PolicyCast: Why Housing is Booming While Economy Busts

Kirk Willison    00:00:03    Forget everything you’ve heard about economics. It isn’t always the dismal science, a term coined by Scottish historian, Thomas Carlyle in the 19th century. That’s why in this episode of the Arch Mortgage Insurance PolicyCast, I’ve invited two of the country’s more engaging economists to share their outlook for the housing economy, given the ongoing pandemic and the new Biden administration about to take office. Ralph DeFranco is Global Chief Economist for Arch Capital Services. He writes the quarterly housing and mortgage markets review also known as the HaMMR Report. And Ralph just issued his fall 2020 edition a few days ago. Ralph has been with Arch since 2010 and he previously worked for Freddie Mac, JP Morgan Chase and Triad Guarantee Insurance. He’s based on the west coast. Joining Ralph for his First American Title’s, Chief Economist, Mark Fleming. In his role, Mark leads an economics team responsible for analysis, commentary and forecasting trends in the real estate and mortgage markets. Mark previously worked for CoreLogic and Fannie Mae. And he’s based right here in Washington.

Kirk Willison    00:01:28    Well, Ralph, Mark, thank you very much for appearing on the Arch Mortgage Insurance Policy Cast today. I’m really looking forward to learning from two of the best chief economist in the housing business today. Listen guys, perhaps one of the biggest surprises that we faced in this pandemic economy has been the rapid rise and really the continued performance of the housing economy. Ralph, in your latest housing and mortgage market review, or the HaMMR Report, you’ve gone into this issue in significant detail and I wanted to know, you know, what is it that seemingly increasing this demand for housing?

Ralph DeFranco    00:02:22    Great, thanks, Kirk. It’s great to be here. So it’s ironic really. I mean, nobody thought that it was going to be the stronger housing market when the pandemic first hit. So it’s been benefiting, the housing market’s been benefiting by the fact that the Fed has lowered interest rates down to record lows. And so that’s translated into excellent affordability. So interest rates are now record lows for U.S. mortgages. So that’s bringing an extra demand, but also I think what’s happened here is there’s a fundamental shift in people’s preferences. So in economics, it’s all about marginal trade-offs between things. And a year ago, you could think about spending your money on a big wedding or international travel or just lots of live entertainment. Well, those options are all out. I needed a home office. I need room for my exercise equipment. Maybe you’ve got a college-aged child who’s come back from college, staying with you. So people need more space. And so that has resulted in a bump up in demand. And so what we’re really seeing is very strong demand for housing. And it’s continued for many months and it’s strong even right now. And I expect it’s going to continue to remain strong, but I’m just curious if Mark has a similar view on it.

Mark Fleming    00:03:40    I mean, I think you’re absolutely right. Clearly the benefit of mortgage rates, I find it, you know, the housing market is relatively unique and maybe unique in the sense that when there’s a recession, we get an immediate benefit, right? So the loosening of monetary policy, the reduction in rates lowers mortgage rates. So the housing market gets this positive tailwind when otherwise, all things else are not going so well economically. And that has clearly been the case. I mean, it was actually the case leading in, mortgage rates, I never thought I would get to say this as a professional real estate economist, sub 3%, that’s, you know, but here we are. And that’s largely a function of the pandemic, but even a longer run, ten-year long run sort of lowering of rates. In addition to the short term effect though, I think there’s even a longer term benefit of, you know, Millennials have been aging into their desire for home ownership over the last three years. And they tend to be more educated, tend to have higher income, those dual incomes combined with low rates, house buying power through the roof, and then add on top of that, the pandemic. And we have a recipe for a relatively good environment, even though everything else is struggling.

Kirk Willison    00:04:53    So, we all are working from home these days. So as Ralph said, we need home offices and the like. Is the housing, the development, that great growth in housing, will it continue past the pandemic?

Mark Fleming    00:05:09    Yes. For one of the main reasons that I said is the demographic tailwind, it doesn’t go away with the vaccine, you know, is basically, we’re three years into it with a solid five or more years of, you know, the largest generation in American history, aging into wanting to become a homeowner. That’s going to buoy us through. Now, obviously also what will depend is how low rates stay and how long they stay this. Most forecasters and our, you know, first of all, I think it’s an economist fool’s errand to forecast mortgage rates, but here it goes, you know, and arguably maybe I have a better shot at it than ever because you know, Jay Powell and the Fed has pretty much said, we’re going to keep it low. So I think odds are pretty high that next year we will have the low rates still. We will have that strong demographic demand. And, you know, those underpinnings to the housing market will continue to buoy us . I think the challenge is you can’t buy what’s not for sale and there’s a great demand, no supply, recipe for rising prices.

Kirk Willison    00:06:18    And we’ll tackle that in a bit, Ralph, we’ve seen anecdotal stories about New York City emptying out or people leaving urban areas and going to the suburbs, or maybe even if they’re having a job that they could work anywhere, they’re suddenly going into other parts of the country that are less populated. Is that a trend we’re likely to see? Or is that just kind of a one-off experience?

Ralph DeFranco    00:06:43    Well, it’s both temporary and some permanent effects. So let’s think of it this way. Roughly 5% of the U.S. workforce has been working fully remote before the pandemic. So now it might be 10, 15%, we don’t know the exact number there’s going to be more for sure, in fact, I have a friend, a close friend, John Coanda who’s in the tech industry, his company is decided everyone’s going to work remote forever now, we’re going to not have an office. So there’s definitely going to be some movement towards home offices. So there’s gonna be some shift in the need for space, from commercial real estate, into people’s residential homes. I don’t think that’s going away. So there’s going to be a permanent bump up and demand for second homes. Now, even if you don’t work fully remote, what should be much more common is people working some days from home, maybe a few days a month, maybe a few days a week. And so they could be further out. So we’ll see some movement towards the suburbs. And so it will be more of a hybrid model where some people are going to dial in by video and other people will be in the office in person. So I think that that’s going to be the most likely scenario. So people will still prefer to be close to the city, just because of the entertainment. It’s not just the fact that we have an office there, if you’re young and in your twenties, or, you know, single, there’s a reason to be close to the action. And so cities will come back once the pandemic is over. So cities have survived much worse than this throughout the centuries, and have always come back stronger than ever. So I’m not worried about cities in general, there will be some permanent effects. And I would expect continued migration from higher tax states like New York, California to places where it’s lower cost to live. As more people at the margin are allowed to work remotely.

Mark Fleming    00:08:20   One of the things we’ve tried to look for, you know, this sort of pandemic flight to the suburbs, and we looked across about 40 major metro areas, looking at the data to try and tease out could we see some systemic, significant effect of change of urban versus suburban over the last few months. And we only really found it in one place, New York City. And I would argue, let’s see, well, it is the most dense urban place. Density, people density, not good in time of pandemic. It’s also heavily reliant on public transportation to get that dense population around. Public transportation, not good in time of pandemic. So a city like New York, clearly there is this sort of flight to the suburbs driven by its, you know, arguably one of the, you know, would be the riskiest sort of scenarios to live in as a densely populated place where you’re taking public transportation. I think that’s not the same in Houston, Charlotte or somewhere like that. I think those are, because of the way those cities are by definition, less densely populated, more spread out, less commuter oriented. The effect is probably less strong there. What I think is true though, is across all these markets, again, there was already a demographic trend towards suburbia anyway. Right? You said it Ralph, like if I’m young, AKA single, not married, no kids. Yeah. I don’t want to live in the suburbs. It’s not cool. And I’m probably renting in some more urban and fun areas. Well, as soon as I turned 30, 32, 33, I form a family, I started having children, there was already that shift to the desire for suburban residential living that is separate from the pandemic, that will go through the pandemic as well. And so actually, if you look back in the longer run, you know, part of the struggle of urban cities in the seventies and eighties and the revitalization of the urban cities in the nineties and 2000’s is actually because of the fluctuations in demographics, because we have big populations of democracies coming and going out of wanting to live in the cities and have that. And so, you know, there is that risk, I guess, in the longer run going forward is how does a city attract people, forget the pandemic, but how does the city attract people when most of them just want suburbia for what suburbia offers for raising families, as an interesting dynamic of how these things go.

Ralph DeFranco    00:10:59    Yeah, can we stay on that topic, Kirk, if you don’t mind? So Mark is dead on that there’s a demographic benefit to housing going on right now. So there’s a record number of people in their late twenties and early thirties, and the median age of first-time home buyers is 32. So we’ve got lots of people moving into this. They’re already more than normal, say more than five, 10 years ago, already at that sort of prime age, there’s lots more coming. And so once you have kids, dogs, things like that, having a house with a backyard, there’s a lot more feeling than a small apartment downtown. Nevertheless, cities are still going to have some appeal, both because there will still be single people, there will still be people who want a short commute and so forth. And then there’s also some economic magic in face-to-face interactions. So even though Zoom is great, I still think productivity and, it benefits from, creativity and productivity benefit from being in the same space. So there’s a reason companies like Google, pre-pandemic were hiring people in Manhattan and San Francisco and so on, instead of just letting everybody work wherever they want. There’s still an economic magic in cities that I think will still be there. Even when the dust settles.

Mark Fleming    00:12:16    I have a hilarious anecdote to send back you up here, Ralph, I can’t remember where I read it, maybe it was back in April or May, but it was a study of which professions are most able to work remotely and from home, and the number one profession, do you know which one it was? Economist. Now, is that saying something about how we don’t like to be around each other or anyone in general, or is that something to do with the profession itself? I think it could go both ways.

Kirk Willison    00:12:48    Let’s look at the experience of the government recently when we have a crisis, America, most places around the world turn to their government for a solution. And in our case, we saw really dramatic and quick action by federal housing regulators to protect borrowers in the form of avoiding evictions, also in creating a forbearance program. It seems to be, it’s been a remarkable success in keeping people in their homes. Is there any concern going forward, though, that we’re going to have a significant rise in defaults or foreclosures. Mark, why don’t you take that one first and then we’ll throw it to Ralph?

Mark Fleming    00:13:30    I’ll take a small exception with some very refined use of your words, keeping people in their homes. I think the forbearance program has been successful at keeping people up to date or from not being technically delinquent on their mortgages. That’s not the same as in their homes. And I’ll explain, I’ve subscribed to this concept of the dual trigger theory of foreclosure. Trigger number one, inability to make your mortgage payment, which is necessary, but not sufficient for foreclosure, right? Trigger number two, lack of equity, also necessary, but not sufficient for foreclosure. Now, what we saw in the global financial crisis was those dual triggers showing up together, right? Because house prices declined, equity was wiped away and you were having inability to pay problems. Now we had foreclosures and then the vicious cycle, because foreclosure power prices increases, lack of equity and off you go. This time around though, we’re addressing the forbearance program, the inability to pay problem, which is separate from whether or not you have equity or not. And the truth of the matter is, right now, as measured by the Federal Reserve, about $20 trillion with a T of home equity is owned by existing homeowners. And we do the same, what we call the national LTV. We’re basically measuring the total amount of mortgage debt outstanding to the total amount of home value. And that sets the low 40% right now, which is significantly lower than in the global financial crisis. People are much less levered, have a lot more equity. So even if, and we don’t really know from a policy perspective, whether forbearances will be continued or not, but even if people truly become delinquent, the solution will be unfortunately involuntarily being told to sell your home, but not foreclosure. The good news is well, bad news is it’s an involuntary request. You don’t have much choice in the matter. The good news is to our earlier conversation, there’s plenty of people out there who would like to buy your home from you.

Ralph DeFranco    00:15:43    Yeah, I would totally agree with Mark that we have a near record amount of home equity out there, according to some research, there’s only a few percentage of mortgages where the borrower owes more than the loan amount. The house is worth less than the loan amount I mean, and back 2010, it was more like a quarter of all mortgages. So we’re in a completely different situation. This is nothing like the last time around, we are in fact in the exact opposite situation of things last time around. And so the other thing that’s important, I think for everyone to realize is that the forbearance programs that have been offered are generous by any measure. And so if you have difficulty getting caught up for those missed payments, do work with a servicer and it’s quite possible they can just take the missed payments and just add them to the very end of the mortgage. And so that is very generous and should help lessen the number of foreclosure. So it will be more people in distress if they can’t recover their income by the time the forbearance programs end. So it might be difficult for an airplane pilot to recover his high salary. But so there will be cases, unfortunately, as Mark was saying where people will be forced to sell, but by far and large, there are people who have money in their homes. So if they sell the thing, actually have some cash leftover when they pay off their mortgage and they’ll sell instantly, cause there’s just no supply out there. Demand is astronomically strong. So it’s a great time to do it.

Mark Fleming    00:17:19    If you’d have the involuntary sell, now’s the time to do it. That’s a terrible thing to say, but yes.

Kirk Willison    00:17:26    Well, looking at the broader economy, we had an incredible third quarter. Economists such as the National Association of Business Economists are predicting a much slower pace. And in fact, one of their predictions is that 10 to 20% of the jobs that previously existed will never come back after the pandemic. What are your general thoughts about the broader economy, Ralph?

Ralph DeFranco    00:17:55    Yeah, I’m not worried because those jobs will be replaced by other jobs. Look, it’s never been the case that, oh my God, this new change in where people work causes permanent problems. It may be temporary problems, certainly for the people who are getting laid off that are working in retail stores downtown, but there’s jobs in the fulfillment industry, delivering things for Amazon and so forth. So it’s not ideal, but that’s just how the economy works and it’s shifting towards what people want to do and how their world is. So in the long run, it will be, unemployment will go right back down to very low levels. And in fact, it’s already starting to come back up. The number of job openings that were listed and the most recent data was similar to pre-pandemic. Now, clearly there’s still some job matching issues. Those jobs might be for advanced programmers. And meanwhile, there’s people that are unemployed, service workers who don’t match those skills. So there’s always that issue of the mismatch, but I think that the economy will heal. And if anything, we may actually be in for a stronger bounce back than people are thinking. Most economists are thinking it’s gonna take many years to get back to a low unemployment rate. That’s certainly possible, but it’s also possible that if enough people get vaccinated and we feel safe again, that we would actually have quite an economic boom. And the reason I think that is because I, for one feel pretty pent up and we love to go out to street fairs, vacation, get around. And I think I’m not the only one, so there’s money to be spent once people feel safe.

Mark Fleming    00:19:27    You refer to it. I agree in the long run Ralph, you’re referring to like<inaudible> and the process of creative destruction, right. And you know, economies have gone through that for centuries. And in all of those scenarios, whether it’s a horse and buggy makers transitioning to cars, whether it’s, you know, any of these examples that we have, you know, the term Luddite comes from this guy named John Lud in London who led riots because of the automated loom for making, you know, men’s stockings, you know, in those days they made the stockings up to your knees. And he didn’t like the idea that this machine could do it better. You know, this is, the process of creative destruction has always happened. And Ralph, as you suggest, the challenge is, creative destruction is good, but the short term process itself may not necessarily be that pleasant for many people. And I do have concerns in the shorter run at least about the skills mismatch problem and that, you know, that person who got laid off, was an airline pilot, highly trained, highly skilled, highly compensated, you know, is now working at Amazon, or the person who got laid off from a restaurant job, you know, going to get hired as a data scientist. There are, I think, issues with the skill mismatching, which effectively kind of gum up the works, if you will, of recovery. The other thing I would simply say is, you know, if you dig enough, a deep enough hole, as we did in a very short period of time, you know, a rebound we’ve rebounded about halfway, and it looks amazingly impressive, but, you know, going from zero to one is a 100% gain, going from 10 to 11 is also one, but it’s not a 100% gain. So part of those numbers are belying the base from which you’re jumping. We’re only about halfway there, we’ve got half way to go. It’s going to get more difficult. So in other words, the pace of the recovery is going to slow over the coming year or so, but I completely agree with Ralph. And by the way, we’re economists Ralph, we’re not supposed to agree so much, but at this point I still agree that, you know, we will get back there. We will get back to that sort of parity and grow again like before. And we will have benefited from the process of creative destruction, making us what makes us uniquely special as an economy in the U.S. more flexible and likely to have higher growth potential because of it in the long run.

Kirk Willison    00:22:05    Mark, turning back to the housing economy of the early parts of the 21^st century, economists made a lot of money writing stories about how Millennials are going to be so different than everyone else and they’re going to be so late into buying homes, in your writing and earlier in our conversation today, you’ve said that they’ve kind of turned a corner. Can you talk a little bit about that? And are we finally seeing the millennials leaving their parents’ basements and starting households of their own?

Mark Fleming    00:22:38    Well, I didn’t realize I could make lots of money by saying these things. I didn’t realize that was the case. That didn’t happen to me. Oh, no, wait, maybe it was because I’ve been saying all along, just give it time, give it time, they’ll show up. They’re no different than any other generation, which has now been pretty much proven. You know, Millennials are no different than any other generation in terms of their desire for home ownership. But for one simple fact, they just chose to do it later than any other. And why? So the interesting question is why later, well, getting education takes time. So getting education and then going out and getting jobs and focusing on career actually, instead of forming family in those twenties, the average age of marriage of the silent generation was early twenties. The average age of baby boomers with mid twenties, generation X marriage was on average late twenties, Millennials, it’s early thirties. And so this natural progression from generation to generation of pushing family formation, getting married and in particular, having children, by the way, in our research on home ownership, the kicker for wanting to become a homeowner is kids and in particular, the second, then all bets are off, I’m looking for a home, oh, by the way, in suburbia. That dynamic is, you know, has changed that shift. I don’t think we should have been shocked that it was going to happen. I think there wasn’t some sort of structural change in people’s behavior of not wanting to own a home.

Kirk Willison    00:24:15    So Ralph, now that the Millennials are out there, they face the doubly difficult task of finding a home because we just don’t have enough. I mean, the classic situation of an economist deals with supply and demand, and we’ve talked a little bit about the demand issue, but the supply is really problematic. And you’ve talked a little bit about this in the HaMMR, but, share with us some of your thoughts about why we seem to be getting further and further behind on the supply end?

Ralph DeFranco    00:24:48    There’s both a temporary effect and sort of a fundamental longer-term effect going on here. There’s a temporary effect from the pandemic. So the listings, the number of homes listed for sale this year is down about 10% from what it would have been last year overall. And that’s because some people don’t want to have strangers walking through their house for open houses. There’s some homes that will come back on the market say next year or the year after when, once people feel safe, that’s great because we need all that and then some, so that’s just a temporary effect. The bigger effect is the fact that we haven’t been building enough homes and many people put it as a shortfall of maybe 1 million, maybe 2 million homes across the whole country, maybe more that we underbuilt as a country. And people at Urban Institute or Moody’s Analytics think even a year or two back, we were still under building by 300,000 homes supposedly multifamily and single family. So I think that what we really need to do is ramp up housing where people want it, in some ways, this is good, that people will have more options to live further out from home if they can work a few days remotely, or even fully work remote and say, move to someplace with beautiful natural amenities and a somewhere lower cost to live. So that’s all very good because there’s been way too much pressure on certain cities where there’s not been enough space to build more homes. And that’s causing huge affordability problems with places like the San Francisco Bay Area. So in some ways, this is a good thing to see more people spread out.

Mark Fleming    00:26:14    On the building part. Yeah. We can’t build enough houses fast enough right now. We’ve been under building for about a decade and, you know, to the tune of a few million houses short. And the way we measure that is you got to think about, it’s not about just building more houses for the existing people, but you’ve got every year more new households being formed. And so you not only have to keep up with the expanded demand for shelter, this is multifamily and single family, but also make up for the shortfall you’ve already had. So it’s kind  of like the old debt deficit problem. We’ve been running deficits for a decade and the debt just keeps getting bigger.

Kirk Willison    00:26:51    The election is over. It’s clear that we’re going to have, or is it, the Biden administration appears to be moving into office, come January. What could a Biden administration do with or without Congress to help increase home ownership opportunities for more people?

Ralph DeFranco    00:27:13    Well, we have a real problem with affordability. And I think that the real problem isn’t something the national government could solve, the real problem, places like California is local billing restrictions. I live, between me and downtown San Francisco, there’s some towns where you need two or five acres to build a house. So they, basically, some of these towns are frozen in time and there’s been no new development effectively for 50 years. And that’s crazy. And that isn’t something that really the federal government has much control over. So to me, the fundamental problems aren’t going to be really addressed in Washington, but there are some things at the margin they can do to push, to support affordable housing in four cities, to have to build some fraction of new homes, to be affordable housing. Although what that typically does is just increase the cost to middle-class housing, because the extra cost to the builder has to go into something. So there’s no free lunch when it comes to that sort of thing.

Mark Fleming   00:28:00 Dang it, Ralph. What he said. You know, yeah. Traditionally housing policy at the federal level has been all about trying to create more demand, right? Provide access down the income scale, allow access to homeownership, stimulate demand. That’s all well and fine when there’s plenty of supply. But if you push on the demand lever in an environment with no supply and to Ralph’s point like that, you know, we’ve talked about it, that’s a problem and a lot of it has to do with regulation and zoning. There’s a reason why Houston’s growing and buildings all happening there, and it’s not happening in the Bay Area, big regulatory differences. If you try and stimulate demand against tight supply, only one thing happens. House prices go up.

Kirk Willison    00:28:59    You guys have been great. Listen, I very much appreciate your coming. Mark, before we leave, you’ve begun your own podcast. Do you want to share with the viewers how they can listen to it?

Mark Fleming    00:29:09    Sure. We’re two episodes in. Thanks for the plug. The podcast name is Reconomy, get it, our economy, and you can find us now on https://blog.firstam.com/, as well as all your popular places where you download your podcasts.

Kirk Willison    00:29:27    Terrific. Hey, thank you both very much for the time today. Take care of you and hang in there with this changing economy.