The Week of December 5, 2022: Real estate worries, the economy, antitrust, ESG and much, much more.
The Week of December 5, 2022: Real estate worries, the economy, antitrust, ESG and much, much more.
T he distortions brought on by ultra-low interest rates were always going to lead to trouble. Messing around with the price mechanism has a way of doing that. And messing around with the price of money — because of the knock-on effects that it can set in motion — is particularly dangerous, since many of those effects will (inevitably) be unexpected. The chaos in the market for British government bonds that did so much to bring down Liz Truss (she, you might remember, was briefly Britain’s prime minister a month or so ago) owed a great deal to measures taken by pension fund managers to (a) deal with ultra-low interest rates and (b) the assumption that we had entered an era when interest rates would stay low and would not move too dramatically.
That rising U.S. mortgage rates (for a while they crossed the 7 percent threshold, taking them to 20-year highs) might mean trouble for the American housing market is hardly surprising of course, but given the long era of ultra-low rates, it is difficult to know how far the sell-off might go.
In a Capital Letter back in October, I wrote this:
Most of those who bought homes over the past decade did so not out of any speculative motive, but because they simply needed somewhere to live. In 2023, they may look back and think that they overpaid for their home, but from the perspective of, say, 2017, they paid the going rate. The issue is that the going rate had been inflated by ultra-low interest rates. But that rate was affordable because of those same ultra-low rates, and so prices kept rising. . .
I also wondered whether a U.S. housing crash was on the way:
Some [recent poor] numbers are merely a descent to earth after the pandemic-related surge in demand and prices, a fact that will be cold comfort to those who bought during that period. This would probably have been expected even without the Fed hiking rates. I cannot help wondering, however, if the decline in prices now creeping into forecasts – I saw one prediction that prices would fall three percent in 2023, for example – are too modest. A recession would be expected to knock down prices further and sell-offs can feed on themselves.
Although my guesses carefully calibrated “forecasts” should always be treated with caution, a fall of 2-3 percent in 2023 looks even more modest than it did just a month or so ago. The numbers have gotten worse: Home price growth continues to falter (prices are below highs earlier on in the year) and the number of home sales is still falling.
Andreas Steno Larsen, former chief global strategist of Nordea — the Nordic region’s largest bank (where I worked myself for a couple of years two decades ago) — has now set up his own independent research company. Agree or disagree with his arguments (I’ve done both), his writing is always worthwhile and his latest substack caught my eye on Thursday morning.
Larsen notes that the current U.S. residential real estate market is (though he doesn’t use the word) stuck. Admittedly, that’s better than the situation in, say, Canada or Sweden (and there are — or soon will be — other troubled markets to choose from). However, is this the calm before the storm?
As calms go, it is not particularly calming. Most people are locked into their current mortgages at very low rates (70 percent of existing borrowers have borrowed at below 4 percent) that they won’t want to give up. That makes them reluctant to sell, constraining supply and thus keeping prices higher than they would otherwise be. This, in turn, further discourages buyers already daunted by much higher borrowing costs. Put the two together (especially after the earlier strength in home prices) and affordability is at or close to its lowest level in many years. Unsurprisingly, home sales have fallen sharply.
Sellers listed 24% fewer homes in October compared with a year earlier, the fourth straight month with a drop, according to data from Zillow. At the same time, purchases sank and are now 17% below their levels in October 2019, before Covid hit.
Larsen expects the U.S. will move into recession in 2023 (I’d agree). He wonders what will happen if people start losing their jobs in large numbers and have to sell. To summarize quite a lot, he concludes that “a 15-20% decline in the nationwide BIS Residential Price Index looks probable” (and for good measure asks whether that is pessimistic enough).
Probable? I don’t know. Possible? Certainly. If it’s any comfort, Larsen is still something (but only something) of an outlier, although expectations are quickly moving south. According to Forbes:
Morgan Stanley predicts that average housing prices could decline as much as 10% between June 2022 and early 2024. While that number appears drastic, it’s small potatoes against the market’s 40% price jump since early 2020.
According to the Wall Street Journal, Goldman Sachs is expecting a 7.5 percent drop in home prices next year. KPMG is expecting a 20 percent decline. The National Association of Realtors, by contrast, sees the prices of existing homes rising 1.2 percent next year (though some might think that such optimism is part of their job description).
And then there are the “local” factors. Larsen highlights weakness on the West Coast, which will only be reinforced by a growing wave of layoffs in the tech sector. He also speculates that the East Coast may follow suit. He may well have a point. As someone who owns a place in Manhattan, it is hard to feel happy about what’s going on in the office sector. That will have implications for residential real estate too. And my concern was amplified when I read Larsen’s suggestion that we may be looking at more suburbanization to come. As someone unconvinced that working from home (on its current scale) will endure, I am yet to be persuaded that the suburban will “replace” the urban, though I did find myself anxiously re-reading an excellent recent piece by Joel Kotkin titled “Do Cities Have a Future?.” No matter one’s opinion on suburban ascendancy, however, most analysts agree that homes bought at the peak of the Covid flight (when the market went nuts) will almost certainly have to wait awhile to get their money back.
One in 12 purchase mortgages originated in 2022 is now underwater, as the downturn in home prices over the past few months has opened the door to a slowly emerging but potentially problematic issue, Black Knight found.
And this, via MarketWatch caught my eye:
“Cheap, but likely to get cheaper.”
That’s the vibe of the roughly $8.7 trillion market for mortgage bonds with government backing, a key source of funding for U.S. homeowners, heading into next year, according to a BofA Global outlook for 2023.
A backdrop of uncertainty unleashed this year by the Federal Reserve’s campaign to fight inflation through dramatically higher interest rates has resulted in a sputtering housing market. It’s also left those who invest in the bonds used to finance much of the estimated $44 trillion housing market sitting on their hands.
And with Quantitative Tightening underway, the Fed is not going to be stepping in to buy mortgage-backed securities.
All this may add to the pressure on financing for would-be buyers.
And on that topic:
Cracks also have emerged recently in riskier parts of U.S. housing credit, including the collapse of home lender Reverse Mortgage Investment Trust Inc. in November, the year’s biggest bankruptcy so far, according to S&P Global Market Intelligence.
The company, which makes reverse mortgages, listed assets and liabilities of at least $10 billion each in its bankruptcy petition. Chapter 11 bankruptcy allows companies to keep operating while they work on a plan to repay creditors.
Reverse mortgages, a type of home loan geared toward seniors, allow borrowers to convert equity in their homes into cash without needing to sell or pay more monthly bills.
The mortgage industry is contending with a massive slowdown in business as sky-high rates deter new borrowers. Many homeowners locked in low rates during the last two years, and now they’re reluctant to give them up.
In addition to being a lender and servicer of more than 84,000 reverse mortgage borrowers, Reverse Mortgage Funding has been a frequent seller of securitized bonds backed by mortgages. That business came under strain recently as well: late last month, the company shelved a $290 million bond sale amid market volatility.
This failure is part of a broader trend, already visible months ago, that will have important effects on the economy because, today, these non-bank lenders really matter. Scarred by 2008–09, and incentivized by the regulatory changes that followed, banks have reduced their mortgage business, but — since markets work — these independent lenders have stepped up to fill the gap.
The good news is that a plunge in real-estate prices is much less likely to trigger a systemic banking crisis similar to what we saw at the end of the aughts.
The bad news is that the reshaped mortgage lending market has less depth than it had before. Worse still, the current lack of demand for mortgages (and the decline in the market price of the loans they have on their books) has left a good number of these small lenders — quite a few of which are not particularly well capitalized —struggling so badly that (as Reverse Mortgage Funding shows) some will face going out of business. Some, indeed, already have. Many others will have to cut back on their lending.
To repeat myself, this will matter. Bloomberg (August 19):
In 2004, only about a third of the top 20 lenders for refinancings were independent firms. Last year, two-thirds of the top 20 were non-bank lenders, according to LendingPatterns.com, which analyzes the industry for mortgage lenders. Since 2016, banks have seen their share of the market shrink to about a third from about half, according to news and data provider Inside Mortgage Finance…
Unlike banks, independent lenders often don’t have emergency programs they can tap for financing when times get tough, nor do they have stable deposit funding. They depend on credit lines that tend to be short-term and depend on mortgage prices. So when they’re stuck with bad assets, they face margin calls and potentially go under.
Many independent lenders have managed their risk well, and for lenders that work extensively with government-backed companies like Fannie Mae and Freddie Mac, the situation is less dire. They can often get emergency funding from government-sponsored enterprises if they run into difficulty. But those lenders that make riskier loans and work less often with the GSEs have fewer options when they face margin calls.
Many other lenders have seen the value of their loans drop, said Scott Buchta, head of fixed-income strategy at Brean Capital, an independent investment bank. The Federal Reserve has tightened rates by 2.25 percentage points this year in an effort to tame inflation, and 30-year US mortgage rates have surged above 5% for government-backed loans. That’s close to their highest levels since the financial crisis, from around 3.1% at the end of last year.
That’s beaten down the value of home loans made just a few months ago. A mortgage made in January and not eligible for government backing could have traded in early August somewhere around 85 cents on the dollar. Lenders usually try to make loans worth somewhere around 102 cents to cover their upfront costs.
And, of course, interest rates have risen quite a lot since then.
That raises questions about the financial health of those that backed such lenders. According to one source from that August Bloomberg report, banks were “extremely on top of things.” This implies that banks were making margin calls and scaling back lending to the lenders, and thanks to even higher interest rates since then, that process will only have accelerated. The implications for home prices are. . . not good.
Perhaps it’s also worth remembering that — with housing accounting for some 15–18 percent of GDP — a real-estate slump can add to a recession, thus feeding on itself.
In short, there are good reasons to be nervous.
Capital Matters Conference, New York City, January 26, 2023
National Review’s Capital Matters is hosting a conference called “Innovation, Growth—And Their Newer Enemies” at the Union League Club in NYC. Sponsorship information and tickets are available here: https://bit.ly/3VH8i0x.
Speakers so far: Larry Kudlow, Kevin Hassett, Linda McMahon, Amity Shlaes, David L. Bahnsen, Jason Trennert, Peter J. Travers, Andrew Puzder and, well, me.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 96th episode David is joined by Adam Brandon, the CEO of FreedomWorks and a devout advocate of a free society aimed toward human flourishing. They discuss the midterms, the 2024 elections, the economic and existential value of work, why social and economic conservatism is one and the same, the fate of ESG, and so much more. You will come away from this talk encouraged for the future.
No Free Lunch
David has also launched a new six-part digital video series, No Free Lunch, here on National Review Online. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy…
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Other guests (so far) include Larry Kudlow, Dennis Prager and Dr. Hunter Baker.
Enjoy.
The Capital Matters week that was . . .
Antitrust
Jessica Melugin and Iain Murray:
Even in the wake of Meta’s biggest mass layoff ever and a $71 billion loss this year, antitrust regulators around the world are peering into crystal balls to head off hypothetical future harms by the social-media and virtual-reality company. On the pretext of safeguarding competition, they are raising concerns about markets that don’t yet, and might never, exist to block deals that could benefit consumers and spark innovation. The main difference between these regulators and fortune-tellers is that the former can shape the futures they envision…
Fiscal Policy
America’s state governments are currently flush with funds and expanding their spending commitments. Congress had provided over $1 trillion in pandemic aid to state governments, fearing that Covid-19 would cause their revenues to collapse and entitlement costs to surge. Yet, state Medicaid spending actually fell as Americans sought fewer elective procedures, while their own-source real tax revenues increased 12 percent on pre-pandemic levels.
This dynamic — of states overextending themselves in healthy fiscal times and then relying on national bailouts when the business cycle takes a downturn — has become characteristic of modern American federalism. Funds are poorly targeted to help those who most need assistance, and destined to fall short during recessions…
With economists anticipating a recession in 2023, Congress may soon revisit its regular practice of expanding unemployment benefits to aid growing numbers of laid-off workers and stimulate a sagging economy…
Real Estate
Here maybe is another sign of trouble ahead as we adjust to our departure from an era in which ultra-low interest rates had made money close to “free” (the latest economic data would not suggest that the Fed will be inclined to offer much relief on the interest-rate front any time soon)…
I wrote on Monday about the wave of withdrawals from Blackstone’s BREIT (Blackstone Real Estate Investment Trust). BREIT has focused, in particular, on rental-housing and logistics facilities. BREIT is an unquoted vehicle, and typically redemptions (withdrawals) from that vehicle are capped each month. One reason for that is to avoid, so far as possible, a fund such as BREIT having to make forced asset sales in order to come up with the cash to pay out those who want to redeem. The risk obviously is that forced sales would depress the fund’s asset value lower than it ‘should’ be…
Cryptocurrency
If there’s a lesson to be learned from the blowup of the algorithmic stablecoin Luna and the implosion of cryptocurrency exchange FTX, it is that we need to regulate stablecoins and crypto firms like banks.
Why? Crypto firms and stablecoins alike are susceptible to runs and misuse of customer funds without it. Simple regulation — rules governing customer deposits in crypto firms such as FTX and mandating the full backing of stablecoins — akin to deposit insurance can help bring stability to a sector that desperately needs it…
Energy
The best guess remains that Europe will, albeit with some pain, be able to conserve enough gas to avoid the lights going off this winter, but the approach of much colder weather has governments (wisely) announcing some contingency plans…
This morning, Andrew Stuttaford mentioned the measures European governments are taking to avoid facing the worst consequences of their bad energy policies. Here is yet more evidence that, when it comes to energy and to industrial policy, not only is the world upside down, the U.S. itself is headed in the wrong direction. Indeed, when the U.S. president is lectured by his French counterpart about America’s abusive use of green energy, including electric-vehicle subsidies, you know you’re in a bizarro new world…
Nikki Haley and August Pfluger:
America is at risk of losing one of the most important battles of the 21st century — the fight for energy security. China, Russia, and other enemies are weaponizing global energy supplies, with the goal of undermining America and ultimately defeating us. President Biden is letting it happen, so Republicans must take up the mantle of leadership. We must secure our energy future, and with it, our country’s survival…
Inflation
In a classic case of outsmarting themselves, the economists at the Fed seemed to have found a way to create money for the government to spend while avoiding the negative consequences, chiefly inflation. But the ramifications of this monetary malfeasance were only delayed, not denied. To understand why, we need to go back to the last time the Fed avoided massive inflation after record-setting money creation: the 2008 global financial crisis…
ESG
While the “Red Wave” never emerged in this November’s midterm elections, the issues that have riled up conservative voters the most in the past two years aren’t going away anytime soon. In fact, one such issue — politicized investing — is likely to continue growing in prominence. Fights over the grab bag of left-wing policy ideas better known as environment, social, and governance (ESG) theory will continue to be a flashpoint between Democrat policymakers (and their allies) and free-market advocates in next year’s legislative sessions at both the federal and state level…
Fund management giant ($7 trillion under management) Vanguard has been doing some rethinking.
[Vanguard] said on Wednesday that it was resigning from the Net Zero Asset Managers [NZAM] initiative, whose members have committed to achieving net zero carbon emissions by 2050.
The NZAM initiative was formed by a group of asset managers (with $66 trillion under management as of early November). The signatories’ commitment extends, in ways set out here, to their investment portfolios…
Industrial Policy
In the race for global tech supremacy, the United States will not beat China by becoming China, as many pundits today effectively argue it will. America should instead re-embrace and extend the innovation culture that made our nation’s information-technology sector a global powerhouse: open markets, skilled workers, vibrant capital markets, and flexible public policies that reward bold entrepreneurial endeavors.
The let’s-be-more-like-China crowd calls for a different approach: retrench and re-shore, break off global trade ties, massively boost government support for favored firms and sectors, and do a whole lot more bureaucratic steering of tech markets toward predetermined ends…
Transportation
The Federal Motor Carrier Safety Administration (FMCSA), which regulates interstate trucking, is looking to place surveillance devices on commercial trucks for safety-monitoring purposes. The agency said in its notice of proposed rulemaking in the Federal Register that such a move could “improve the efficiency and effectiveness of the roadside inspection program by more fully enabling enforcement agencies to focus their efforts at high-risk carriers and drivers.”…
The Economy
Without income to support consumption, consumers are running up massive debts. Total household debt, which includes mortgages, is up by 8.3 percent relative to last year, and credit-card debt is up 15 percent. Add higher interest rates to that equation and the fundamentals are aligned for consumers to hit a brick wall sometime next year.
In other words, we are seeing the reverse of the normal recession pattern from consumers. Normally, things get a little rough, and then prudent consumers prepare for the storm by reducing their debts and increasing their savings. This time, things got a little bit rough in the beginning of the year, and consumers threw a massive party.
The best explanation for this behavior is that the extremely generous fiscal policy during the pandemic and even after it has taught consumers that there is a fiscal-policy analogue to the Greenspan put. Call it the “Covid put.” Just as Greenspan was always there to bail out equities when times got tough, Congress will be there to mail checks as soon as the seas are stormy. And it’s not just the federal government: California has already mailed “stimulus” checks of up to $1050 this year.
The problem, of course, is that risk is real. When governments try to protect economic agents from the consequences of risky behavior, the risky behavior increases…
Trade
The International Trade Commission is going woke, as revealed by a report that is getting a lot of pushback from trade economists. Some background is needed here: U.S. trade representative Katherine Tai apparently agrees with the Biden administration’s claim that trade protectionism advances the goal of racial equity. Enter the U.S. International Trade Commission (ITC), which released a report showing that trade liberalization disproportionally hurts minorities.
Trade economists disagree…
Infrastructure
Conversations about infrastructure are commonly centered around government. Governments at various levels do own most roads, airports, and seaports in the United States, and those are vital and expensive. But in a recent blog post, Chris Edwards of the Cato Institute points out that the private sector is actually responsible for most infrastructure in this country, and that fact has interesting implications for how we ought to think about infrastructure policy…
Regulation
If you’re a good driver, you follow the rules of the road, obeying the speed limit, coming to full stops at stop signs, and yielding to pedestrians in crosswalks. And that ought to be enough. But now imagine that the government mandated you carry a state trooper in your passenger seat, one assigned to ensure you obey every traffic law at all times — and one whose salary you were obligated to pay out of your own pocket.
Sound far-fetched? It’s not. Something similar is happening to me today…
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