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Covid-19 Will Sicken the Housing Market Until the Pandemic Lifts

Bloomberg logoBloomberg 5/12/2020 Timothy L. O'Brien
a sign on the side of a building: Might have to wait for a coronavirus vaccine. © Photographer: Justin Sullivan/Getty Images Might have to wait for a coronavirus vaccine.

(Bloomberg Opinion) -- Bill McBride is a trained chemist and self-deprecating data junkie who is publicity-shy. For years he blogged anonymously, eventually outing himself only so he could praise a deceased co-writer in an interview with a reporter. And if you wanted to know where the housing market was headed long before it began imploding back in 2007, all you had to do was listen to him.

“I have taken to calling the housing market a ‘bubble,’” he wrote on his blog, Calculated Risk, on April 4, 2005. “Speculation tends to chase appreciating assets, and then speculation begets more speculation, until finally, for some reason that will become obvious to all in hindsight, the ‘bubble’ bursts.”

Bill’s writing was wonky, exacting and chart-heavy — and inspired by what he saw happening around him in southern California. There were “spikey-haired” mortgage brokers in their 20s cashing in and driving Ferraris. A friend at a local gym in Newport Beach with a modest income was stoked about a relatively expensive condominium she just bought. “It was weird because it was so obvious to everyone I knew,” he recalls. “If people making $20,000 a year could buy $300,000 condos, you had a problem.”

Calculated Risk has always been awash in metrics. One of Bill’s hat tricks is combining three data points — single-family housing starts, new home sales and residential investment as a percentage of gross domestic product — into a bellwether that accurately traces tops and bottoms in the housing market over decades. Last October, he noted that housing vitality also generally correlated with the beginning and end of broader economic recessions. “New home sales are up solidly year-over-year,” he wrote at the time. “No worries.”

As fall turned to winter, he remained optimistic about housing and the economy, his faith in the data unwavering. “I think data kind of tells you the truth, even though every bit of data is flawed,” he says. “People can tell you all the stories they want, but data kind of tells you the truth.”

Bill, 66, will also remind you that data only gets you so far. The unforeseen, he allows, can shred the soundest of models.

On Feb. 25, Nancy Messonnier, a senior official with the Centers for Disease Control and Prevention, warned that the coronavirus was about to lay siege to the U.S. “It’s not so much a question of if this will happen anymore, but rather more a question of exactly when this will happen, and exactly how many people within this country will have severe illness,” she said.

Financial markets plunged in response, and Bill, stunned by Messonnier’s warning, stopped going to dinners and lectures to avoid an infection. “Several readers have asked about the economic impact of the novel coronavirus,” he wrote on Feb. 28. “The answer is it depends on the severity of the epidemic.” Then, on March 13: “This is a sudden stop for the U.S. economy like nothing I've ever seen.”

Bill is still watching the data but has no idea what lies ahead for housing or the economy. “I’m still trying to get my head around this. It’s so far out of my experience that I don’t know what to say about it,” he says, as we chat about the 128.6 million households staring down yet another crisis. “The outlook for housing is completely dependent on the outlook for the virus.”

Today’s housing market isn’t remotely as speculative or unhinged as it was when Bill watched it enter a free fall in 2007. Back then, rock-bottom interest rates had made it easy to borrow, buy and flip homes. Investors hungry for returns chased after high-yielding packages of mortgage-backed securities — prompting Wall Street to construct and sell ever more exotic, opaque and lucrative bundles.

Credit rating companies gave overly glowing grades to the debt which helped spark sales. Banks and other originators had wildly lenient lending standards. Poorly built and privately traded derivatives gave market players far weaker default insurance than they believed they had, and looser financial regulations helped make it all possible. Along the way, borrowers like those Bill was watching in California spent more on housing than their incomes could support, and the market for subprime mortgages — granted to the least credit-worthy homeowners — boomed. Then housing cratered.

Bill, the son of a Navy pilot and a mother who was a teacher and principal, wasn’t a professional analyst or investor when he began scrutinizing the housing market in 2005. An undergraduate degree in chemistry from the University of California at Irvine in 1976 landed him a job coding software. He worked for a telecommunications company after that, and his next employer, a medical device manufacturer, paid for the MBA he earned from Irvine. By 1996, he made enough money to retire and begin traveling, hiking, investing and poring over data full-time. A lifelong Republican, he campaigned for John Kerry, a Democrat, in the 2004 presidential election because he believed the Bush administration had manufactured data to justify invading Iraq. During the campaign he became hooked on blogs — particularly those from authors with deep subject expertise — and decided to launch his own data-driven take on housing.

Calculated Risk’s views of housing dynamics were so richly informed and prescient that the blog quickly developed a cult following among investors, financial analysts and business journalists. It also got nods from a well-regarded Federal Reserve economist just a few months after it launched. Bill added a whip-smart former mortgage banker, the late Doris Dungey, as a co-blogger, and they had about 100,000 readers a day by the time the housing meltdown threatened to unravel the entire financial system in 2008.

“Housing frequently leads the economy into recessions, and I was thinking that not only could housing go down, it could potentially take the economy with it,” he recalls. “I was confident that housing prices would collapse dramatically and people would lose their homes.”

Bill, who has a quick laugh and endless curiosity, also considers himself an optimist. Amid a savage crisis that eventually produced the longest recession since World War II — and a 33% drop in housing prices spurring almost 8 million foreclosures — he looked for bright spots. Auto sales data hinted at a potential rebound. “These will be rays of sunshine in a very dark season,” he wrote in February 2009, annoying market bears who thought him naive. “That doesn't mean a thaw, but it will be a beginning.”

Although average workers didn’t see their wages rise in the subsequent financial rebound, Bill was right that the economy wasn’t catatonic. He correctly called a bottom in the housing market in 2012 (again defying conventional wisdom).

In a 2013 blog post “The Future Is Still Bright!,” he could barely contain himself. “Overall it appears the economy is poised for more growth over the next few years. And in the longer term, I remain very optimistic too,” he wrote, noting that housing starts appeared ready to soar. “Last year, I said that looking forward I was the most optimistic since the '90s. And things are only getting better. The future's so bright, I gotta wear shades.”

The unemployment rate sank from 9.6% in 2010 to 5.3% in 2015 to 3.7% last year. The stock market went on a record-setting bull run from 2009 to 2019, and the housing market came roaring back, too. By the middle of last year, home prices were about 50% higher than they had been at the same point in 2009.

Although worries had surfaced that housing was bubbly again, Bill, comfortable with his data, was sanguine. While prices were toppy he saw little irrational speculation. New home sales had been rising for several years but remained low on an historical basis. And with the cupboard somewhat bare — the inventory of homes available to buyers was tight — he thought there would be little downward pressure on prices. Low mortgage rates helped ease the pain of lofty prices for some prospective buyers.

“At the end of last year, I thought everything was good and would get better again this year,” Bill says.

Housing’s foundations were strong coming into 2020. Fewer exotic loans were available, credit standards were tighter, banks had stronger balance sheets, and the mortgage process had become more transparent. Regulators were more vigilant, and banks, borrowers and brokers had generally become more conservative about risk. The homeownership rate, which peaked at 69.2% in 2004 before tanking to a record low of 62.9% in 2016, rose to 65.3% in the first quarter of this year. The delinquency rate for mortgages at the end of 2019 was 3.77%, the lowest since 1979 and far below the peak rate of 11.54% in early 2010.

The average age of first-time homebuyers was about 32 or 33 and demographics were solidly behind the market as well. New households were forming more rapidly than in the past and analysts expected that to continue through the year. Millennials who had been locked out of the housing market for years had started to reconsider, buoyed by improving wages, low borrowing rates and emotional distance from the 2007 housing collapse.

In January, Bill reminisced on Calculated Risk about an unemployment graphic — “the scariest jobs chart ever” — he had regularly updated from 2007 to 2014. The jobs rebound convinced him to stop posting the chart. “I don't expect a downturn for employment any time soon (unlike in 2007 when I was forecasting a recession),” he wrote.

The coronavirus landed on this happy scenario like a wrecking ball.

After lockdowns began and businesses shuttered, the unemployment rate spiked. By the end of April more than 23 million Americans were out of work, producing a jobless rate of 14.7% — the highest since the Great Depression — and obliterating all of the jobs created in the previous decade. That rate also zipped past the Great Recession’s high of 10% unemployment in 2009. People without jobs tend to stop buying things, including houses. And those who already own houses but lose jobs often fall behind on their mortgage payments.

“Both the depth and length of the economic downturn are extraordinarily uncertain and will depend in large part on how quickly the virus is brought under control,” Federal Reserve Chairman Jerome Powell told reporters on April 29. “I think everyone is suffering here, but I think those who are least able to bear it are the ones who are losing their jobs. It is heartbreaking to see all that threatened right now.”

March traditionally has been the best performing month for the mortgage market, but delinquencies rose this year, the first time there had been a March increase in two decades. Pending home sales fell 21% in March, and the National Association of Realtors projected sales to decline 14% for the year. By late April, mortgage applications had plunged 31% compared with the same period a year earlier. And all of this would have been much worse had Congress and the Federal Reserve not stepped in.

Housing is just one part of an ongoing, multi-faceted public health and economic crisis — unlike in 2008 when the housing meltdown was what set the crisis in motion. When the federal government stepped in this time it began spraying trillions of public dollars at multiple targets: small businesses, large corporations, airlines, unemployed workers, hospitals, state and local governments, educational institutions — as well as the housing market. For its part, the Fed cut interest rates and ultimately unfurled 11 different credit facilities intended to throw financial lifelines to almost anyone who found themselves drowning.

Congress and the White House ordered a moratorium on housing foreclosures. They also directed mortgage servicers to offer homeowners with government-backed mortgages reduced payments — or to even allow them, depending on their financial situation, to postpone their payments entirely for as long as a year.

“Almost everything has been unprecedented over the last few months, but I think it’s worth considering that the Federal Reserve used every tool in its arsenal that it had picked up from the 2008 crisis,” says Michael Fratantoni, chief economist for the Mortgage Bankers Association, a trade group. “Congress moved quickly too. The housing market will certainly be one of the beneficiaries of those policy responses.”

Those responses are also likely to cause some pain.

The housing market is knitted together by a nexus of relationships — buyer to banker to bondholder, for example. When one part of the chain gets rattled, every participant feels the shockwave. A foreclosure moratorium and forbearance are necessary and compassionate policies that also put servicers — big banks and others who collect loan payments from borrowers and pass a portion of that money  along to investors — in a possible bind. If a significant portion of borrowers delay paying, then servicers may be forced to pay investors out of their own pockets. And if they can’t, they’ll look to the government to bail them out.

The Mortgage Bankers Association observed in March that if 25% of homeowners received a three-month forbearance, the servicers would need to come up with $36 billion to cover the shortfall in payments; a nine-month forbearance could potentially leave servicers on the hook for more than $100 billion. Several days ago, the MBA disclosed that 3.8 million Americans, representing about 7.54% of the mortgage pool, had gone into forbearance as of April 26. Black Knight, an analytics firm, estimated that represented about $4 billion a month in missed payments on government-backed loans alone.

Even with multiple government backstops in place, banks have started battening down their hatches. Mortgage-making has shrunk dramatically, and home equity lines of credit are being pulled in, despite a promising uptick in mortgage applications. Depressed home sales will have a knock-on effect on the economy that will also make it harder for Americans to bounce back quickly from the damage the coronavirus has already unleashed. None of this captures the even greater hardships facing 40 million households across the country that rent rather than own, and haven’t received comparable public support.

Perhaps the biggest unknown of all is time. Every dollar in federal aid, every interest rate cut and every effort to offer public support to homeowners, workers, business owners and the health care system is predicated on the idea that the measures aren’t permanent — that once the pandemic eases or passes things can get back to normal. If, instead, we’re in the early stages of a multi-month or multi-year battle that continues to require economic sacrifices, the calculus changes.

“My current guess is the economy will start growing — slowly — in June (maybe July),” Bill wrote a few weeks ago. “But growth will likely be slow at first as people put their toes in the water. I don't expect a ‘V’ shaped recovery unless there is an effective treatment or a vaccine, then growth will pick up quicker.”

Bill isn’t expecting a vaccine to arrive anytime soon however. Calculated Risk has always featured a wide array of data sets, including movie box office receipts, travel and transportation information, hotel occupancy rates and auto sales. It also now features regular looks at Covid-19 tracking data.

“The course of the economy will be determined by the course of the virus. If it doesn’t last a long time we’ll be fine. If we’re not out of this in just a few months we’ll have a real problem,” he tells me. “I’m the wrong guy in the wrong field to ask where housing will go. Infectious disease specialists will know.”

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Timothy L. O'Brien is a senior columnist for Bloomberg Opinion.

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