Dave:
Hey, what’s up, everyone? Welcome to On the Market. I’m your host, Dave Meyer, and today we’re going to step into the macroeconomic global economy. And I know on the show we normally talk about real estate and housing, and we are still talking about that tangentially. But we’re sort of going to zoom out and talk about what is going on a global stage, and how things that are happening in China, the conflict in Israel, the war between Ukraine and Russia are impacting global economics, and how that might translate to our investing decisions here in the United States.
To do that, we’re bringing back one of our most popular guest ever, Joe Brusuelas, who’s the principal and chief economist at RSM. He was actually named the best economic forecaster in 2023 by Bloomberg, so you’re going to want to pay attention, especially at the end here where he gives some very specific predictions and forecasts about where he thinks the US economy is going.
Before we bring Joe on, I just want to caveat that some of the stuff that Joe’s talking about is a little bit more advanced. It’s a little bit extrapolated from direct real estate investing decisions. But I encourage you to listen and pay close attention to what Joe’s talking about, because he really helps explain what’s going on in global stage, and then translates that back to what it means for you and me and our personal investing decisions.
So with that, let’s bring on Joe Brusuelas, the principal and chief economist at RSM. Joe, welcome back to the podcast. Thanks for joining us again.
Joe:
Thanks for the invite, and I always look forward to talking with you.
Dave:
Likewise. Well, let’s just dive right in. I want to start here by talking about China. Can you give us a broad economic overview of what’s happening in China and why their economy seems to be taking a bit of a nose dive?
Joe:
So the Chinese have entered a period of debt and deleveraging. I’m not going to call it a crisis, but one economic era in China has ended and a new one’s beginning. In some ways, it looks a little bit like what Japan went through in the nineties, and what the United States went through between 2007 and 2014. There’s an enormous debt overhang in their banking sector, in their housing sector, and their commercial real estate sector, and that’s really caused the economy to slow to a crawl.
Now, China, who for the past four decades has relied on a model that basically revolved around state-directed investment in infrastructure, housing, and commercial real estate. That development model now has reached an end. They’re in what economists would call a middle income trap. They’ve gone about as far as they can go with the current approach, and it’s going to have to change, but the problem is the political authority is not comfortable with changing that up. Essentially, they’re going to have to spend the next seven to 10 years working down that debt. They’re going to be selling properties around the world to repatriate capital to deleverage. Now, anybody out there who’s listening, this should resonate because this is what happened in the United States after an epic housing bubble that burst, which obviously caused real problems and came close to causing the United States domestic banking system to collapse.
Now, because China’s a one-party authoritarian state, they’re trying to slow drip to work their way through this. The current policy path isn’t to reflate the housing sector to absorb the excess inventory; it’s to redirect risk capital away from housing, buildings, infrastructure towards manufacturing. Problem is, they can’t mop up that excess supply. We already for the last about a half a year or so have seen an export of deflation out of China. China is going to attempt to export the burden of adjustment to its trade partners, primarily in North Asia and Southeast Asia. It’s going to cause a problem, because China is really trying to protect its employment base. They don’t want to see a significant increase in unemployment from already current elevated rates.
Now, what that means is if you trade with China, when you buy their industrial goods and you produce industrial goods yourself, you’re going to have to accept a smaller share of manufacturing as a percentage of global GDP. That’s going to cause an increase in tensions both economically and likely in the security side through all of Asia. Now the Chinese just, again, aren’t going to be growing at 7-10% anymore. India’s the one that’s going to do that. China’s going to be slowing to probably that 2-3%. Even the 5% they reported for last year is highly dubious. So we really are in a different world when it comes to Chinese growth.
Dave:
That’s super interesting. Thank you for setting the stage there. And just to make sure I understand what’s going on, they have extended themselves too much in terms of debt, and that’s mostly revolved around real estate development, right? They’ve poured a lot of money into building, like you said, commercial real estate. You see a lot of residential towers that have gone empty.
I’m just curious. Because, as you said, China is a one party authoritarian state, how did this happen? Because in the US, in retrospect, we can sort of trace this to lax lending standards and a lot of different debt practices that happened in the private market. But how does this happen in state-controlled investments, as you said?
Joe:
Well, when you look at China’s… The composition of how their economy is organized and where it’s directed, we often in the West make the mistake of thinking it’s a one-party, communist-controlled state, and Beijing controls everything. That’s not the case. A lot of the development was driven by the prefects, the states or the municipalities, the cities. Not just in the state-owned banking sector, not even on the private real estate developers or the private commercial real estate developers, but the debt at the states and municipalities is anywhere between $15-66 trillion depending on who you listen to. So their development model, in many ways was locally driven in a way that didn’t have proper oversight or accounting. So they’re in a real difficult situation where they’re going to have to work down that debt.
If you remember 2007 to 2010, Ben Bernanke’s heroic move to create a bad bank inside the Fed to take those distressed assets off the hands of the financial markets, the banks and other owners of that debt, and to create a situation where we could buy time to deleverage. This is going to be difficult. Right now, the Chinese just haven’t moved to create that bad bank that’s going to have to be created.
Another example that some of your listeners might remember is the savings and loan crisis from the late eighties, early nineties. Essentially, we created a long-term workout strategy vehicle set up by the federal government, and it took until literally the eve of the great financial crisis, 2008, when it was really getting intense, for us to actually have worked through all the backlog of all that bad debt, all those overpriced properties. It took a good 20 years.
And so the Chinese haven’t even really got down the road on that yet. That’s why the policy pathway they’re taking is quite problematic. I’m not convinced that it’s going to work. They’re going to need to simultaneously reflate the financial system and the household, the Chinese household, in order to absorb the excess capacity.
What that does is it creates a situation where what’s happening now, they’re just turning and taking on more bad debt, which is going into unproductive investment in a situation where industrial policy amongst the advanced developing nations has returned. And it’s going to be difficult for the Chinese to sell anything other than low-value added materials into the West, and that’s not what they’re really building right now. They’re building value added goods that no one’s going to be interested in buying.
So the next three years with respect to China and its relationships with the West and the rest is going to be fraught with difficulty and very tense.
Dave:
Okay, so now that we’ve discussed why China is in such financial trouble, we’re going to discuss how this impacts the US and global economy right after this break.
Welcome back to On the Market podcast. We are here with Joe Brusuelas. I just want to ask one follow up first about the bad bank that they created here in the United States. Can you explain that a little more detail and how that helped the US over the course of 6, 5, 6 years get through the debt crisis, and how that differs from the Chinese approach?
Joe:
Sure. In some cities, we had a 50% decline in housing crisis. People were underwater. Those were distressed assets on the balance sheet of banks. Those assets had to be removed so that those banks stayed solvent, because we went from a liquidity crisis to a solvency crisis. Right? Federal Reserve was buying those assets. They were injecting liquidity or flooding the zone with liquidity, which then reflated the banking sector. We prevented a great depression, but the period from 2007 to 2014 featured one of the more disappointing economic recoveries we’ve seen in the post-second World War era, and it wasn’t until 2014 that the economy truly recovered.
When you go back and you take a look at debt and deleveraging eras, typically it takes seven to 10 years to work through it. Now, we got through it in seven years. There’s a case be made that Japanese are just coming out of it four decades later. So the policies put forward by the Bernanke era Fed and were sustained by the Yellen era Fed in terms of using the balance sheet of the bank to smooth out fluctuations in the business cycle. In the case of Bernanke, avoiding a great depression, and then again during the J. Powell era of avoiding a serious economic downturn during the pandemic, which was a whole unique and a separate discussion, are examples of how the Fed or the central bank can use its balance sheet, in the case of Bernanke, to create a bad bank.
We know how to do these things. These are not unusual. We had the depression, we had several property crashes. Of course, the savings and loan crisis with the Resolution Trust Corporation set up by the Bush Administration is a prime example of a non-central bank approach, using the fiscal authority to do it.
The Chinese are going to be forced to do this. Right now they don’t want to because they don’t want to admit that their economic model has fundamentally changed to the point where it’s not sustainable. In an open, transparent democracy where you would essentially let things fall, cause an increase in unemployment, let bankruptcies happen, let the market work so it clears… Not friendly, very painful. Right? But you end up getting through these things a bit quicker than you do in sort of the closed, non-transparent systems that are… Again, the Chinese is one of the more opaque systems. So I am not confident that they’re going to bounce back anytime soon, and again, I think that the era of 7-10% growth in China is just now over. They’re going to be growing at 2-3% just like everybody else.
Dave:
Well, that was sort of my question, is that if everyone else is growing at 2-3%, what’s the problem here? Do they need to grow faster to pay off this debt and go through the deleveraging, or is it they just have broader aspirations than a lot of the rest of the world?
Joe:
Their unique challenge is the size of their population. For years, conventional wisdom said that if growth were to slow below 5%, they would have significant social problems because it wouldn’t accommodate the growth in the working age population, depending on which number you believe or are looking at. Youth unemployment’s clearly around 20%. In a democracy, that’s a crisis. Right? In an authoritarian state, that could be an existential problem that has to do with the stability of the regime. So China’s got unique challenges due to its size and the composition of its society and economy, and we shouldn’t compare it to Europe or the United States or even Japan.
Dave:
And I believe that they stopped sharing data for youth unemployment. They’ve just stopped releasing that data as probably shows the depth of how serious a crisis they see this as.
Joe:
Well, earlier I mentioned that I didn’t quite believe their 5.2% growth rate in 2023, but one of the reasons why is it’s an already opaque economies become even more so. The shop stopped sharing data. The alternative data that we were using to look at say like electricity generation has also clearly been constrained. So it’s difficult to get a sense on what the true growth rate is.
When you talk to people on the ground, it doesn’t sound or look like the official data, which causes me to tend to think that no, they’ve slowed and they very well could have contracted last year. If you listen to people on the ground, that’s what they’re saying. I don’t know that that’s the case, but something’s clearly not right, and they’ve definitely entered an era of debt and leveraging.
Dave:
So given this slow down and this crisis that’s going on there, how does this impact American investors?
Joe:
Well, what it does is it’s what you’ve seen. You’ve seen capital exit China. You’ve seen the dollar grow stronger. We clearly are past our problems with inflation. So my sense is that the United States is going to be the primary generator of global growth, along with India and a few of the other emerging markets. It’s likely because of the unfortunate geopolitical competition we’re now engaged in with China that it will lager better for investment in capital flows into the United States simply because it’s just not as risky as it is putting it in China. China’s moved to the point where it’s virtually uninvestable, I think. People have been saying that for a while, but based on what I’ve observed in the post-pandemic era 2023, I think that that’s true now.
Dave:
Wow, that’s a bold statement. It’s a big difference from where we were five or 10 years ago, isn’t it?
Joe:
Yes, and also the way we talk about China. Look, China’s going to be a problem geopolitically. They steal our technology. They’re going to be problems in the South China Sea and the Taiwan Straits. All that’s not going to change. But the idea of China taking over the world via their economy, I think is actually just simply not true.
Dave:
So before we move on, because I do want to talk about some of the other geopolitical stuff going on, last question about China here, Joe: Is there any risk that the turmoil in the Chinese property market spills into American banking or American property markets?
Joe:
Right now it looks to me like it’s more of a domestic local issue. It does not have the properties of a global systemic challenge, like what occurred after the United States financial system came close to collapsing. It’s been going on now for two years. And it’s been clear for a year and a half, two years that China was caught in a debt trap. Right? So the deleveraging in terms of the big globally important systemic banks has largely occurred. Now, this does turn into a crisis inside China. We’ll have to watch closely. Because it’s not what we know it’s what we don’t know and then the risks taken. But right now the answer would be a qualified no.
Dave:
Okay, so we’ve gone through what’s happening in China now, and next we’re going to delve into what’s going on in Europe and Israel right after this quick break.
All right, so now that we’ve sort of gone deep on China, and thank you for your insights here, there are two other major conflicts going on in the world. Obviously we have Russia-Ukraine, and the conflict in Israel. So I want to talk just economically speaking, how are these things? How do you see this confluence of geopolitical instability going to impact the global economy?
Joe:
So when you think about the global economy, the first thing you should think about is commodities. The foremost of those commodities are energy and wheat, oil and grains. So let’s take what’s going on in the Eastern Mediterranean, Red Sea and the Middle East. Clearly, that’s roiled the region. The Israeli economy contracted at a significant pace and is in recession. But we did not see a disruption of oil prices other than a modest period of volatility.
But when one is looking at the US economy like I do and the global economy like I do, you have to always think about the risk matrix. And in this case, the channel through which that risk would be transmitted is the oil and energy channel. In many ways since October 7th, my assessment hasn’t changed. As long as the conflict does not involve the attack and/or destruction of oil producing facilities in Iran, this is something that’s going to be largely contained with periods of enhanced volatility.
So that’s a risk, but it’s not dragging down either the global economy or the US economy. With respect to Ukraine, the invasion of Ukraine created the conditions where we had a massive spike in oil. That was largely a reason why US CPI, the inflation moved up to above 9%. But we’ve come back from that peak and we’re through that. The other component of that is the export of wheat out of the Crimea, out of Ukraine, and then that’s caused problems in emerging markets. But again, we’re two years past. The United States, Argentina, Australia, Brazil have flooded the world with those same products to the point now where food prices have come back to earth. Right? So when you’re thinking just purely about the risk matrix, the commodities channel, it’s grains and oil.
Okay, now there’s a bigger question out there around Ukraine and Russia that’s got to do with the political dysfunction inside the United States, which is how to fund the Ukrainian war effort by the West. We’re beginning to see the entertainment of very unorthodox ideas. Today, the Secretary of the Treasury, Janet Yellen was talking about unlocking the value of those frozen Russian assets, IE the $300 billion in Forex reserves sitting in Europe and the US, a little over $200 million in Europe, a little less than $100 billion here in the United States.
Right now the Western powers are considering something very unorthodox, which is not confiscating the assets, but taking them, putting them in an escrow account, using them as collateral to float essentially zero interest bonds to finance the war effort. Now, that may be over 20 or 30 years, but that would create a series of incentives for one, the Russians to not continue with this; two, it would fund the defense of Ukraine; and three, it would avoid the confiscation of those assets because the idea is they’re just being used as collateral. They’re going to be paid back, and the Russians can have them back after 20 years.
This is some very difficult terrain we’re now caught in, and the innovative financial mobilization of the deep reservoir or pools of capital in US financial markets and European capital markets, it does represent the next mobilization of Western power in approaching this fight, and I would expect this is going to be part of the narrative going forward in global financial markets and the global economy and international security over this next couple of years. These are extraordinary things that are happening in real time that we really haven’t seen since even like 1914, when John Maynard Keynes was called the London to come up with a plan to prevent the collapse of the UK financial market, which was then the center of the world economy. And it was during a week when two-thirds of the gold reserves in the Bank of England were basically withdrawn in three days. We’re not quite in that sort of emergency here, but we are seeing the sort of same innovative proposals put forward by the community of economists and financial professionals in order to think about how to deal with all of this.
Dave:
Do you think these types of proposals represent, I don’t want to say desperation, but an increased risk to the market because we’re traditional methods or what we’ve been doing so far haven’t been working?
Joe:
Well, I don’t think it’s risk. I think what it is that your situation where you’re acknowledging the reality of the difficulties of the US political entity. So we’re thinking about how to get innovative until that can be ironed out. My sense here is that the West has been reluctant to mobilize its most powerful asset, one of those financial markets and those deep pools of capital. They’ve done things on sanctions, they froze the assets due to the illegal action by the Russians, but they have yet to really even push secondary sanctions onto the Russians. But the fact that they’re doing this means it’s getting a bit more serious.
Now, I don’t think it’s a point of desperation at all. The risk is that you would ruin the reputation for reliability, the rule of law and contracts in Europe and the United States when it comes to investment. That’s why it’s important that this not be a seizure, that it not be a confiscation, that it just be a more innovative proposal that retains ownership. But we’re going to use this because what you did was not a good idea and is actually illegal. It’s a challenge of the rules-based order that the United States and Europe is in charge in, and we don’t intend to see that go. What’s the use of all of this capital, all of this wealth, if we’re not going to defend that which is most dear, and I think that’s essentially what’s happening here.
Dave:
Got it. Well, that’s sort of fascinating. I hadn’t heard of this, but it’s certainly going to be interesting to see how it plays out. Before we get out of here, Joe, I’m just curious, what’s your outlook for US economic growth? You said you think US and India are going to lead global growth. Do you think that’s going to start this year, or is that more of a long-term forecast?
Joe:
It already started. Right now our forecast for the year was that we had 1.8% growth right at trend, but it’s looking that it’s going to be quite a bit stronger, quite possibly in the 2.5-3% range. Unemployment will range between 3.7-4%. By mid-year, we’ll be at 2% in the core PCE; 2.5% in PCE, that’s the Fed’s policy variable; and by the end of the year, CPI will be back at 2.5%. In other words, price stability will have been restored by the Federal Reserve, which you’re going to see is as inflation comes down. That means the real wages of people increase, and that’s going to support overall spending, which is why we had significant risk to the upside of faster growth on our annual forecast. We put the forecast together last November and we haven’t changed it. We had a 15, that’s one 5% probability of a recession, and a 25% probability that the US economy would outperform our 1.8% forecast. That looks like where we’re going.
Now with respect to rates, we thought we’d see 100 basis points of rate cuts. That’s 425 basis points starting in June. Pushing down the front end of the curve, we think that due to the issuance of treasury supply and the decline in the cash on hand in the reverse repo program, you’re going to see rates begin to move up here pretty quickly. We’re already between 4.25 and 4.3. I expect we’ll move closer to 4.5, and then down to 4.25 at the end of the year, and that’s our year-end target.
We had a good year last year. Bloomberg named us as the best rate forecaster along with our colleagues at Goldman Sachs. So we take that portion of the forecast and all the forecasts significantly, and we’re very serious about that.
We think that by the end of next year, you’re going to have a positive upward sloping shape of the term structure, and this is going to be the first time we’re going to see something like this approximate, really since before the great financial crisis. Essentially, that period of zero interest rates, real negative interest rates as a tool of policy, is effectively in the rearview mirror. The normalization of the rate structure is upon us, and the economy will adjust accordingly. Now we think the United States is well-positioned to take advantage of that and do well.
Last thing I want to share with you, the most constructive and encouraging development in the US economy has been the boom in productivity over the past three quarters. Productivity in the United States has increased by 4%. This is an extraordinary thing. We haven’t seen levels like that since the 1990s. For economists, once you start thinking about productivity and growth, it’s hard to think about anything else. That’s that magical elixir or that mythical tide that lifts all boats. It means we can grow faster, have robust employment, low unemployment rates, low inflation. Most importantly, it lifts the living standard of all who participate in the economy.
That’s not something we’ve been able to say in a long, long time. You know what? We can continue to see productivity anywhere near the vicinity of 2.5%. That’s a game changer, and we’re going to be having a very different discussion around the economy at that point. One that doesn’t so much involve risks, but upside potentials and good things.
Dave:
Wow. Well, thank you so much, Joe. We really appreciate your insights here and your very specific forecast and thoughts on the economy. For everyone listening or watching this, if you want to learn more about Joe, we’ll put a link to all of his information where you can contact him, all that sort of stuff in the show description below. Joe, thanks a lot. Hope to have you on again sometime soon in the near future.
Joe:
Thank you.
Dave:
Another big thanks to Joe for joining us on this episode. I hope you all learned a lot. I sure did. The global macroeconomic climate is not something I study as closely as the housing market here in the United States, but I think it’s super important to just help you set this context and backdrop for your investing decisions. It’s super helpful to know are there a lot of risks outside the country that could start dragging on the US economy, or are there things that can increase geopolitical tensions. Because sometimes those are blind spots for us as investors that we might not see, and so we wanted to bring on Joe. In the future, I’d love your opinion on if we should bring on more people like this, because I personally find it helpful and think that it’s worthwhile for real estate investors here in the US to listen to, but would be curious about your opinion.
I do want to just clarify two things Joe was talking about at the end. He was talking about the yield curve and a bond yield. We don’t have to get all into that, but he was basically saying that at the end of the year, he thought that long-term 10 year bond yields would be around 4.25%, and that is important because that means if you extrapolate that out to mortgage rates, because bond yields and mortgage rates are highly correlated, that in normal times we would see mortgage rates around 6.25%. Normally the spread between bond yields and mortgage rates is about 190 basis points or 1.9%. Right now, they’re closer to 3%. So that means if Joe’s forecast is accurate, we’ll probably see mortgage rates at the end of the year be somewhere between mid sixes to high sixes. And of course, we don’t know if that’s for certain, but I just kind of wanted to translate what he was saying about bonds into the more tangible thing for real estate investors, which is mortgage rates.
The second thing he talked about, which I didn’t know and I think is super important, is about productivity. Now, productivity is basically a measure of how much economic output the average US worker creates, and it is super important in terms of economic growth. When you try and figure out GDP and how much economic growth there might be in a country, there’s really only two basic variables. How many people are working in an economy and how much economic value do they produce? And so if we’re in a time where our population isn’t growing as much as possible, and there’s only so much population growth and contributions in additions to the labor force that you can make at this point, and so the better way to grow the economy, according to most economists is to increase productivity. Now, a 4% increase may not sound like a lot, but that is huge, and as Joe was saying, if that trend continues, that could bode extremely well for long-term American economic growth.
Again, I hope this types of more global, more macro level look at the investing climate is helpful to you. We’d love to hear your feedback if you’re on YouTube, or you can always find me on Instagram and send me your thoughts about this episode where I’m at, the DataDeli, or you can find me on BiggerPockets and do the same.
Thanks, you all, so much for listening. We’ll see you for the next episode of On The Market.
On The Market was created by me, Dave Meyer and Kaylin Bennett. The show is produced by Kaylin Bennett with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.
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Why Hometap is betting on the growth of the home equity investment market
Based on the notion that far too many U.S. homeowners are “house-rich, cash-poor,” home equity investment firm Hometap provides clients with a way to tap into their home equity instead of selling their home or taking out a loan.
Hometap, as an investor, provides cash in exchange for a share of their home’s future value. When the home sells or the homeowner settles the investment within the 10-year period. In return, Hometap receives an agreed-up percentage of the sale price or current appraised value.
“We do see this as a new asset class in the real estate ecosystem and we see it as complementary to traditional debt options that exist today,” Dan Burnett, head of investor product at Hometap, said in an interview with HousingWire.
The market for home equity investment is still small, with the estimated investment volume from players in the market to be around $2 billion and $3 billion.
With continued demand for home equity investment from homeowners, Burnett is confident that the market is poised for growth in the decade ahead.
While Hometap doesn’t directly work with mortgage lenders or real estate brokerages right now, Burnett sees an opportunity for partnership to help buyers’ homeownership in the long term.
Read on for Hometap’s business model and areas of potential partnerships with other players in the housing industry.
This interview was condensed and lightly edited for clarity.
Connie Kim: A potential concern that investors could raise about Hometap’s business model is that it’s dependent on the home’s future value going up. But history shows that this isn’t always the case. I’m curious how Hometap is hedging against that risk.
Dan Burnett: There are three ways that we approach this. One is through the market that we’ve approached. Home prices have been historically resilient asset classes generally historically. Average home price appreciation over the last 50 years floated in the 5%-range.
While the Great Financial crisis obviously is the most notable home price depreciation period, there are not too many other examples of that outside of the Great Depression.The ones that you have seen have a tendency to be short and sharp – like a one or two year correction, but not occurring over a full 10-year span.
Second is the selection of homeowners. We do spend quite a bit of time thinking through our underwriting rules and making sure that our homeowners are able to and are capable of paying their first mortgage. We also look at the appraised value of the home to make sure that we’re making a possible investment into a home that’s in good condition.
The third part is the structure [of the deal]. Because it is not a one-to-one exchange rate, we do get a little bit of extra ownership for every dollar that we put in, so that does provide a little bit of protection on the downside in case home prices depreciate.
Kim: There are a handful of home equity investment firms in the market. Hometap’s investment volume hit $1 billion in February, surpassing 10,000 home equity investment issuances since it was established in 2017. How does the company differentiate itself from other competitors in a niche market?
Burnett: We are trying to take the homeowner-first mindset as possible into everything we do as a business. An example of that is our product structure. We make an investment right at the moment of the investment and we have a fixed percentage ownership in the property. That was a different approach than what has historically been prevalent in the space prior to Hometap’s entry.
Two other companies in the space – Point and Unison Equity Sharing – both use a share of appreciation model. What they’re doing is, they’re taking a percentage of the future growth in value of the home. So if the home went from $1 million to $2 million, they would own a share of that appreciation.
We view our approach as a more simpler way of explaining this to homeowners and making sure that there was clear alignment and understanding of our product. We have a home equity dashboard that’s available to the public, which can be used to do scenario planning with a product like ours as well looking at other potential financing opportunities. So we think sort of holistically by providing a product that is homeowner-focused and technology to help people make important decisions.
Kim: Interest rates are expected to drop sometime this year, how does this affect Hometap’s growth trajectory?
Burnett: After being founded in 2017, we made our first investments in 2018 and 2019. An interesting thing about our business is we were kind of born into a headwind in terms of the interest rate environment. With the rise in interest rates, we had seen continued appetite in terms of homeowners being interested in taking on a product like ours.
It has no monthly payment component. That’s what we do and although we do see interest rates coming down over time, we’re confident that we would still be competitive in a low-rate environment like what you saw in 2017 through 2020 as well as where we kind of expect rates to shake out in the future, around the historical norm of 4.5% to 5%. So we still think our value proposition with homeowners continues to hold very strong.
From a capital markets perspective, as rates go down, we are a more compelling alternative investment vehicle for a broader swath of investors as well, which hopefully creates additional demand on the capital side and provides more competitive pricing to our homeowners.
Kim: The home equity investment space is still a niche market. How big is it?
Burnett: Between $2 billion and $3 billion in investment volume. I think there’s just several large players, who make investment volume of high-nine figures on an annual basis and then there’s a significant number of smaller businesses that are still getting their footing who are probably in the low-nine figures, high-eight figures.
Kim: With interest rates elevated, a significant number of mortgage lenders have started offering home equity lines of credits (HELOCs) and home equity loans. Does Hometap foresee an opportunity to partner with mortgage lenders to expand the home equity investment market?
Burnett: We do see this as a new asset class in the real estate ecosystem and we see it as complementary to traditional debt options that exist today. I think there are absolutely use cases on the homeowner side where a product that is aligned on the value of the home and is providing relief in terms of the amount of monthly payments you need to make to continue to service the debt itself.
In the long term, we’re looking to potentially reduce or to augment their first lien they’re taking on when they purchase a new home and use home equity as a way to potentially bring more capital to bear without meaningfully increasing their monthly costs so they can achieve homeownership and get into the home they’re looking to purchase in the first place.
Kim: What are some ways Hometap sees a potential partnership with real estate agents or loan originators?
Burnett: There are scenarios where a homeowner may be looking for a HELOC or a HELOAN and ultimately that’s not the right fit for them and conceivably you could absolutely see scenarios where it would make sense for a partnership to evolve over time where we’re folks potentially work with Hometap to take on a home equity investment as an alternative. I do think it’s greatly speculative at this point.
We don’t have direct partnerships with real estate agents today. I think what could be compelling is life cycle management. Real estate agents are building relationships over time with homeowners and they want to make sure that they’re helping those homeowners meet their financing needs as much as possible and it doesn’t necessarily need to result in a home sale.
To the extent that home equity investment makes sense particularly as a mechanism where a homeowner has a partner who’s aligned on increasing the home value over time, allowing them to stay in their home until it’s the right time for them to potentially move while also providing them the necessary funds, I think it could be another tool in the tool bag for those real estate agent to use.
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Strong jobs report suggests rate cuts won’t come ‘til summer
Though all signs point to a cooling labor market overall, the economy picked up another 275,000 jobs in February. The jobs report on Friday is unlikely to convince the Fed that rate cuts are necessary when the Federal Open Markets Committee meets later this month, economists said.
Jobs increased by 275,000 in February, up from a revised rate of 229,000 in January, according to data released by the Bureau of Labor Statistics on Friday. February’s reading exceeded the average monthly gain of 230,000 over the prior 12 months.
The national unemployment rate ticked up for the first time in four months to 3.9%, its highest level since January 2022, but still below the full employment rate of 4%. The number of unemployed Americans also rose to 6.5 million.
“While unemployment is still low, the leverage held by workers is weakening,” Bright MLS chief economist Lisa Sturtevant said in a statement. “Job seekers are taking longer to find work, and the number of job switchers has declined.”
Job gains occurred mainly in health care, government, food services, social assistance, transportation and warehousing. Meanwhile, retail trade, mining, quarrying, oil and gas extraction, manufacturing, wholesale trade, information, and financial activities posted fewer jobs in February.
During his semiannual monetary policy testimony on Wednesday and Thursday, Federal Reserve Chair Jerome Powell reiterated that the Fed sees no urgency to cut rates just yet. Powell stressed that the Fed needs more assurance that inflation is on a sustainable path toward its target before making any moves.
Average hourly earnings for private-sector employees grew by 0.1% month over month to $34.57 and were up 4.3% from a year ago. In February, employment continued to trend up in construction, adding 23,000 jobs month over month. Job openings were essentially unchanged at 8.9 million at a rate of 5.4%, down from 10.4 million the prior year. Meanwhile, job quits remained steady at 3.4 million while the rate shrank to 2.1%.
The jobs report contains two conflicting implications for the housing market, according to Sturtevant.
On the one hand, the rising uncertainty among businesses and workers caused by high-interest rates could also make home shoppers wearier about making big financial decisions. On the other hand, a cooling job market could give the Federal Reserve the signal it needs to cut interest rates sooner rather than later.
“It is still likely to be summer before the first Fed rate cut,” Sturtevant said. “However, the economic data we’re seeing now could cause the market to react, anticipating future Fed action, which could lower borrowing rates, including mortgage rates. Lower rates this spring could give housing market demand a boost.”
Lawrence Yun, the chief economist at the National Association of Realtors, said the economy is clearly slowing and the housing crisis grows more acute each month.
“The short-term timing of purchase is dependent upon mortgage rates and inventory availability,” he said. “Home sales recorded the lowest activity in 2023 in nearly 30 years. Note that there are 158 million payroll jobs today compared to 117 million when home sales were similarly low. It implies sizable potential real estate demand on the sidelines, ready to pounce once short-term conditions move favorably.”
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China Falters and Israel’s Oil Danger Used Against Them
China’s economy is on its last legs. Thanks to massive overspending and high unemployment, the Chinese economy is beginning to break down, with real estate prices crashing at a scale similar to 2008 in the US. This is bad news for not only Chinese investors but also global investors with money in China. But could these tumultuous conditions spill over into the global economy?
We’ve got arguably the world’s best economic forecaster, Joe Brusuelas, back on the show to get his take on the global economy and what could be next for the US. Joe has studied the Chinese economy in-depth and sees a “debt and deleveraging period” forming. This is bad for Chinese investors, but will it affect the US housing market? Next, Joe speaks on the other global crises, from Israel to Ukraine to Iran and beyond. With our global reliance on importing commodities like wheat and oil, how risky are we getting with the massive Middle East and Eastern European conflicts?
Finally, Joe touches on domestic trends, including one substantial economic insight that could point to a new era of economic productivity in the US. This could be game-changing for you if you own stocks, bonds, real estate, or any other US-based investments. What trend are we talking about? Stick around; we’re getting into it all in this episode!
Dave:
Hey, what’s up, everyone? Welcome to On the Market. I’m your host, Dave Meyer, and today we’re going to step into the macroeconomic global economy. And I know on the show we normally talk about real estate and housing, and we are still talking about that tangentially. But we’re sort of going to zoom out and talk about what is going on a global stage, and how things that are happening in China, the conflict in Israel, the war between Ukraine and Russia are impacting global economics, and how that might translate to our investing decisions here in the United States.
To do that, we’re bringing back one of our most popular guest ever, Joe Brusuelas, who’s the principal and chief economist at RSM. He was actually named the best economic forecaster in 2023 by Bloomberg, so you’re going to want to pay attention, especially at the end here where he gives some very specific predictions and forecasts about where he thinks the US economy is going.
Before we bring Joe on, I just want to caveat that some of the stuff that Joe’s talking about is a little bit more advanced. It’s a little bit extrapolated from direct real estate investing decisions. But I encourage you to listen and pay close attention to what Joe’s talking about, because he really helps explain what’s going on in global stage, and then translates that back to what it means for you and me and our personal investing decisions.
So with that, let’s bring on Joe Brusuelas, the principal and chief economist at RSM. Joe, welcome back to the podcast. Thanks for joining us again.
Joe:
Thanks for the invite, and I always look forward to talking with you.
Dave:
Likewise. Well, let’s just dive right in. I want to start here by talking about China. Can you give us a broad economic overview of what’s happening in China and why their economy seems to be taking a bit of a nose dive?
Joe:
So the Chinese have entered a period of debt and deleveraging. I’m not going to call it a crisis, but one economic era in China has ended and a new one’s beginning. In some ways, it looks a little bit like what Japan went through in the nineties, and what the United States went through between 2007 and 2014. There’s an enormous debt overhang in their banking sector, in their housing sector, and their commercial real estate sector, and that’s really caused the economy to slow to a crawl.
Now, China, who for the past four decades has relied on a model that basically revolved around state-directed investment in infrastructure, housing, and commercial real estate. That development model now has reached an end. They’re in what economists would call a middle income trap. They’ve gone about as far as they can go with the current approach, and it’s going to have to change, but the problem is the political authority is not comfortable with changing that up. Essentially, they’re going to have to spend the next seven to 10 years working down that debt. They’re going to be selling properties around the world to repatriate capital to deleverage. Now, anybody out there who’s listening, this should resonate because this is what happened in the United States after an epic housing bubble that burst, which obviously caused real problems and came close to causing the United States domestic banking system to collapse.
Now, because China’s a one-party authoritarian state, they’re trying to slow drip to work their way through this. The current policy path isn’t to reflate the housing sector to absorb the excess inventory; it’s to redirect risk capital away from housing, buildings, infrastructure towards manufacturing. Problem is, they can’t mop up that excess supply. We already for the last about a half a year or so have seen an export of deflation out of China. China is going to attempt to export the burden of adjustment to its trade partners, primarily in North Asia and Southeast Asia. It’s going to cause a problem, because China is really trying to protect its employment base. They don’t want to see a significant increase in unemployment from already current elevated rates.
Now, what that means is if you trade with China, when you buy their industrial goods and you produce industrial goods yourself, you’re going to have to accept a smaller share of manufacturing as a percentage of global GDP. That’s going to cause an increase in tensions both economically and likely in the security side through all of Asia. Now the Chinese just, again, aren’t going to be growing at 7-10% anymore. India’s the one that’s going to do that. China’s going to be slowing to probably that 2-3%. Even the 5% they reported for last year is highly dubious. So we really are in a different world when it comes to Chinese growth.
Dave:
That’s super interesting. Thank you for setting the stage there. And just to make sure I understand what’s going on, they have extended themselves too much in terms of debt, and that’s mostly revolved around real estate development, right? They’ve poured a lot of money into building, like you said, commercial real estate. You see a lot of residential towers that have gone empty.
I’m just curious. Because, as you said, China is a one party authoritarian state, how did this happen? Because in the US, in retrospect, we can sort of trace this to lax lending standards and a lot of different debt practices that happened in the private market. But how does this happen in state-controlled investments, as you said?
Joe:
Well, when you look at China’s… The composition of how their economy is organized and where it’s directed, we often in the West make the mistake of thinking it’s a one-party, communist-controlled state, and Beijing controls everything. That’s not the case. A lot of the development was driven by the prefects, the states or the municipalities, the cities. Not just in the state-owned banking sector, not even on the private real estate developers or the private commercial real estate developers, but the debt at the states and municipalities is anywhere between $15-66 trillion depending on who you listen to. So their development model, in many ways was locally driven in a way that didn’t have proper oversight or accounting. So they’re in a real difficult situation where they’re going to have to work down that debt.
If you remember 2007 to 2010, Ben Bernanke’s heroic move to create a bad bank inside the Fed to take those distressed assets off the hands of the financial markets, the banks and other owners of that debt, and to create a situation where we could buy time to deleverage. This is going to be difficult. Right now, the Chinese just haven’t moved to create that bad bank that’s going to have to be created.
Another example that some of your listeners might remember is the savings and loan crisis from the late eighties, early nineties. Essentially, we created a long-term workout strategy vehicle set up by the federal government, and it took until literally the eve of the great financial crisis, 2008, when it was really getting intense, for us to actually have worked through all the backlog of all that bad debt, all those overpriced properties. It took a good 20 years.
And so the Chinese haven’t even really got down the road on that yet. That’s why the policy pathway they’re taking is quite problematic. I’m not convinced that it’s going to work. They’re going to need to simultaneously reflate the financial system and the household, the Chinese household, in order to absorb the excess capacity.
What that does is it creates a situation where what’s happening now, they’re just turning and taking on more bad debt, which is going into unproductive investment in a situation where industrial policy amongst the advanced developing nations has returned. And it’s going to be difficult for the Chinese to sell anything other than low-value added materials into the West, and that’s not what they’re really building right now. They’re building value added goods that no one’s going to be interested in buying.
So the next three years with respect to China and its relationships with the West and the rest is going to be fraught with difficulty and very tense.
Dave:
Okay, so now that we’ve discussed why China is in such financial trouble, we’re going to discuss how this impacts the US and global economy right after this break.
Welcome back to On the Market podcast. We are here with Joe Brusuelas. I just want to ask one follow up first about the bad bank that they created here in the United States. Can you explain that a little more detail and how that helped the US over the course of 6, 5, 6 years get through the debt crisis, and how that differs from the Chinese approach?
Joe:
Sure. In some cities, we had a 50% decline in housing crisis. People were underwater. Those were distressed assets on the balance sheet of banks. Those assets had to be removed so that those banks stayed solvent, because we went from a liquidity crisis to a solvency crisis. Right? Federal Reserve was buying those assets. They were injecting liquidity or flooding the zone with liquidity, which then reflated the banking sector. We prevented a great depression, but the period from 2007 to 2014 featured one of the more disappointing economic recoveries we’ve seen in the post-second World War era, and it wasn’t until 2014 that the economy truly recovered.
When you go back and you take a look at debt and deleveraging eras, typically it takes seven to 10 years to work through it. Now, we got through it in seven years. There’s a case be made that Japanese are just coming out of it four decades later. So the policies put forward by the Bernanke era Fed and were sustained by the Yellen era Fed in terms of using the balance sheet of the bank to smooth out fluctuations in the business cycle. In the case of Bernanke, avoiding a great depression, and then again during the J. Powell era of avoiding a serious economic downturn during the pandemic, which was a whole unique and a separate discussion, are examples of how the Fed or the central bank can use its balance sheet, in the case of Bernanke, to create a bad bank.
We know how to do these things. These are not unusual. We had the depression, we had several property crashes. Of course, the savings and loan crisis with the Resolution Trust Corporation set up by the Bush Administration is a prime example of a non-central bank approach, using the fiscal authority to do it.
The Chinese are going to be forced to do this. Right now they don’t want to because they don’t want to admit that their economic model has fundamentally changed to the point where it’s not sustainable. In an open, transparent democracy where you would essentially let things fall, cause an increase in unemployment, let bankruptcies happen, let the market work so it clears… Not friendly, very painful. Right? But you end up getting through these things a bit quicker than you do in sort of the closed, non-transparent systems that are… Again, the Chinese is one of the more opaque systems. So I am not confident that they’re going to bounce back anytime soon, and again, I think that the era of 7-10% growth in China is just now over. They’re going to be growing at 2-3% just like everybody else.
Dave:
Well, that was sort of my question, is that if everyone else is growing at 2-3%, what’s the problem here? Do they need to grow faster to pay off this debt and go through the deleveraging, or is it they just have broader aspirations than a lot of the rest of the world?
Joe:
Their unique challenge is the size of their population. For years, conventional wisdom said that if growth were to slow below 5%, they would have significant social problems because it wouldn’t accommodate the growth in the working age population, depending on which number you believe or are looking at. Youth unemployment’s clearly around 20%. In a democracy, that’s a crisis. Right? In an authoritarian state, that could be an existential problem that has to do with the stability of the regime. So China’s got unique challenges due to its size and the composition of its society and economy, and we shouldn’t compare it to Europe or the United States or even Japan.
Dave:
And I believe that they stopped sharing data for youth unemployment. They’ve just stopped releasing that data as probably shows the depth of how serious a crisis they see this as.
Joe:
Well, earlier I mentioned that I didn’t quite believe their 5.2% growth rate in 2023, but one of the reasons why is it’s an already opaque economies become even more so. The shop stopped sharing data. The alternative data that we were using to look at say like electricity generation has also clearly been constrained. So it’s difficult to get a sense on what the true growth rate is.
When you talk to people on the ground, it doesn’t sound or look like the official data, which causes me to tend to think that no, they’ve slowed and they very well could have contracted last year. If you listen to people on the ground, that’s what they’re saying. I don’t know that that’s the case, but something’s clearly not right, and they’ve definitely entered an era of debt and leveraging.
Dave:
So given this slow down and this crisis that’s going on there, how does this impact American investors?
Joe:
Well, what it does is it’s what you’ve seen. You’ve seen capital exit China. You’ve seen the dollar grow stronger. We clearly are past our problems with inflation. So my sense is that the United States is going to be the primary generator of global growth, along with India and a few of the other emerging markets. It’s likely because of the unfortunate geopolitical competition we’re now engaged in with China that it will lager better for investment in capital flows into the United States simply because it’s just not as risky as it is putting it in China. China’s moved to the point where it’s virtually uninvestable, I think. People have been saying that for a while, but based on what I’ve observed in the post-pandemic era 2023, I think that that’s true now.
Dave:
Wow, that’s a bold statement. It’s a big difference from where we were five or 10 years ago, isn’t it?
Joe:
Yes, and also the way we talk about China. Look, China’s going to be a problem geopolitically. They steal our technology. They’re going to be problems in the South China Sea and the Taiwan Straits. All that’s not going to change. But the idea of China taking over the world via their economy, I think is actually just simply not true.
Dave:
So before we move on, because I do want to talk about some of the other geopolitical stuff going on, last question about China here, Joe: Is there any risk that the turmoil in the Chinese property market spills into American banking or American property markets?
Joe:
Right now it looks to me like it’s more of a domestic local issue. It does not have the properties of a global systemic challenge, like what occurred after the United States financial system came close to collapsing. It’s been going on now for two years. And it’s been clear for a year and a half, two years that China was caught in a debt trap. Right? So the deleveraging in terms of the big globally important systemic banks has largely occurred. Now, this does turn into a crisis inside China. We’ll have to watch closely. Because it’s not what we know it’s what we don’t know and then the risks taken. But right now the answer would be a qualified no.
Dave:
Okay, so we’ve gone through what’s happening in China now, and next we’re going to delve into what’s going on in Europe and Israel right after this quick break.
All right, so now that we’ve sort of gone deep on China, and thank you for your insights here, there are two other major conflicts going on in the world. Obviously we have Russia-Ukraine, and the conflict in Israel. So I want to talk just economically speaking, how are these things? How do you see this confluence of geopolitical instability going to impact the global economy?
Joe:
So when you think about the global economy, the first thing you should think about is commodities. The foremost of those commodities are energy and wheat, oil and grains. So let’s take what’s going on in the Eastern Mediterranean, Red Sea and the Middle East. Clearly, that’s roiled the region. The Israeli economy contracted at a significant pace and is in recession. But we did not see a disruption of oil prices other than a modest period of volatility.
But when one is looking at the US economy like I do and the global economy like I do, you have to always think about the risk matrix. And in this case, the channel through which that risk would be transmitted is the oil and energy channel. In many ways since October 7th, my assessment hasn’t changed. As long as the conflict does not involve the attack and/or destruction of oil producing facilities in Iran, this is something that’s going to be largely contained with periods of enhanced volatility.
So that’s a risk, but it’s not dragging down either the global economy or the US economy. With respect to Ukraine, the invasion of Ukraine created the conditions where we had a massive spike in oil. That was largely a reason why US CPI, the inflation moved up to above 9%. But we’ve come back from that peak and we’re through that. The other component of that is the export of wheat out of the Crimea, out of Ukraine, and then that’s caused problems in emerging markets. But again, we’re two years past. The United States, Argentina, Australia, Brazil have flooded the world with those same products to the point now where food prices have come back to earth. Right? So when you’re thinking just purely about the risk matrix, the commodities channel, it’s grains and oil.
Okay, now there’s a bigger question out there around Ukraine and Russia that’s got to do with the political dysfunction inside the United States, which is how to fund the Ukrainian war effort by the West. We’re beginning to see the entertainment of very unorthodox ideas. Today, the Secretary of the Treasury, Janet Yellen was talking about unlocking the value of those frozen Russian assets, IE the $300 billion in Forex reserves sitting in Europe and the US, a little over $200 million in Europe, a little less than $100 billion here in the United States.
Right now the Western powers are considering something very unorthodox, which is not confiscating the assets, but taking them, putting them in an escrow account, using them as collateral to float essentially zero interest bonds to finance the war effort. Now, that may be over 20 or 30 years, but that would create a series of incentives for one, the Russians to not continue with this; two, it would fund the defense of Ukraine; and three, it would avoid the confiscation of those assets because the idea is they’re just being used as collateral. They’re going to be paid back, and the Russians can have them back after 20 years.
This is some very difficult terrain we’re now caught in, and the innovative financial mobilization of the deep reservoir or pools of capital in US financial markets and European capital markets, it does represent the next mobilization of Western power in approaching this fight, and I would expect this is going to be part of the narrative going forward in global financial markets and the global economy and international security over this next couple of years. These are extraordinary things that are happening in real time that we really haven’t seen since even like 1914, when John Maynard Keynes was called the London to come up with a plan to prevent the collapse of the UK financial market, which was then the center of the world economy. And it was during a week when two-thirds of the gold reserves in the Bank of England were basically withdrawn in three days. We’re not quite in that sort of emergency here, but we are seeing the sort of same innovative proposals put forward by the community of economists and financial professionals in order to think about how to deal with all of this.
Dave:
Do you think these types of proposals represent, I don’t want to say desperation, but an increased risk to the market because we’re traditional methods or what we’ve been doing so far haven’t been working?
Joe:
Well, I don’t think it’s risk. I think what it is that your situation where you’re acknowledging the reality of the difficulties of the US political entity. So we’re thinking about how to get innovative until that can be ironed out. My sense here is that the West has been reluctant to mobilize its most powerful asset, one of those financial markets and those deep pools of capital. They’ve done things on sanctions, they froze the assets due to the illegal action by the Russians, but they have yet to really even push secondary sanctions onto the Russians. But the fact that they’re doing this means it’s getting a bit more serious.
Now, I don’t think it’s a point of desperation at all. The risk is that you would ruin the reputation for reliability, the rule of law and contracts in Europe and the United States when it comes to investment. That’s why it’s important that this not be a seizure, that it not be a confiscation, that it just be a more innovative proposal that retains ownership. But we’re going to use this because what you did was not a good idea and is actually illegal. It’s a challenge of the rules-based order that the United States and Europe is in charge in, and we don’t intend to see that go. What’s the use of all of this capital, all of this wealth, if we’re not going to defend that which is most dear, and I think that’s essentially what’s happening here.
Dave:
Got it. Well, that’s sort of fascinating. I hadn’t heard of this, but it’s certainly going to be interesting to see how it plays out. Before we get out of here, Joe, I’m just curious, what’s your outlook for US economic growth? You said you think US and India are going to lead global growth. Do you think that’s going to start this year, or is that more of a long-term forecast?
Joe:
It already started. Right now our forecast for the year was that we had 1.8% growth right at trend, but it’s looking that it’s going to be quite a bit stronger, quite possibly in the 2.5-3% range. Unemployment will range between 3.7-4%. By mid-year, we’ll be at 2% in the core PCE; 2.5% in PCE, that’s the Fed’s policy variable; and by the end of the year, CPI will be back at 2.5%. In other words, price stability will have been restored by the Federal Reserve, which you’re going to see is as inflation comes down. That means the real wages of people increase, and that’s going to support overall spending, which is why we had significant risk to the upside of faster growth on our annual forecast. We put the forecast together last November and we haven’t changed it. We had a 15, that’s one 5% probability of a recession, and a 25% probability that the US economy would outperform our 1.8% forecast. That looks like where we’re going.
Now with respect to rates, we thought we’d see 100 basis points of rate cuts. That’s 425 basis points starting in June. Pushing down the front end of the curve, we think that due to the issuance of treasury supply and the decline in the cash on hand in the reverse repo program, you’re going to see rates begin to move up here pretty quickly. We’re already between 4.25 and 4.3. I expect we’ll move closer to 4.5, and then down to 4.25 at the end of the year, and that’s our year-end target.
We had a good year last year. Bloomberg named us as the best rate forecaster along with our colleagues at Goldman Sachs. So we take that portion of the forecast and all the forecasts significantly, and we’re very serious about that.
We think that by the end of next year, you’re going to have a positive upward sloping shape of the term structure, and this is going to be the first time we’re going to see something like this approximate, really since before the great financial crisis. Essentially, that period of zero interest rates, real negative interest rates as a tool of policy, is effectively in the rearview mirror. The normalization of the rate structure is upon us, and the economy will adjust accordingly. Now we think the United States is well-positioned to take advantage of that and do well.
Last thing I want to share with you, the most constructive and encouraging development in the US economy has been the boom in productivity over the past three quarters. Productivity in the United States has increased by 4%. This is an extraordinary thing. We haven’t seen levels like that since the 1990s. For economists, once you start thinking about productivity and growth, it’s hard to think about anything else. That’s that magical elixir or that mythical tide that lifts all boats. It means we can grow faster, have robust employment, low unemployment rates, low inflation. Most importantly, it lifts the living standard of all who participate in the economy.
That’s not something we’ve been able to say in a long, long time. You know what? We can continue to see productivity anywhere near the vicinity of 2.5%. That’s a game changer, and we’re going to be having a very different discussion around the economy at that point. One that doesn’t so much involve risks, but upside potentials and good things.
Dave:
Wow. Well, thank you so much, Joe. We really appreciate your insights here and your very specific forecast and thoughts on the economy. For everyone listening or watching this, if you want to learn more about Joe, we’ll put a link to all of his information where you can contact him, all that sort of stuff in the show description below. Joe, thanks a lot. Hope to have you on again sometime soon in the near future.
Joe:
Thank you.
Dave:
Another big thanks to Joe for joining us on this episode. I hope you all learned a lot. I sure did. The global macroeconomic climate is not something I study as closely as the housing market here in the United States, but I think it’s super important to just help you set this context and backdrop for your investing decisions. It’s super helpful to know are there a lot of risks outside the country that could start dragging on the US economy, or are there things that can increase geopolitical tensions. Because sometimes those are blind spots for us as investors that we might not see, and so we wanted to bring on Joe. In the future, I’d love your opinion on if we should bring on more people like this, because I personally find it helpful and think that it’s worthwhile for real estate investors here in the US to listen to, but would be curious about your opinion.
I do want to just clarify two things Joe was talking about at the end. He was talking about the yield curve and a bond yield. We don’t have to get all into that, but he was basically saying that at the end of the year, he thought that long-term 10 year bond yields would be around 4.25%, and that is important because that means if you extrapolate that out to mortgage rates, because bond yields and mortgage rates are highly correlated, that in normal times we would see mortgage rates around 6.25%. Normally the spread between bond yields and mortgage rates is about 190 basis points or 1.9%. Right now, they’re closer to 3%. So that means if Joe’s forecast is accurate, we’ll probably see mortgage rates at the end of the year be somewhere between mid sixes to high sixes. And of course, we don’t know if that’s for certain, but I just kind of wanted to translate what he was saying about bonds into the more tangible thing for real estate investors, which is mortgage rates.
The second thing he talked about, which I didn’t know and I think is super important, is about productivity. Now, productivity is basically a measure of how much economic output the average US worker creates, and it is super important in terms of economic growth. When you try and figure out GDP and how much economic growth there might be in a country, there’s really only two basic variables. How many people are working in an economy and how much economic value do they produce? And so if we’re in a time where our population isn’t growing as much as possible, and there’s only so much population growth and contributions in additions to the labor force that you can make at this point, and so the better way to grow the economy, according to most economists is to increase productivity. Now, a 4% increase may not sound like a lot, but that is huge, and as Joe was saying, if that trend continues, that could bode extremely well for long-term American economic growth.
Again, I hope this types of more global, more macro level look at the investing climate is helpful to you. We’d love to hear your feedback if you’re on YouTube, or you can always find me on Instagram and send me your thoughts about this episode where I’m at, the DataDeli, or you can find me on BiggerPockets and do the same.
Thanks, you all, so much for listening. We’ll see you for the next episode of On The Market.
On The Market was created by me, Dave Meyer and Kaylin Bennett. The show is produced by Kaylin Bennett with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.
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Private-label securities are in demand as investors bet Fed peak is reached
Federal Reserve Chair Jerome Powell indicated in recent congressional testimony that interest rate hikes are now likely at the “peak for the current tightening cycle,” after signaling in November of last year that the Fed was close to the end of its war on inflation.
For investors in the private-label securities (PLS) market, the earlier signal was enough to unleash a boatload of money that had been sitting on the sidelines waiting for the “peak” to arrive, according to several market experts interviewed recently by HousingWire.
“November really signaled that the [Fed’s] shock-and-awe campaign is over,” said Peter Van Gelderen, a specialist portfolio manager in the fixed-income group and co-head of Global Securitized at TCW, a leading global asset management firm with some $210 billion in assets under management.
“Since November, there’s greater certainty by the investment community that the hiking cycle is done and that the economy is not falling off a cliff, that the housing market is not falling off a cliff.
“And so [investors] can start having greater conviction in the future path of interest rates and in the health of the mortgage market.”
Michael Warden, managing principal and CEO of Invictus Capital Partners — one of the largest players in the nonqualified mortgage (or private-label) securitization space via Verus Securitization Trust — is also quite bullish on the future of private capital in the mortgage market.
Non-QM mortgages include loans that cannot command a government, or “agency,” stamp through Fannie Mae or Freddie Mac. The pool of non-QM borrowers includes real estate investors, fix-and-flippers, foreign nationals, business owners, gig economy workers and the self-employed.
“The rating agencies and bond market have recognized the pristine nature of [residential mortgage-backed securities, or RMBS] and are rewarding that over time with tighter and tighter spreads, which allows for better financing, which then allows for better pricing ultimately back to the borrower,” Warden said.
“My guess is we’ll do 10 or 11 deals this year in the $5.5 billion to $6 billion range [in total value] — maybe a little more.”
Warden added that Invictus has had increasing participation from bond investors in its deals and now averages about 40 investors per transaction, “so our participation is really high.”
Alexander Suslov, head of capital markets at A&D Mortgage, said the Florida-based lender is now working on its second private-label securitization deal of this year. He expects the company to stay on a pace for an offering every two months in 2024.
“Overall, you know, we’re going down the hill [in the rate cycle],” he said. “It’s a matter of speed. … Our analytical team believes we’re approaching a bull market as far as fixed-income [securities].”
Keith Lind, CEO of Acra Lending, a leading non-QM lender, said the PLS market is “fully healthy and functional, and I think it’s going to get better.”
“There’s a lot of demand from investors that want to buy these bonds backed by non-QM, but there’s only so many loans to be bought to securitize,” Lind said. “And future rate cuts mean less return [for investors].
He noted that investors can lock in today at a higher interest rate, but three or four months from now, the rate might be lower once the Fed starts cutting benchmark rates.
“So [investors] want to lock in these higher returns today, and that’s why there’s a lot of demand for these [securities] that are out in the market right now.”
Upward adjustment
The Kroll Bond Rating Agency (KBRA) issued a recent report covering what it calls RMBS 2.0 — encompassing the prime jumbo, nonprime/non-QM and home equity lending space, as well as credit-risk transfer deals. The report revealed that January 2024 PLS issuance totaled $7.5 billion, up 81% from the same month last year.
“Given Q1 2024’s strong start, we estimate total issuance could reach $20 billion — which would be the highest-issuance quarter since Q2 2022 — exceeding our earlier expectations by nearly $8 billion,” the KBRA report states.
“We also forecast Q2 2024 to follow with robust issuance at nearly $20 billion as the resultant spread tightening and market conditions draw issuers back to the market.
KBRA expects fiscal year 2024 issuance for RMBS 2.0 to be approximately $67 billion, up 22% year over year. Home equity lines of credit (HELOCs) and closed-end second (CES) mortgage deals are expected to account for $11 billion of the increase.
“Despite the relatively high interest rate environment, elevated inflation rates and housing-affordability concerns, the RMBS [or PLS] sector appears to be having a rebound from a sluggish 2023,” KBRA stated.
Warden said the largest buyers of triple AAA, or top-rated, RMBS are generally the large money managers.
“Almost all of them are participating,” he added. “Generally, you find a lot of those same investors buying all the way down [the capital stack] as well.
“But then you also add in hedge funds and other private equity-type funds that are looking for a bit more yield to satisfy their capital requirements.”
Van Gelderen explained that some of these investors used to be active players in the commercial mortgage market “and nobody can figure out what’s going to happen to the commercial mortgage world.”
It is a huge investment sector “that has all been taken away from them,” due to the post-pandemic woes afflicting commercial properties, such as office buildings, Van Gelderen said.
“And so they have to find other places to go, and when you find other places to go, you drive up prices in those other places,” he said.
Note of caution
Ryan Craft, CEO of Saluda Grade — a real estate advisory, securitization and asset management firm — said the current driver of investor demand is the expectation that rates will go lower later in 2024 and into 2025. He added that is why so many investors are “coming off the sidelines.”
“The most interesting thing that I’ve seen from my position as an issuer [of bonds] in the market is the depth of the new buyer base that’s coming into the market,” Craft said “… A broad swath of investors has come [into the market] since the beginning of the year, so it’s been a very deep buyer base.”
Craft cautions, however, that the U.S. government is forecasting that it will need to issue some $1.8 trillion in Treasurys in 2024. He said that could throw a wrench into the overall supply-and-demand equation in the secondary market.
“The market is seeing a lot of demand on limited [bond] supply in the private-label market … but at the same time, you are seeing a huge forecast of government debt, which could be a balloon effect in keeping rates higher for longer,” Craft said. “Those two clashing dynamics will be interesting to watch in 2024.
“So, I would say I’m cautiously optimistic, cautiously bullish right now … but I think it’s important to be cognizant of some of the other fundamentals at play.”
Ben Hunsaker is a portfolio manager focused on securitized credit for Beach Point Capital Management, a multibillion-dollar investment management firm that serves public and corporate pension funds and endowments in the U.S. and Europe. Right now, he said, there is “a lot of cash chasing bonds.”
“You had throughout the fourth quarter [of last year] like $5 billion per week in taxable fixed-income bond-complex inflows, and this year that’s accelerated to beyond $10 billion per week,” Hunsaker said. “Right now, there’s way more demand than there is supply.”
That comes on top of the fact that life insurance companies are writing record volumes of life policies and multiyear guaranteed annuities, “and so all that crowds into the fixed-income credit markets,” he added. In the latter half of this year, a tipping point could be reached if bond supply outstrips demand.
“This is all supply and demand at the end of the day, and both supply and demand are dependent upon this one factor [interest rates],” he said.
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First American’s Paul Hurst on the allure of big tech ideas
HousingWire Editor in Chief Sarah Wheeler sat down with Paul Hurst, chief innovation officer at First American, to talk about the challenge of attracting and retaining tech talent and how to know if a project has a big enough vision.
Sarah Wheeler: How do you think about buy versus build?
Paul Hurst: Before I joined First American, I worked with a lot of companies to decide this exact question. My view is that you should be very sober about where you have a right to win. Given enough capital, you can build a lot of technology. If you will be the best in the world at building and distributing that tech, you should build. For everything else, you should partner with other people.
At First American, we focus on building internally where we think we have the right to win: digitizing and automating settlement, the search and examination process, and title decisions. Everything else we look to partner. RON is a great example: Only 15-20% of RON happens in real estate — everything else is in other industries. If we build it, we can only monetize it across that 15-20%. So we partner with Notarize, which as a third-party company can spread that monetization across multiple industries.
SW: How is First American leveraging AI?
PH: Generative AI has certainly captured public attention over the last 18 months, but obviously AI has been going on a lot longer than that. We’ve been investing heavily in AI for years — we have more than 10 patents on data extraction from public record data. So generative AI doesn’t change our strategy, but advancements in AI are like a turbocharger for all of those innovation priorities, helping us to do things faster and cheaper across our existing areas of innovation.
One new use case that’s emerged with specifically generative AI, is solving for a knowledge problem in email. We, like many companies, have a lot of knowledge in email systems across our business. How do we get that information and organize it in a way that helps the underwriters do their job quickly and effectively?
One of the things that we are always conscious of at First American is the concept of proprietary IP. We’ve been engaging a lot with Microsoft because we’re very comfortable with them. Real estate companies might want to engage with AI, they might want to use those tools. But you’ve also got to think through what’s your data worth? And how do you protect it?
Lots of people talk about AI in real estate as: how do we reduce the number of FTEs at our company? I think that’s kind of a minimalist way of looking at things. I like to think about how much more business each of our people could be doing if they are able to focus on the human elements of a transaction. How do you enable these super-powered humans to do more transactions and make more money in the process?
SW: We have seen an increasing number of cyberattacks on companies in real estate and mortgage, including First American.
PH: Yes, we covered details of that in our Q4 earnings call — I would direct people there for anything First American-specific. At an industry level, I would say that the level of sophistication of the outfits running these attacks seems to be increasing, particularly with the advancement of AI. This is something where we — as an industry — have to figure out how to protect ourselves. .
SW: What keeps you up at night?
PH: First is just attracting and retaining the best talent. I spent 15 years at the intersection of some large company technology organizations. And what I witnessed is that the difference between a good product design engineering team and a great one is actually exponential. So a lot of my time is spent working together with our chief human resource officer, working through how we make sure we’re attractive to great talent — either recruiting them or identifying them internally.
As a company, “people first” is our mantra. For technology teams, when you think about incentives, there’s nothing quite like the incentive of making payroll to drive ingenuity, like you would see at a start up. If you juxtapose that with a publicly traded, profitable company, the excitement of making payroll is diminished. At a large company there’s less chance of life-changing wealth creation than at a startup — even though the chance is pretty remote there. So we’ve done quite a lot to work on the goals that we set for our teams and the incentives we attach to those goals.
The second is prioritization of investment and resources. There are just so many things that you could choose to do and invest in as a company like First American. My personal view is that real change comes not from making thousands of small investments, but rather picking a few very critical areas to invest in and hold teams accountable. That’s what we’re doing at First American with our innovation strategy.
SW: How do you make sure your teams are working on interesting projects that keep them engaged?
PH: When you’re trying to attract talent, they want to know they’re working on something meaningful. They like to know they are working for a company that is impacting 25% of all real estate transactions that happen in the U.S. This is about homeownership. And you have to make sure they’re working on something big. The quickest way to find out whether an idea is not big enough is to try and recruit talent against it. If you can’t find great talent, well, then the idea isn’t good.
Once you’ve managed to find the talent, the second piece is how do you create milestones and goals that enable you to give them appropriate compensation targets without giving them softballs. We’ve run a lot of our own internal innovation efforts a little bit like a venture portfolio company. So if you run a venture-backed company, it’s not a perfect science, but roughly speaking, we call a quarterly board meeting to talk about how you’re performing against the metrics that define success. And then approximately once every 18 to 24 months, there’s sort of like a funding event. Did you meet the milestones we talked about for last 18 months? Should we continue funding this?
We’ve tried to sort of bring the venture mindset and the way venture backed companies are run across our internal innovation efforts.
SW: When you think about tech in the real estate space, what makes you optimistic about the future?
PH: When people first come to real estate, they realize it’s not like ordering a cab or ordering some groceries online. This is a transaction that people do once every seven to 10 years so as a result of those transactions being very big, very important, and not very frequent, change takes longer. Right. So first of all, we’ve just got to have some intestinal fortitude and discipline around yes, you have a good idea, but it might take, 10 plus years for it to get adoption. And you’ve got to be able to be around for that period of time, during macro swings. That’s why I think it’s attractive working for a company like First American because you have the ability to innovate and you have the balance sheet that enables you to stick around and really drive change over a multi-decade-long time horizon.
As far as optimism, there’s been over something like $50 billion of venture capital invested in proptech since 2017, and probably countless more dollars if you include the internal innovation within public companies in the space. And yet, like when you look at the real estate transaction, the number of transactions an agent, or loan officer, or an escrow officer can handle a month hasn’t increased materially. So I think there’s still a lot of low-hanging fruit and improvements to be made in the processes that all of our people do on a day-to-day basis.
The reality is that a lot of ground work that we did over the last five years was the first step of digitizing a lot of those processes, which is a necessary precursor to automating things. Once you combine that with the advancements we’re seeing with AI, I think there’s a lot of opportunity to complete the vision of efficient real estate transactions.
And it might be a little counterintuitive, but I think that the macro environment we’ve been in recently, will turn out to be a good thing for innovation and real estate. There was a lot of money being spent on business models that were perhaps not as resilient as they could have been, or at least sort of relied on low interest rates and capital-fueled growth to succeed. And you always had this “rising tide raises all ships” right into 2020 and 2021. And so now, I think there’s a lot more diligence going into making products or services that are truly better, faster and cheaper. And I think it’s going to be easier to distinguish the signal from the noise. Our industry is always going to be cyclical and the resilience that the industry has developed in the last 24 months will pay dividends in the long run, even though in the short term it was pretty painful.
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Fed’s Beige Book shows recent moderation in mortgage rates propped up demand for homes
Moderation in mortgage rates led to a pickup in demand for residential real estate, but limited inventories across the country hindered actual home sales, the Federal Reserve reported in its Beige Book survey of regional business contacts that was published Wednesday.
Several Fed districts reported that a dearth of for-sale inventory contributed to faster home price growth since January. The spring homebuying season, which got underway a bit earlier than usual, was off to a good start in districts like New York and Dallas.
“Should mortgage rates fall, demand for residential real estate would increase, encouraging buyers who had been waiting on the sideline to move forward with home purchases,” according to the Beige Book.
The outlook for future economic growth remained generally positive as economists, market experts and business organization leaders interviewed for the report noted expectations for stronger demand and less restrictive financial conditions over the next six to 12 months.
The Beige Book, which was compiled by the Federal Reserve Bank of San Francisco using information gathered on or before Feb. 26, does not reflect the most recent rise in mortgage rates, which have surpassed 7% on HousingWire’s Mortgage Rates Center.
The Beige Book is published two weeks before each meeting of the policy-setting Federal Open Market Committee. The FOMC is expected to leave its benchmark interest rate unchanged when policymakers gather on March 19-20. The benchmark rate was last changed in July 2023, when it was raised to a range of 5.25% to 5.5%.
Federal Reserve Chair Jerome Powell reiterated Wednesday that policymakers still need to gain “greater confidence” that the battle against inflation is conquered before cutting interest rates.
“We believe that our policy rate is likely at its peak for this tightening cycle,” Powell said during testimony before the House Financial Services Committee. “If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year.”
Following are excerpts of statements on housing conditions from the Federal Reserve districts, drawn from the newly released Beige Book.
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Boston: Residential Realtors expressed growing optimism as both property listings and pending home sales increased. Contacts cited modest declines in mortgage rates since last fall as a likely reason for buyers’ increased willingness to enter the market.
Although inventory levels remained low, listings increased by modest to significant margins around the First District in recent months, lending increased optimism for sales moving forward. Still, contacts emphasized that the number of units for sale stayed far short of what they considered a balanced market, and that a dearth of inventories had contributed to faster house price growth from 2022 to 2023.
New York: Housing markets strengthened as the spring selling season got underway a bit earlier than normal. While inventory generally remained exceptionally low, inventory in New York City has begun to normalize. Many buyers who were waiting for a reprieve in mortgage rates have started to return with the intention of refinancing later. Though mortgage rate lock-in continues to limit new listings, particularly in the New York City suburbs, listings have increased in upstate New York as people have continued to leave the area for warmer climates.
Still, with such limited inventory, home prices have continued to press higher. Bidding wars were prevalent in the New York City suburbs but have been more limited in upstate New York.
Philadelphia: The inventory of for-sale properties remained extremely low as it has since the pandemic began. But real estate agents noted that higher interest rates have severely limited new listings over the past year and were responsible for the significantly lower level of closings.
New-home builders continued to report steady sales at relatively strong levels, in part because of the lack of existing for-sale homes. Most expect their pipeline of contracts to keep construction busy through the year.
Cleveland: Residential construction contacts reported that demand increased as mortgage rates declined. But real estate agents indicated existing-home sales changed little because inventory remained low.
Looking ahead, homebuilders and real estate contacts anticipated that demand would increase should mortgage rates fall, encouraging some “customers [who had been] waiting on the sideline” to move forward with home purchases.
Richmond: Respondents noted an increase in listings and buyer activity, but the elevated mortgage rate made buyers more tentative on making home purchase decisions. Sales prices have flattened, but there were still multiple offers on many homes.
Days on market increased slightly but remained below historic averages. The home construction market was constrained as it was difficult to find land and to receive permitting for new developments. Residential construction costs started to moderate this period.
Atlanta: As mortgage rates retreated from cyclical highs, homeownership affordability improved throughout the district. But home sales in most major markets ended the year well below seasonal norms and remained significantly behind pre-pandemic levels. Potential buyers locked into historically low mortgage rates remained reluctant to move, and migration into the district moderated through 2023, resulting in diminished housing demand.
Existing-home inventory levels were also suppressed by the “lock-in effect,” resulting in flat to moderate price growth in many markets. Demand for newly constructed homes was boosted by the lack of existing homes and builders.
Chicago: Residential real estate activity was down moderately, although prices were steady overall. High interest rates and a low supply of existing homes for sale continued to hold back activity.
St. Louis: Residential real estate sales have slowed since our previous report. Contacts in Arkansas and Tennessee reported that the low end of the market continues to be strong, while contacts in Missouri and Southern Indiana reported higher-end homes selling better. Rental rates for residential real estate have remained unchanged since our previous report.
Minneapolis: Single-family development remained soft, with modest but spotty increases in some district markets compared with a year earlier. A Minnesota contact said that “consumers quite abruptly stopped spending discretionary income on larger home improvements.”
Dallas: Home sales rose during the reporting period, and contacts noted that the spring selling season was generally off to a good start. Cancellation rates were down, buyer incentives were less prevalent, and builders said they were raising prices slightly in some markets.
Outlooks were positive, although contacts cited economic and political uncertainty, diminished affordability and tight lending.
San Francisco: Real estate activity rose slightly overall. Residential construction strengthened. Demand for single-family homes picked up slightly, as mortgage rates, though still elevated, moderated a bit in recent weeks. To attract reluctant homebuyers, some homebuilders began offering variable-rate mortgages at below-market interest rates, which revert to market pricing after a year, at which point buyers are reportedly expecting rates to be lower.
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Price trumps location in Coldwell Banker consumer survey
Amid an elevated mortgage rate environment, consumers are reevaluating their priorities when it comes to purchasing real estate. According to a recent nationwide survey conducted by Coldwell Banker, the price of a home carries more weight in the decision-making process than its location.
Price was the most important factor when choosing a home for 56% of survey respondents, while location was cited by 50% of respondents. Women (60%) also exhibited a stronger inclination toward prioritizing price compared to their male counterparts (48%).
And despite economic uncertainties looming over the housing market, a majority (56%) of respondents remain buoyant about the future of real estate. This optimism is reflected in their belief that the housing landscape will either improve or maintain its stability compared to last year.
Another noteworthy trend discerned from the survey is the growing propensity for migration among consumers. Notably, 39% of respondents reportedly considered relocating to a different city following the sale of their current residence, an increase from the 19% share in 2022.
Social media shapes home preferences
Social media platforms wield considerable influence over consumer behavior, including in the realm of real estate. In total, 43% of survey participants reported being either “somewhat influenced” or “highly influenced” by social media in shaping their home preferences.
This receptiveness to social media is more pronounced among younger demographics, with 64% of consumers between the ages of 18 and 24 citing social media as a significant factor in their decision-making process. TikTok emerges as a frontrunner in influencing the preferences of younger adults, while Facebook maintains its relevance among older demographics.
Generational and racial disparities
While more than one-quarter of respondents (26%) have either not provided or do not intend to provide financial assistance to their offspring for their first home, younger respondents ages 25 to 34 display a greater propensity (49%) toward offering such support.
Moreover, the survey revealed a greater likelihood among Black Americans (46%) and American Indian or Alaska Natives (49%) to financially aid their children in acquiring their first home. And 58% of respondents agreed with the perception that homes are assets to be passed down to children.
Profile of the ideal home
Almost one-third of respondents (32%) expressed a preference for homes situated in the South, while 24% favored properties in the Northeast.
When it comes to architectural styles, ranch homes emerged as the preferred choice, garnering 13% of the vote, followed closely by “modern contemporary” designs at 11%. But a substantial proportion (16%) remained indifferent to any particular architectural style.
Coldwell Banker collaborated with Censuswide on the survey. The research was conducted from Nov. 27 to Dec. 11, 2023, and included 1,053 respondents.
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Reverse mortgage volume, securities issuance fall in February
Despite feelings of optimism expressed by loan originators in the opening weeks of 2024, the road to more normalized levels of reverse mortgage volume and securities issuances may be longer than expected.
Home Equity Conversion Mortgage (HECM) endorsements fell 11.8% to 1,900 loans in February, a drop telegraphed by lagging case numbers and sluggish endorsement activity in January, according to data compiled by Reverse Market Insight (RMI).
HECM-backed Securities (HMBS) issuance also recorded lower performance in February, dropping to $429 million. That was down 3.6% from the $445 million figure in January, according to Ginnie Mae data and private data compiled by New View Advisors. The data prompted New View analysts to term February’s performance as a “Valentine’s Day Massacre.”
HMBS issuance will have a fairly long road to recover to 2023 levels, which were already severely reduced from the record-setting issuance of 2022 brought about by elevated HECM-to-HECM refinance activity during the COVID-19 pandemic.
Industry remains optimistic
Every tracked geographic region recorded lower volume in February, but the largest — Pacific/Hawaii — recorded the least severe drop of 6.2%, according to RMI. Despite an overall drop in activity, the fact that the Pacific region remained more resilient than others is a good sign, according to RMI President John Lunde.
“It’s great to see the largest region drop less than most others, as that has a disproportionate impact on the overall industry,” Lunde told RMD. “Secondly, the Southwest also held up relatively well among the top three.”
Based on interviews RMD conducted with reverse mortgage originators and managers in the opening weeks of the year, most professionals relayed a sense of optimism about the number of inbound inquiries they were receiving. They also shared the progress they have made in building up loan pipelines, especially compared to the end of last year.
When asked whether this optimism may be misplaced considering the endorsement volume declines over the past two months, Lunde wasn’t so sure.
“I think about this differently in that originators could very well be seeing bright shots at a recovery and the endorsements simply haven’t caught up to that yet given the inherent lag,” he said. “The first sign we’ll get [a rebound] is case [numbers] issued, but that reporting has been later than usual the past few months, so we might not see it for a few more weeks.”
Professionals who have spoken with RMI are also generally optimistic, but Lunde said that could simply be an attribute of people within the industry.
“I’ve mostly heard some optimism, but I feel like all of us in the industry tend toward that by default on a pure survivor’s bias effect.”
Leading lenders
Among the top 10 lenders, only Goodlife Home Loans (a dba of Traditional Mortgage Acceptance Corp.) and Longbridge Financial recorded increases for the month. Lunde said that’s particularly encouraging in the case of Longbridge, considering its trajectory over the past four months and the volume declines of other top 10 lenders in February.
As for what other industry participants can do to keep business moving in a positive direction, Lunde said that recent changes to the HECM for Purchase (H4P) program could illustrate that the little-used reverse mortgage variation could be approaching its breakout point.
“I think the best places to focus right now are giving the H4P a muscular new push due to the seller concessions update, and working with forward mortgage distribution and servicing opportunities to convert forward loans into new reverse borrowers,” he said.
As for professionals who work in the country’s smaller regions, which recorded more severe decreases in February, Lunde said this could translate to opportunity for tenacious local professionals.
“There’s always an opportunity to be a big fish if you’re in a small pond and dominate your local area,” he said. “There may also be some easy, repeatable practices you can take from higher-volume regions that haven’t been fully explored in smaller markets yet. Smaller-market local media could be cheaper and still impactful there in ways that stopped working years ago in the bigger ponds.”
HMBS issuance
HMBS issuance in February came in $16 million lower than January’s figure. It was also the second-lowest monthly issuance ever recorded outside of the earliest days of Ginnie Mae’s HMBS program in 2009, according to New View.
“One would have to look to 2014 to find lower monthly volume,” New View stated in its commentary accompanying the February data.
Despite the fact that the former Reverse Mortgage Funding (RMF) portfolio continues to not produce any HMBS pools, New View partner Joe Kelly explained to RMD that there isn’t much pressure on the larger program because of that.
“No pressure, really — the Ginnie Mae market is very liquid,” he said.
One potentially positive development is that New View had originally predicted that HMBS production would be lower than it actually is, due to larger factors that influence pool production.
“Low issuance is caused by higher interest rates, resulting in lower Principal Limit Factors (PLFs), combined with the high upfront Mortgage Insurance Premium (MIP),” Kelly explained. “Until the upfront MIP is restructured, it will keep origination volume down. Most industry growth must come from proprietary loans.”
A recent addition to the HMBS program that allows for smaller aggregate pool sizes below $1 million is also seeing more buy-in from issuers each month, but it remains in line with expectations, Kelly explained.
Looking back
When asked to compare the low-issuance figures from 2014 with the current market, Kelly referred RMD to its blog post that detailed HMBS results for April 2014.
“Beginning with FY 2014, HECM principal limits were cut once again, and FHA imposed new restrictions on the initial draw allowed for certain borrowers,” the 2014 blog post stated. “The resulting lower HECM production inevitably reduces HMBS production.”
Contextualizing this with the current market, Kelly said that lenders closed more loans in anticipation of the impending changes, which had an adverse impact on that year’s loan production. But other factors influenced the industry then, so 2014 will likely be a better year for issuance than 2024 based on current projections, Kelly said.
“The reverse mortgage industry (in 2014) was in transition,” Kelly explained. “The big banks had just left and new lenders were gearing up: American Advisors Group (AAG), RMF and others. Still, HECM production and HMBS issuance finished strong in 2014 and nearly made it to $7 billion in total issuance, more than 2023 and much more than 2024 at its current trend.”
Despite these lower figures, liquidity is less of a concern, Kelly noted.
“The HECM program is on strong financial footing and the HMBS program is providing excellent liquidity,” he said. “Also, The HMBS program will be greatly improved if Ginnie Mae creates an ‘HMBS II’ securitization program for buyouts. Finally, HMBS execution has improved somewhat [so far] in 2024.”
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NYCB, a struggling $78B resi mortgage servicer, to receive $1B equity investment
A group of investors led by the former U.S. Department of Treasury Secretary Steven Mnuchin’s private equity firm, Liberty Strategic Capital, will inject $1 billion in equity investment in struggling New York Community Bancorp (NYCB), one of the nation’s largest residential mortgage servicers. The move strengthens the bank’s balance sheet amid a confidence crisis related to its commercial real estate loan portfolio.
Liberty is expected to invest $450 million, followed by $250 million from Hudson Bay Capital and $200 million from Reverence Capital Partners. Citadel Securities, other institutional investors, and company management members will also participate in the transaction, subject to definitive documentation and regulatory approvals.
In turn, the bank is expanding its board of directors, adding four new seats to include Mnuchin, the former Comptroller of the Currency Joseph Otting, Allen Puwalski from Hudson Bay, and Reverence Capital’s managing partner Milton Berlinski.
The leadership is also changing. A former CEO of OneWest Bank from 2010 and 2015, Otting will become the CEO of NYCB, replacing Alessandro DiNello, who has held the position since Thomas Cangemi stepped down earlier this week. DiNello was the CEO of Flagstar Bank, the depositary recently acquired by NYCB, and will be named as non-executive chairman.
NYCB concluded the acquisition of Flagstar Bank in December 2022 and rescued Signature Bank in March 2023. In January, it was involved in a confidence crisis after reporting a $193 million net loss available to common stockholders during the last three months of 2023, including a provision for loan losses of $552 million, mainly due to its exposure to commercial real estate loans.
The Long Island-based bank was under more pressure after rating agencies Fitch and Moody’s downgraded its debt ratings on March 1. This followed the company’s disclosure of internal control deficiencies and a $2.4 billion goodwill impairment.
DiNello said in a statement that the investment is “a positive endorsement of the turnaround that is underway.” It also allows the bank to “enter this next chapter with a strong balance sheet and liquidity position supported by a diversified and retail-focused deposit base,” he added.
“In evaluating this investment, we were mindful of the Bank’s credit risk profile,” Mnuchin said in a prepared statement. “With the over $1 billion of capital invested in the bank, we believe we now have sufficient capital should reserves need to be increased in the future to be consistent with or above the coverage ratio of NYCB’s large bank peers.”
On a call on February 7, management told analysts that the bank’s total liquidity was $37.3 billion, with a coverage ratio of 163%. Its capitalization ratio, measured by its common equity tier 1 (CET1), fell to 9.1% as of December 31, 2023, down from 9.59% in the third quarter.
Targeting a 10% CET1 ratio, the bank cut its quarterly dividend from $0.17 to $0.05 to assist with capital generation. Analysts at Keefe, Bruyette and Woods (KBW) estimate a mortgage servicing rights sale (MSR) could improve the bank’s CET1 ratio by 10 to 15 bp basis points.
NYCB became a large residential mortgage servicer after the acquisition of Flagstar. Its owned servicing portfolio reached $78 billion in unpaid principal value (UPB) at the end of 2023, with a carrying value of $1.1 billion, according to the KBW analysts.
In connection with the transaction, which is expected to close on March 11, NYCB will sell and issue shares of common stock at $2 and a series of convertible preferred stock with a conversion price of $2. NYCB stock was trading at $3.80 on Wednesday around 3 p.m. EST, up 18% compared to the previous closing.
Jefferies LLC is the exclusive financial advisor and sole placement agent to NYCB in the transaction.
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The month in reverse mortgage rates: March 2024
The federally insured reverse mortgage known as a Home Equity Conversion Mortgage (HECM) is unique, as are the rates that impact the HECM product. For this reason, I will provide a short monthly educational focus, followed by a summary of the HECM rate market.
Keep in mind that almost all HECMs are adjustable-rate mortgages (ARMs), and so each rate update will concentrate on ARMs.
With a HECM loan, the U.S. Department of Housing and Urban Development (HUD) determines how much principal a lender can provide a borrower. This “principal limit” calculation is based on factors like home value, age, and of course, interest rates.
Why are there two HECM interest rates used with HECM loans?
When calculating principal limits, HUD requires lenders to use long-term forecasted rates (tied to the 10-year Constant Maturity Treasury [CMT] rate). These are called “expected rates.”
When expected rates are higher at origination, borrowers qualify for less principal at closing. Conversely, when expected rates are lower at origination, borrowers are offered more principal.
For calculating accrued interest and the growth of the principal limit after closing, HUD requires lenders to use short-term rates (generally tied to the 1-year CMT). These rates are called “note rates” or interest rates.
When note rates rise after closing, borrowers have faster interest accrual and faster principal limit growth. Conversely, when note rates fall, borrowers have slower interest accrual and slower principal limit growth.
Ultimately, HUD requires us to use two rates because it is risky for the Federal Housing Administration (FHA, the insurer) to use short-term rates to calculate long-term borrowing capacity.
Imagine an extreme example where the 1-year CMT is 1% and the 10-year CMT is 6%. FHA would be nervous about providing high principal limits to borrowers with the assumption that current short-term rates will always remain at 1%.
March 2024 update
Early in February, we saw a lower weekly average 10-year CMT (4.01%). The rate in effect for March 5 is 25 basis points higher (4.26%). This has caused HECM principal limits to drop for new applications. The 1-year CMT also followed this upward trend as shown here:
As an example, a 2.50% lender margin combined with a 4.26% 10-year CMT index would produce a HECM expected rate of 6.76%. Using this expected rate, a 73-year-old homeowner with a home that appraises for $500,000 would qualify for a principal limit of $196,000 as shown here:
For updated principal limit calculations like this, a loan originator can use a mobile app like RapidReverse or use any HECM loan origination system of their choice.
Note: 2.5% lender margins are used for education purposes only. Expected rates are rounded to the nearest 1/8% for calculating HECM principal limits. For calculating principal limits, 6.76% rounds to 6.75%.
This column does not necessarily reflect the opinion of Reverse Mortgage Daily and its owners.
To contact the author of this story: Dan Hultquist at dan@understandingreverse.com
To contact the editor responsible for this story: Chris Clow at chris@hwmedia.com
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