their all time lows, the denominator of sales sales volumes have already pulled back materially. Right. So months of supply is the number of months that it would take for the existing inventory to get sold

at the current sales pace, exactly. And if we think about the absolute level of months of supply right now, we're sitting right around four. And that's total months of supply for units for sale for both existing and new versus total new and existing home sales, right, and that number the general rule of them is if you're below six months of supply, then that's a tight inventory market. Right.

That is theoretically going to be a seller's market because there's more demand than there is supply of those homes. And that historically has seemed to hold true. If we look at total months of supply going back to today, whenever months of supply has been below six, and again we're at four right now. Home prices have continued to be climbing six months forward, and that is one hundred that has been the case of the time. How low

could it go? So I'm just looking at the last and you know, this is what's so fun about how is it is there's just a million ways to slice and dice this, But I'm just looking at the last. Like existing home sales for August seasonally adjusted annualized rate four point eight million, but like that's a still bit higher than uh, you know, that's higher than it was in couldn't continue to go substantially lower from here? And if this divergence that you're talking about where activity and

prices diverged, how extreme could that get? Yes, so we do think that it will continue to go lower from here with current homeowners locked in with affordability pressures for from new home buyers. In fact, if we look at the affordability deterioration, we comp that to the Great Financial Crisis. It's been worse, it's been faster. But if we kind of index both periods to win the affordability deterioration really started, we're out pacing the Great Financial Crisis to the downside

in terms of how fast sales have have fallen. We think that the conditions that we've talked about could allow that to remain the case for at least the next six to twelve months. Our existing home sales forecast in our base case have us falling basically to below levels, so not getting We don't think that the peak to trough will be as substantial as it was during the Great Financial Crisis, so we're not entertaining those levels. But you mentioned right now we can see it coming down

about levels in the base case. What kind of supply response would you expect from the home builders in this kind of environment. So you know, people have been talking about the US being structurally short on housing for many years now, but at the same time interest rates are going up. There's this big question mark over the future of the market. As we've been discussing, would you expect them to ramp up production in that environment? It seems unlikely.

We agree with the final piece of that statement. We do think that it is unlikely right now. We agree structurally short supply right now, we have estimates on that. We wanted to be conservative two million units underbuilt. If we wanted to be a little bit more aggressive in our assumptions, we can get that numbered six million units underbuild. You would think that that would call for a higher

rate of home building. And by the way, those estimates are for both single unit and multi unit housing holistically. But we're seeing some interesting dynamics there. Builders have been responding to what had been record growth and home prices, this tight inventory environment. Building single unit building in particular increased pretty spectacularly in the immediate aftermath of COVID. In fact,

we hit all time lows. The data there goes back to that we use in kind of the winter of So this was kind of a final pop after almost a decade of growth in building volumes. But now we we've plateaued, and you mentioned a little bit earlier, Tracy, the difference in building volumes today versus the great financial crisis. Let's level set with what that decade of growth and building has where that's brought us. If I look at twelve months trailing single unit starts, we're only back to levels.

So we haven't crossed the two thousand We haven't. We haven't gotten to two thousand two or the real building pop in oh, four oh five or six. But because of things like supply chain issues we talked about labor market issues very briefly earlier. The units under construction, we pay so much attention to starts. We pay so much attention to completions, the time in between those when the shovel's broken ground, but you haven't finished the home yet.

Because of these backlogs, single unit starts back to levels, units under construction back to two thousand four levels, so you do have a little bit of a backlog that needs to be cleared. We do think that this is going to when you combine it with affordability pressures when you can buy, which is exaggerated by the mortgage rate moves. We think this is going to lead builders to pull back. We think single IT starts are going to come down

pretty sharply in the fourth quarter. We think they're gonna be downe compared to so so we don't think that it's as strong environment for that behavior. Yeah, I'm looking at the well, I'm actually I pulled up a chart of multi family units under currently under construction. It's one of the few lines in housing that is still like a straight up right because I guess it's just so slow with the process of building all these things that

they're still they're still getting done. I guess if you start a new construction, you finish it we'd like to believe that it once you break ground, that you're going to make your way towards finishing and at least some point in the future. And you're right, the multi unit under construction that there's one of the charts we see pretty frequently is total units under construction is finally passed the Great Financial Crisis, And we do think that you have to take a step back and look at this

single unit versus multi unit narrative. Single unit, as I mentioned back to oh four multi unit, I believe the numbers back to where it was in the ninety's it is looking now looking at single family. Um, yeah, it looks like I guess back to for you know, I was in Dallas recently and the number of multi family homes being like that happened built there, and it's just crazy compared to what it used to be. It used

to all be single family. But anyway, since we're talking about supply, one thing that has come up on the show at various times is the idea of a certain cohort of homeowners, the baby boomers, many many of whom bought their houses at relatively low prices, and have seen them appreciate the idea that you know, eventually, let me think how to phrase this. Eventually they're going to pass on um maybe you know, they'll retire or have to go to nursing homes or something will force that inventory

to get unlocked. Is that something that you're keeping an eye on. Yes. From a demographic perspective on the housing market, we spend a lot of time talking about millennials and Gen Z and the demand that they're going to represent as they roll through. We do think that you need to start focusing on the baby boomers. When we look at the percentage of homes of owned homes that are held by people over the age of sixty from two

thousand twelve, it is a very consistent number. It's roughly the housing stock it oscillates between from two thousand twelve to today. It's gone from to roughly thirty one out of every three homes in this country is held by somebody over the age of sixty five. When we look at how long they've owned those homes, over of them, roughly fifty four moved in before the year two thousand. So when we think about our activity forecasts, we think sales are going to fall for the dynamics we've discussed.

We think prices are going to be more protected. That doesn't mean that they won't turn a little bit negative year over year. But when we think about what are the stresses to that scenario, it's where could an uneconomic seller, if you will work at an uneconomic seller, evolve from. And we do highlight this group as one of those potential and economic sellers. They have a lot of equity in their home if they owned a home. They own a home today, odds are I mean, we know that

over half of them moved in before two thousands. They own that home. In two thousand and eight, they saw the property, the value of their property fall, they saw it stay below its original value for almost a decade. Perhaps as headlines come through, they're going to be more willing to sell that property at a lower price point than we expect given the lock and effect that we've talked about. Now, the counter argument there is aging in place.

That trend has happened a lot more frequently. People are living longer, they're living in their homes longer. We don't expect this supply to be a factor in our price forecasts for at least another decade, but if that would have come up sooner, that's where we kind of get into more of a bearer case, and that would provide

more pressure on home prices than we're currently expecting. Before I forget just on the home prices question itself, some of these indusicries have shown some declines, right, yes, And when we think about home prices, there are a lot of different industries, a lot of different ways to interpret the indusseries. And so I think that we actually just revised our home price forecast down the last week, and one of the things that precipitated that we talked about

your rear home prices. Month over month home prices for Case Shiller turns negative in July. First time that's happened since on a seasonally adjusted basis, I believe, since two thousand twelve. First time that happened in a decade. Now. We already thought the pace of growth was gonna slow. We just expected that to happen in September. It's happening a little early, and it's happening in certain parts of the country more so than others. California we're seeing price

declines on a month over month basis. Denver, Seattle, Portland. Those are some of the bigger, especially case Shiller M says, that are already showing that month over month price decrease, and in some instances you're seeing three or four percentage points down, you're over year even in those metros were still up nine. These are some places that have seen

it up much more spectacularly. But that second derivative, if you will, is changing and the pace of that decreases a ccelerating and that should continue to happen as we go into the back half of this year the first half of next year. So why shouldn't someone look at that say, oh, it's happening. The price declined, Like, why is that not a signal of actual like sustained declines.

So the reason that we don't think it's a signal for actual sustained declines is because a for true home price declines to to be dramatically in excess of what we're forecasting. So so year over year eight ten plus per cent um, we think you would need to stress. You need forced sellers that really need to hit a

lower bit on their home. You've mentioned kind of the things that we typically look at from a turnover perspective, death and divorce other metrics that would make you forced to sell a home that can be roughly five percent of the housing market. That that's that's not enough of a of a metric for us to really weigh on home prices. But the other pieces is supply listings of homes is so tight if people aren't willing to sell into the kind of depressed demand that we're talking about.

What we think you're going to see is a market that kind of stalls out here, right, and that that will lead national home prices to show a little bit of weakness. Our forecast of down three percent year over year December three, Like, the negative headline attached to that is that's down seven percent from today. Okay, the positive headline attached to that is that only brings home prices back to January. Crazy it's been up until very recently, and that brings you back to January, which is thirty

above March. So you changed your forecast relatively recently. I think you're looking for I mean basically flat or something like that, and you changed it to minus three percent. As you just mentioned, what was the sort of tipping point that you saw on the market that made you hit the button on that. Yes, So I think the fact that we saw home prices turned negative a little bit earlier than we thought they would, sales volumes were coming in a little bit weaker than our forecasts had expected,

but forward looking expectations changed as well. Like when we think about research at Morgan Stanley, we're taking into account what all of our various teams are saying. Our US economics team, given the persistence of inflation, they recently raised their call for monetary tightening, adding basis points worth of hikes to the November, December and January meetings. Are US interest rate strategists on the back of that, raised their forecast for the tenure, so they raised their forecast fifty

basis points. In December, they raised its seventy basis points to three point seven five for the middle of next year. That changes where we think mortgage rates could be throughout next year, which means that the deterioration we've seen an affordability there won't be any real relief next year now. And so we were expecting that perhaps kind of during the spring selling season next year that was providing a

little bit more support. That support is now absent. So this actually leads really nicely into something that Joe and I wanted to ask you about, which is when interest rates go up, how does that actually feed into mortgage rates? Because, as we mentioned at the beginning, you know, we have

seen this unprecedented rise in mortgage rates. I think the average thirty years at like almost seven percent in the US now six point seven five something like that, and there's this huge spread between tenure treasury yields and mortgage rates again something else that's at a record. What's going on here? Why does it seem like mortgage rates are increasing at an even faster pace than benchmark interest rates.

I think there's there's a couple of reasons for why that spread that you're talking about between mortgage rates and treasury rates has increased, And one of them is, if you're a mortgage backed securities investor, your structurally short rate volatility.

And not only have mortgage rates or interest rates moved higher, but volatility has been incredibly high the day to day, week to week swings we're seeing in the tenure treasury Like that volatility would in and of itself kind of weigh a little bit on the spread that we're talking about. But I think the other aspect to this is who are your buyers of mortgage backed securities who kind of

supports that that mortgage rate. For the past couple of years of FED has been an incredibly large buyer quantitative easing, they were directly buying mortgages. They're no longer buying mortgages thanks because of risk weighted asset pressures. They're no longer going to be buying conventional kind of Fannie and Freddie mortgages going forward, what we're seeing from a dollar perspective, across currency perspective might make it a little bit more

difficult for overseas investors to be buying mortgages. And so when when you have so many of what have been your larger buyers over the past couple of years, for various reasons, not as willing and able to step into the market right now, combined with the rate volatility we've seen, or perhaps even exaggerated by the rate volatility we've seen, that can kind of lead to that gap in spreads.

There's a certain irony that post GFC capital requirements are now like leading to higher mortgage rates and potentially causing an affordability issue. Isn't there too? There is you know, this is the part of the interview where I say, could you clarify for our audience, But what I actually mean is to clarify for me. Can you walk through though, why MBS investor is structurally short rate volatility specifically? How

does that work? Yeah, it's basically because of, for better or worse than, the freely prepayable nature of mortgage marketing in the United States. Right as rates rally, as as interest rates come down, as mortgage rates follow them down, your homeowner is going to be much more likely to prepay that mortgage returning principle to the investor in a

lower rate environment where their ability to invest it is challenged. Um, as mortgage rates go higher, all of a sudden, that mortgage backed security that you bought but you had an expected duration on it's going to be longer as people are more incentivized or locked in to stay in their home right now. And that that's kind of the tip

of the iceberg for that. Okay, I have another mortgage rate financing question, and the Mortgage Brokers Association, you know, their mortgage applications data came out and I saw that REFI activity is down, and my question is why is it not down a percent? How is there anyone still refining a mortgage today? Who is who? Like I've refined a mortgage, but that was a few years ago, un rage fund Like, who's refining today? That is a fantastic question.

And we think that harkening back to kind of the beginning of our conversation, it feeds into how much of the housing market, in the mortgage market are at levels that we haven't seen before. So borrowers are out of the money to refinance, so you're thinking that should be zero, Right, They're more out of the money than than they've probably ever been on a weight at average basis. But on the other side, homeowners have more equity in their homes

than they've ever had before. And so if we're talking about a borrower, who if you bought a home with a down and home prices are up almost over the past two and a half years, you can take a little bit of that equity out of your home. So that goes into the refight index that takeing. Yes, so REFI as a combination of both rate and term, So people who just refinanced to get a lower mortgage, right, but also the cash out what you've got is he.

So you mentioned MBS investors being structurally short volatility, which makes me want to ask about where are the g s c s nowadays? Like they used to be a big market stabilizer. No, it's stabilizing force right in the market, and it seems like they're sort of not there anymore.

To put it mildly, I think that they're like when we walk through the buyer bases earlier, they weren't one of the buyers that I mentioned, right, and so that puts more of an onus on those other buyer bases, and some of them are stepping back for those reasons we alluded to. Can we talk a little bit more

about speaking of a buyer stepping back? How do you quantify the significant you know, so rate volatility is one contributor to the widening spread between mortgages and treasuries, and then the other one is, you know, the FED was hoovering up a lot of nbs for a long time and now it's not and it's going into quantitative tightening mode. How do you quantify that or think about the effect of the Fed's role in mortgage as so J back O, who is our cohead of Securit Test Products research. He

runs our agency NBS research team. One of the things that that he's done a great job of with respect to when the FED has been involved, when the FED hasn't been involved, is kind of looking at we talked about this mortgage spread, kind of looking at how the mortgage basis has moved or what level it's existed at depending on the behavior of the FED over time. Right, Because when the FED is buying, when you have this large buyer stepping into the market, like that spread show

be tighter. You have a lot of this demand there. When they're not buying, that spread should be wider, right, And so that's that's definitely something that we keep in mind in terms of thinking about what that mortgage spread has looked like over time and accounting for what the

FET is doing at different points in time. So I have a slightly weird question just going back to supply, but I bought a very old house this year which just had one of those like energy efficiency things done on it, and we got like the lowest score possible because there's absolutely no insulation. How much do technological advances

in housing like potentially drive supply? Like I'm thinking you know, if everyone decides, O, energy prices are so high, I want a really energy efficient house with solar panels on it and that sort of thing. Could that drive like a new round of activity. Congratulations on the home parks, thank you as I watch heating oil prices go up

from starting to doubt myself but fix. But I would view it less as a desire to trade up for a more energy efficient home, if you will, especially given what's happened at home prices and mortgage rates right now, and perhaps more of a willingness of that homeowner too. Maybe remove some of the equity, like we talked about from that from that home, there's a lot of that equity there, and perhaps spend that on their current house to kind of improve the efficiency that you just sort

of anticipated. My question, could the lock in environment where it just like I and you see people talk about this all the time. It's like I can't move anywhere because I don't want to give up my mortgage and markets terrible. Could that sustain renovation activity? And because I think renovation activity also really kicked into a high gear during the pandemic and everyone was stuck at home, is like I gotta like you know, fix my whatever so that I living my home lot more. But could that

lock in have that same effect? That is certainly an

option that could happen. Right now, do you think about how we typically talk about, oh, this is a entry level home and then you have your move up home buyer, and if we've made it much more difficult to kind of progress along that path, then you're kind of looking at your current house and saying, well, what do I need to do to this house to make it more accommodative of how my lifestyle is going to evolve, how my family might be evolving, how my trends and work

from home might be evolving, you know. So speaking staying on this supply and demand question, can you talk a little bit about and we were talking about the boomers earlier, but you say, you know, there's a lot of interest in millennial home buyers or maybe Gen Z homebuyers. What is household formation? What is the process that drives household formation?

And my understanding is I think it's spiked quite a bit, but I don't, you know, it's not I don't have a sense of what it actually is or why it would spike due to COVID, But what is household formation, what drives it, and how is the change and that going to affect the market going forward? Absolutely. So when I mentioned the or pillars at the top, one of them was demand. And when I say demand in this context, I mean household formations. Okay, that is the metric we're

looking at. So to talk about household formations, let's talk about how we define a household would be great if you will, right, and so basically, a household is a a unit living together in a in a shelter. It can be ownership or rentship. I like to use an example where you basically have four people that just kind of maybe they graduated from college, they moved to let's say New York City where we're sitting right now, right

and they live in one apartment. They are one household when they moved, when they graduated, when they moved to the city, that that was a formation of a household because as part of their parents household before that, they didn't count as one. So you have one household formation. What we're really going to be talking about his headship rights. That's the percentage of any group, cohort of the population. How you choose to define it, we're defining it by

age here that heads their own household. So this this group of people, their headship rates four of them in one household. Two years later they all moved into their own apartment. We now have four households. Formation would be three. We went from one to four. It's a net figure, and the headship rate for this very small cohort is ad So when we think about how household formations are going to evolve, we're looking at how those headship rates evolved,

in particular by age. The steepest part of that slope is as people move through their twenties and early thirties, kind of branching out on their own, starting with a heavier roommate environment towards a lesser roommate environment in general. And that's why there's so much focus on millennials and gen Zsa. You mentioned how much we've seen recently the headship rate, the percentage of people in there four, their head ship rate was close to fifty year lows, and

that's for a number of reasons. Did we hear a lot of discussion about things like student loan debt, the fact that a lot of these this generation graduated into a recession, making it a little bit more difficult to kind of form your own household, like those kinds of taking on excess roommates moving into your parents basements. That

that brought them down to fifty year loss. But household formations were still coming in above long run average because you had such a large group of people moving through the age cohorts that were so important for household formations. So the rate at which they were the forming were lower, but the number of people so helpful. This is like answering questions have been too embarrassed to ask for years.

This is is exactly why. So then what happened in that caused So I think that you had a couple of dynamics that we're playing out in one that helped cause the spike. I think A you had the pandemic, which two reasons you had a kind of risk aversion people not wanting to live in such densely populated areas where in a lot of instances you kind of might more likely to have roomates. They want to live in less densely populated areas, more likely to have single family housing.

We tracked home prices by zip code, population density, the gap between suburbs and less densely populated urban areas versus densely populated urban areas gapped out over the course of to the largest we'd ever seen. And again that data goes back late eighties or ninies, but so risk aversion work from home allowed them to make that move. And

then we've talked a lot about mortgage rates. As mortgage rates were falling to all time lows, the buying power of this cohort is now much more substantial, and so that kind of just exaggerates their ability to kind of to drive home prices up there and to afford buying homes before we had this record growth in home prices at the same time leaving these densely populated areas, rents

coming down. That also enabled people who weren't necessarily making that move out to kind of decrease their roommate counts. And so you had household formations from that perspective in terms of going from two or three roommates to living by yourself, and informations from going from a renter in a roommated situation in a densely populated area to kind

of the less densely populated areas. So that took us from above long run average to well above long run average, Tracy, I had totally forgotten that was such a big story. The suburbs verse the city is that was like such a big thing. Yeah, I think a number of people have moved back into the city now, not me though

I'm in the country, um sort of. Anyway, you mentioned millennials there, and we've been talking a lot about housing affordability, and there has been this discussion about whether or not, you know, people that have massive student debt might have difficulty saving in the current environment, whether or not they'll

be able to afford houses in the future. There's also a thing that crops up every once in a while where people talk about, well, maybe a lot of younger people don't want to own home simply because they might be into you know, apartments that come with lots of amenities like pools and movie rooms and things like that. What's your impression of, I guess, the American dream or the viability of the American dream at the moment. Do

people still want to own houses? As you know, affordability really comes into question anytime we've seen kind of like the the softer almost survey based data, it still points

towards people wanting to own homes. I do think that affordability pressures that credit availability like, Yes, we think it's probably moving tighter in the in the short term, But even if it starts to move wider, some of the regulations have been put into place post the GFC make it unlikely that we're going to see lending standards ease to anywhere close to what we saw in two thousand seven.

I say that to imply that right now the home ownership break is between sixty five and sixties six percent. We don't see it going back to like we saw back in the early two thousand's. We do think that there's still a desire to own homes, the step towards owning homes occurring a little bit later in people's lives. But we also think that single family rentorship, which I think has become a much more talked about topic over the course of the past ten of fifteen years, and

largely due to the institutional ownership of those homes. Um we think that that's going to become, or we think it always has been and will continue to be, kind of another pillar of of housing of shelter in this country. So we talked a little bit about your forecast for next year, which is the minus three decline in home prices. What's the variable that you are most closely watching that

could change that outlook? Supply? We are watching inventories, if supply, if uneconomic sellers come from areas that we're not expecting. If supply increases faster than we think it will, then all of a sudden, the likelihood that you have people willing to sell into what we already think will be a meager demand environment increases, and that likelihood would then bring home prices lower. So that's the number one variable we're looking at all right. Well, Jim Egan, it was

lovely having you on all thoughts. Thank you so much for taking the time to walk us through household formations and mortgage as I asked about like five questions that I was like to embarrassed to ask for, like you know, over the last ten years. So I've ship you coming out and answering them clarifying. I actually I feel like I understand the few things. Thank you for having me on.

It was a lot of them. Yeah, that was great, well, Joe, I thought that was fascinating just to sort of like really lay out how unusual this current moment is and how we're sort of like breaking records on a lot of housing market indicators or you know, like structural rates and things like that. The other thing that stood out to me was just that lock in Yes. Well, you know, it's funny like University of Michigan, I think in their economic Sentiment, they asked these questions like is it a

good time to buy? Or is it a good time? And these people say these days they say no. And then the other question they say, is this a good time to sell? And that was really high up until recently because it's like a seller's market, but that's plunged. So we have a very weird situation in which it's a it's a it's neither a seller's market nor a buyer's market, which means we're just going to get this

like freeze where there's just not much transactions. And look, I don't know what's gonna happen with prices, but I find this idea compelling that if if supply doesn't shoot up, it's hard to get a big drop in prices. Yeah. I think that kind of goes to Jim's final point as well about it's sort of all about supply and inventory at the moment. The other thing that I found interesting, and this has come up in a number of conversations at this point, is the idea of the marginal buyer

of a lot of bonds. So in this case, mortgage bonds just not being there anymore. And it's sort of a similar story for for treasuries too. But when it comes to mbs, that's feeding into the rates, right, and so you can sort of almost draw a direct line between higher capital requirements and standards to the massive shooting up of mortgage rates that we've seen well, you know, and to the extend that mbs are a sort of

bet on low volatility. You know, the FED doesn't care about you know, the feed is not a profit seeking entity, I guess it technically, I don't know. Maybe for political reasons wants to have some money to remit to the treasury, but that's not why the fit exists. And so it could absorb that volatility, whereas when it's in quantity, that is that is a that volatility has to be priced.

And so you see that spread and it's really wild because so you just look at the spread of thirty your mortgages versus treasuries, and it's quickly spiked up to where we saw like March, when the entire financial system like briefly when nuts. We're gonna have to put together some of these charts. I think, yeah, let's make a chart list. A a charticle should go along with this episode. Shall we leave it there? Let's leave it there? Okay, This has been another episode of the All Thoughts podcast

on Tracy Halloway. You can follow me on Twitter at Tracy Halloway and I'm Joe Isn't though. You can follow me on Twitter at the Stalwart, follow our producer on Twitter, Dash Bennett He's at dashbot. And Carmen Rodriguez She's at Carmen Armann. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening,