Since March, we have all had to live without professional sports, concerts or parades. Investors have had to live without something far more important to them: positive economic data. While it may be a while before we can go to the ballpark, economic data may be turning in one part of the economy. On Tuesday, the Census Bureau reported that new home sales ran at a 623,000 annualized pace in April, well above economists’ consensus estimates of 480,000. This followed some mixed but generally encouraging data on house prices an hour earlier. In a contraction which has been called “unprecedented” and “unlike anything anyone has seen before,” the housing market is the grizzled old man who smiles wistfully and replies: “I’ve seen worse.”
The mortgage market is a good place to start any discussion on the housing market. Mortgages are by far the largest part of household debt, and they drive U.S. housing as much as any economic fundamental. 1 1 Close In your face, credit cards. You too, student loans! In March, when fixed income markets were dysfunctional, mortgage rates spiked and mortgage applications collapsed. 2 2 Close Bankrate.com, Mortgage Bankers Association, Bloomberg. The Fed responded with large scale purchases of mortgage-backed securities (MBS) which stabilized markets. Since then, applications have come back to near pre-crisis levels, but the mortgage market is still not functioning entirely normally. Banks are reluctant to approve subprime and jumbo mortgages. 3 3 Close The commercial real estate market also has some serious problems, but that is a topic for another week. While nominal mortgage rates are slightly lower than they were in February, spreads to Treasuries have widened. This may be putting a damper both on the recovery in the housing market and on the transmission of lower rates to the economy.
While new home sales are looking better, confidence among home builders has barely recovered. Sales of existing homes appear to be much weaker than new homes. Part of the divergence may be because new home sales are counted at the time of contract while existing home sales aren’t counted until the closing. The best quality data on prices is also slow to come in, but so far looks okay. New home sales prices were down, but the broader CoreLogic and FHFA indexes both rose in March. Zillow, for what it’s worth, seems to think prices are stable, but we’ll have to wait a few more months for confirmation. 4 4 Close Zillow seems to think the price of my house went down, so I’m inclined not to believe its data.
It’s a mixed picture, but the main takeaway from the data is that housing has held up fairly well through the pandemic. There was no housing crisis. 5 5 Close Not bad for a depression! Ironically, some of the factors which have prevented a worse outcome may be holding the market back now. The most important of these is regulation. The CARES act didn’t allocate funds to housing as it did for airlines and small businesses, but it did include an important provision requiring mortgage servicers to offer forbearance on loans. Forbearance allows borrowers to defer payments initially for 180 days with the option to extend to a year. 6 6 Close Consumer Financial Protection Bureau: “CARES Act Mortgage Forbearance: What You Need to Know.” The idea behind the program was to prevent borrowers who have lost their jobs from defaulting and losing their homes. The program doesn’t require proof of hardship. Anyone with an eligible mortgage can apply, but forbearance is not forgiveness. 7 7 Close I almost thought they would include a clause saying “being in love means never having to say you’re sorry.” Everyone must pay eventually. 8 8 Close Unless they declare bankruptcy. Or negotiate a default. It just sounds more dramatic to say everyone.
Around 4.7 million homeowners with over $1 trillion in loans have applied for forbearance. 9 9 Close Black Night as of May 22, 2020. Some of them have made payments anyway, so their applications may have been precautionary. Forbearance has probably helped prevent panic in the market. It has almost certainly reduced the number of foreclosures, but as with any legislation written quickly in a crisis, it has some side effects. In particular, it did not offer any compensation to servicers.
Servicers are not well known, but they play an important role in the mortgage market. A majority of mortgage loans in the U.S. are guaranteed by agencies such as Fannie Mae and Freddie Mac and then sold to investors as pools. While the lenders that originate these loans may no longer hold them on their balance sheets, they typically continue to be involved as servicers, meaning they are responsible for processing the payments. Many decide to sell or subcontract that responsibility either to other banks or independent companies. In cases of forbearance, servicers stop receiving payments from borrowers, but must still make required payments for MBS. This can put a strain on their finances. Lenders don’t want to extend credit to anyone who they think may be a forbearance risk, so lending standards are likely becoming tighter and they may be asking for higher rates than they otherwise would. This may explain why spreads have widened to Treasuries despite the Fed buying over $600bn of mortgage-backed securities. 10 10 Close In addition, agencies generally have not guaranteed loans to people who have previously applied for forbearance, so many of them can’t refinance even if rates go down.
Even prior to the recent chaos, the servicers were particularly well capitalized. In December, the Treasury Department’s annual stability report warned that non-bank servicers “could transmit risk to the financial system should they experience financial stress.” The servicers have asked for help. The head of the Mortgage Bankers Association has written several letters. Ginnie Mae currently offers a lending facility, but Fannie and Freddie still require servicers to cover four months of forbearance before offering assistance. Agencies may be reluctant to get involved because of pressure to improve their balance sheets for eventual privatization.
If regulators can sort out their policy actions, there are reasons to believe housing can outperform in the recovery. For better or for worse, people have been spending most of their time in their homes. They may be willing to spend a higher percentage of their income on housing. Home improvement spending has been one of the few economic bright spots in the past few months. Prior to the pandemic, housing credit had performed well, and defaults had been low. The risks are clear – if unemployment stays high and people can’t pay their mortgages, no amount of forbearance or aid can prevent housing prices from falling, but if rates stay low and unemployment falls, conditions will be quite good for U.S. housing.
What We Are Watching
China Manufacturing PMIs (Sunday/Monday)
In April, Chinese PMIs showed continued recovery in the manufacturing sector, albeit with weakness in export orders, a natural consequence of COVID-19 mitigation policies in the rest of the world. Survey data also pointed to a rebound in construction activity, presumably supported by lower interest rates and expansionary fiscal policy. On the services side, data has been less encouraging, with Services PMIs missing consensus forecasts last month. The weakness may reflect consumers’ uncertainty around the economic outlook, softer incomes, or health concerns. The upcoming data will shed light on how the first large economy to “reopen” is faring in the recovery stage.
European Central Bank Meeting (Thursday)
ECB President Lagarde recently painted a bleak picture for the European economy, noting that the central bank’s “mild scenario” projections for growth were likely outdated. Against this backdrop, some observers expect the ECB to ease further next week through increases to its asset purchase program. Proposals by Germany, France, and the European Commission for sizable joint fiscal support, including grants to countries most impacted by the pandemic, will likely be perceived as a positive development by the central bank. However, with no agreement finalized, and potentially difficult negotiations ahead among member states, the ECB is unlikely to meaningfully change its outlook on these developments yet.
U.S. Employment Report (Friday)
In the April employment report, the Bureau of Labor Statistics (BLS) estimated job losses of about 20 million, more than twice the total number of jobs lost over the course of the 2008-9 recession and ten times larger than the worst month to that point. 11 11 Close The long-time record holder was September 1945, when nearly 2 million jobs were lost as the U.S. demobilized following World War II. Judging by weekly initial jobless claims figures, the economy likely continued to shed a large number of jobs in May amidst ongoing limits on business activity aimed at containing COVID-19. Beyond the headline payroll and unemployment figures, which forecasters expect will continue to show a deteriorating labor market, economists and investors will be looking at a few details within the report. One silver lining in last month’s data was that nearly 80% of unemployed workers described their job loss as temporary. If that proportion remains high, it could point towards a relatively rapid recovery as lockdown conditions ease. Also of interest will be the composition of job losses by industry. If weakness is concentrated in areas directly impacted by shutdown restrictions, it could again offer hope that the removal of these restrictions will promote a faster rebound.