Dave:
Hello, my friends, and welcome to On The Market. I’m your host, Dave Meyer, and today it’s just me. We’re going to be doing an episode where I deep dive into one of the most requested topics we’ve ever had, and I’ve actually been surprised about how many people have reached out to me about this topic because it is not actually directly related to real estate, but it is a huge economic question that, of course, impacts investors and real estate indirectly, so I do think it is a really worthwhile and pretty fascinating topic to talk about. What we’re getting into today is all about the United States dollar and its position as the dominant reserve currency in the world. The reason so many people seem to be asking about this of late is that there has been a lot of news about this topic recently, that has prompted the question.
Just a couple of weeks ago, France and China completed their first natural gas transaction using Chinese currency instead of US currency, which is a really big deal for reasons we’re going to get into. We’ve heard the, quote, unquote, “BRICS nations,” which are Brazil, Russia, India, China, and South Africa. They’ve announced that they’re going to start exploring a new reserve currency to challenge the US dollar. Saudi Arabia’s finance minister has said that they’re willing to trade oil in non-dollar denominations, so there is a lot going on with regard to the United States dollar’s position as the global currency. Of course, this is an important question, and it’s really interesting because, honestly, the US dollar has been the dominant world currency for every one of our lives since the mid 1940s, and we’ll get into that story in a little bit. But basically, none of the people, myself included, anyone listening to this really knows or understands a world where the United States dollar is not the dominant currency.
Basically, none of us have lived through that. Maybe we have a few listeners who are in their 80s, which would be great. Hopefully that’s true, but something tells me that’s a limited number. But most of us basically take for granted that the US dollar is the dominant reserve of currency, but maybe, given all of the news that we’re hearing, we shouldn’t. That’s what we’re going to talk about today. We’re going to get into how the US dollar became the dominant world currency. We’re going to talk about removing the US dollar from the gold standard back in the 1970s. Why being the dominant reserve currency in the world even matters in the first place. We’ll talk about why the USD dominance is under threat right now. Could the US dollar realistically lose dominance, and when might that happen? If that actually happens, what might happen in the United States if the USD is no longer the world reserve?
There is a lot to this, and I’m super excited to get into it. But we have two housekeeping items I just need to get to quick. First, a big thank you to Pooja Jindal. Currency is not my area of expertise. I do have a pretty good understanding of economics, but currency, not my real focus, so I spent, actually, a few weeks expanding my knowledge about this topic before recording. Pooja, who is an On The Market researcher, did an incredible job helping me create this episode. She has a master’s degree in economics. She’s also in real estate in Southern California and is just generally amazing, so a big thank you to her.
Secondly, the whole reason this episode exists is because listeners, just like you, requested it. I got a ton of people reaching out to me on Instagram for this episode. If you have other thoughts for shows that you want to hear researched and discussed, hit me up. I am on Instagram @thedatadeli, that’s T-H-E D-A-T-A D-E-L-I, and I am pretty responsive there, so if you have ideas for the show, let me know. But let me just tell you a couple of guidelines. When we’re making these shows, we want to make them broadly appealing. We are not going to go do some deep dive into a really specific market. I’m sure you’re interested in what’s going on specifically in your area, but this show is meant to help investors from coast to coast, so make it really broad.
Secondly, we also want broad questions, not necessarily opinion. This episode got made because people reached out and asked. They said, “Is it possible the USD loses world dominance, and what could happen?” They didn’t say the USD is losing world dominance. That’s an opinion. Our goal on the show is to explore these broad questions and try to be as objective as we can about them. Those are my two hints. If you want to get something you’re interested in made into a show, make it broad, make it a good question, and we’ll take seriously any requests that you have.
All right, so we’re going to get into the whole situation with the US dollar, but first we’re going to take a quick break.
Speaker 2:
(singing.)
Dave:
To understand what is going on with the US dollar today, we need to look a little bit backwards and establish a little bit of context, understand a little bit of history, we’ll make our conversation about what’s going on right now a whole lot easier. The first question we need to answer is, “What the heck in the first place is a reserve currency?” Because, as I’ve said, we’re talking about the US dollar being the, quote, unquote, “dominant currency.” What we’re really talking about when I say being dominant, I’m talking about being it the dominant reserve currency. Reserve currencies are currencies that are not currently in circulation. It’s not like these are being spent out at a store. It’s not cash held in your wallet or in a business’s bank account. It is currency that is held in a country’s central bank. Most major economies, most major countries in the world have a central bank. In the United States, we call ours the Federal Reserve, which is a very commonly discussed topic here on On The Market, but most major economies have a central bank.
There’s one in Europe. There’s one in China and Japan. All over the world, these countries have central banks, and they control monetary policy. The specific reason that central banks across the whole world hold currencies in reserve is basically to facilitate international commerce and trade. It’s a complicated topic, but basically, if two countries who are trading with one another are using the same currency, it makes it a lot easier for them to trade with one another. There are also secondary benefits for holding foreign currency reserves. Basically, different governments can stabilize their own currency and their exchange rate when needed. But basically, most sophisticated economies hold currency reserves, and every country decides for themselves which kinds of currency they want to hold and reserve. But across the entire world, most central banks are very heavy in US currency.
As of 2022, which is the last data I could find for this, but I think it’s probably still pretty similar, the USD, and just as a side note, I’m going to be calling the US dollar, the United States currency, USD, throughout this episode. I’m basically just talking about our currency as Americans. As of 2022, the USD was about 59% of total reserves throughout the world. That sounds like a lot, and it is a lot because the next highest is just a third of that. The euro, which is the second most common reserve currency, only holds 20% of reserves across the world. US is almost 60%, Euro is at 20%, so those two combined, the United States dollar and the euro, are 80% of the reserve currency in the entire world. Third, we have Japan, which drops all the way down to 5%. Then we have Great Britain, and we also have the Chinese renminbi, which is only about 3%. It’s fifth place, but it’s only about 3%. We’re going to talk about China in a little bit.
What you need to know right now is that the US is truly, truly dominant in terms of reserve currencies. Just for context here, 60% is huge because the US has about 4% of the world’s population, really punching above its weight class there. The US economy is by far the biggest in the world, still. It makes up about 20 to 25% of the world’s GDP, but yet it makes up 60% of the world’s reserve currency. The USD is huge in terms of reserves even compared to the United States major role in the entire global economy, and being the major reserve for the world does have both benefits and a few drawbacks. The major benefit is that it reduces transaction costs. Basically, when you’re trading with another country, if the reserve currency you’re using is your own currency, like it is for the vast majority of deals the United States does, it reduces the transaction costs, which is obviously beneficial.
Second, it lowers borrowing rates for the United States government. This is just basically supply and demand because so many countries want United States currency, which are often held in the form of US bonds. The US can issue bonds and treasury bills at a lower interest rate. So many people want it. That’s really high demand. That means that they can offer it at a lower price, which means the US tends to be able to borrow at very low interest rates.
The third benefit, which we’ll talk about a bunch, is that it actually provides some leverage over other countries. If you control the reserve currency in the world, it allows you to exert power in some interesting ways over other countries, which is something we’re going to talk about a lot and is one of the major reasons why dollar dominance is being called into question right now.
There are a few drawbacks. Generally speaking, most economists believes the benefits of being the world’s reserve currency outweigh the drawbacks. But I do want to just mention that there are some drawbacks, and basically, it can lead to loose spending due to cheap borrowing. Like I said, the US government can borrow at a very low rate and run a deficit relatively easily compared to other governments. I’m not saying that’s necessarily a good thing. I’m just saying, compared to other governments, they can run a deficit relatively easily, and that can lead to the negative impacts of debt. Basically, you can have asset bubbles and large government debt, both of which we’ve seen in the United States in the 50… In the 80 years, excuse me, that the USD has been the dominant world currency.
That is just a primer on reserve currencies and what they are. We’re going to get back to reserve currencies in a little bit and what is happening to the US role as a reserve currency. But first, it is helpful to understand how the United States became the dominant player in terms of reserve currencies, because this is going to help us later understand if and how the emergence of alternative reserve currencies will impact the US. Here’s a very brief overview of the history of dollar dependence. If you’re interested, you can learn way more about this. If you’re a nerd like me, I found this really interesting. I knew a little bit about this, but I dove really deep into it, and it’s a pretty fascinating story. There’s actually a great Planet Money podcast episode. If you don’t listen to that podcast, it’s an NPR production. You can check it out. It’s Planet Money number 553. They go all into basically how this happened if you want to learn about this in more detail. But let me just give you a brief background.
US dollar dependence or the dominance of the USD as a currency goes back to the Bretton Woods Monetary Conference back in July of 1944. Basically, back then, it was after D-Day, the allies were starting to feel pretty confident that they were going to win the war. It’s still a good year away, but they were starting to feel confident that they were going to win the war, and they were turning their attention to how they were going to rebuild the world economy after World War II. 44 different countries sent representatives to this giant hotel up in Bretton Woods, New Hampshire. That’s why it’s called the Bretton Woods Monetary Conference, and the system that came out of it is called the Bretton Woods System.
It’s a long story again of how they argued, who the key players were, but basically what happened at the end of this conference is an agreement that lasted for almost 30 years. In this agreement, they decided that the United States would basically be the dominant world currency. The US’ role would be to fix the value of the US dollar to gold at $35 an ounce. This basically returned the United States to the gold standard, which, if you haven’t heard, the gold standard is basically when a currency like the USD has a corresponding amount of gold held in reserve. For every dollar paper money out there circulating, there was a corresponding dollar’s worth of gold held in reserve by the US government. That is the gold standard.
The US had been on the gold standard for a while, but they moved away from it during the depression in the 1930s. But in 1944, at the Bretton Woods Monetary Conference, the US agreed to go back onto the gold standard, and in exchange, other countries would essentially peg their currencies to the dollar. Everywhere in the world, people knew the US dollar could be exchanged for an agreed-upon amount of gold, and the other countries would set a fixed exchange rate to the US dollar. This agreement put the USD at the center of the currency world because it meant that other countries had to hold USDs in reserve to maintain their exchange rate. Remember, we just talked about how countries before could really choose what reserves that they wanted to have in their central bank, but this agreement for most of the major economies in the world meant that they really had to focus their currency reserves on the US dollar. This is basically how dollar dependence started across the world.
This went pretty well for the US for a while. It helped the US enjoy an enormous economic expansion in the 1950s. It also allowed the countries, including the US, to participate more easily in trade with one another due to the stability of exchange rates. For a while, it actually went pretty well. However, problems started to arise in the 1970s. The US basically no longer had enough gold to back all of the dollars held abroad. Almost all countries in the world needed USDs as reserves because of this system. For each of those dollars out there, the US needed real gold to back it, but it just didn’t have enough gold. There were also some other factors that were impacting the value of the dollar. Inflation was starting to pick up in the late 1960s, and that was eating away at the perceived value of the dollar.
The US started to run a deficit due to an increase in domestic spending and to fund the very expensive Vietnam War that had been going on for a while and was ongoing. Basically, the system was no longer working very well. To solve this problem, the president at the time, Richard Nixon, decided to devalue the US dollar relative to gold. He intended, back in 1971, just to do this temporarily, but the whole system basically collapsed over about a year or two after he did this, people lost faith in the system. After Bretton Woods System collapsed, basically, no other countries were no longer obligated to fix their currencies to the dollar, and they were no longer obligated to hold the USD in reserve. As a result, many economists anticipated that the dollar’s role abroad was going to decline. But instead, what happened was in the decades following the end of the Bretton Woods system, the dollar actually became even more dominant globally.
There were a lot of complex reasons for this, but let me just give you some of the highlights. First and foremost, to make a good reserve currency, you’ve got to have a big economy. The US is, by far, the biggest economy in the world. It is still, like I said, 20 to 25% of the world’s GDP, but back in the ’70s and ’80s, it was actually even bigger, so there was a good reason why people wanted to stick with the USD as the reserve. Secondly, they already had a lot of USDs in reserve, so moving might have just been a hassle unless there was an attractive alternative. Third, there wasn’t really an attractive alternative. We also saw a couple of different things. High interest rates in the 1980s made the US treasuries very attractive for an investment in the US in the 1980s was really high because the US was in a major economic boom. Lastly, there was a system, the pseudo-system set up that is known as the petrodollar system.
We’re going to get back to this in a little bit. I just want to call it out now, but basically the petrodollar system is an agreement where all oil and gas transactions, which you probably know are huge in nature and scope, are conducted in United States dollars. Saudi Arabia, one of the biggest oil-producing countries, up until recently, has always, always, for the last 50 years, even since the collapse of the Bretton Woods System, when they are selling oil, they sell it in USDs. A lot of countries need to buy oil from Saudi Arabia or for other countries that participate in this petrodollar system, so that gives countries across the whole world a very strong reason to be holding USDs in reserve. Even after the Bretton Woods System, the USD remained the dominant currency reserve, and how dominant it is has certainly fluctuated over time. It’s been 50 years. But again, the USD is still, by any estimation, the dominant reserve. But I do want to say that it has been declining.
The dollar share of global foreign exchange reserves fell below 59% back in 2022. It’s hovering around 59% from what I understand. But back in 1999, for example, so almost 25 years ago, it was about 71%, so this has been a long but relatively slow decline. Again, the US is still three times higher than the Euro, 12 times higher than Japan, and 20 times higher than China, so it’s still really dominant. But obviously, there is a reason this stuff is in the news, so let’s get into what is actually happening now because there’s been all this buzz about the USD losing its dominance.
There are a bunch of reasons we’re going to get into, but the theme among all these reasons is that other major economies just don’t want to be entirely dependent on the United States Reserve. There are certain downsides for every country that is not the US in being reliant on the US. Countries, basically, if they have more diversity among their currency reserves, they can reduce their exposure to currency fluctuations, interest rate changes, and economic instability from the United States, and that can reduce the risk of financial crisis or financial contagion like we saw in 2008. Let’s just look at a couple of the key players here who are talking about diversifying away from the US.
The first is China, and China has been actively looking to establish its currency globally, and this has been going on for several years now. This is not necessarily a new thing. There has been a trade war with China over the last six or seven years or so. As that is heated up, China has increased its focus on moving away from the USD or being entirely reliant on USD. Something notable happened just a couple of weeks ago. Back in March of 2023, China and France completed China’s first settlement for a liquid natural gas trade in March of 2023. Basically, they used the Chinese renminbi rather than USD, and this is one of the first big gas trades in the last 50 years that has not used the USD. Remember, I was talking about the petrodollar system and how basically all oil and gas trades have been using the US dollar.
China and France basically just completed a trade that did not use the US dollar, so that’s one of the reasons you’re hearing about this in the news. The second reason you’re hearing about this in the news is the, quote, unquote, “BRICS countries,” which again stand for Brazil, Russia, India, China, and South Africa. There are five of the largest emerging economies in the world, and basically, these five economies have announced that they intend to develop a reserve currency. That won’t depend on the USD or the Euro. This, and I’ll explain why the euro’s in there too in just a minute, but I just first want to say that this actually hasn’t happened yet, but they’ve been talking about it a lot. There is an intention to pursue a new reserve currency. Brazil has actually already begun to accept trade settlements and investments in Chinese currency, the renminbi.
Actually, while I was researching this over the last couple of weeks, the president of Brazil came out and gave a big speech about how they intend to get away from using the US for all of their trade, so they seem pretty serious about this, but it hasn’t happened yet. The third major thing that’s been going on in relation to dollar dominance is the Russia-Ukraine War. In the wake of Russia’s invasion of Ukraine, the US government actually seized the US dollar reserves of the Russian Central Bank, and that was worth nearly $300 billion. The US just seized it. They took it. That was an enormous amount of money. That was the accumulated savings of Russian nation, and it was a really strong illustration of the risk other countries are taking by holding the US dollar, because obviously, the Russian government, the US government, there’s a lot of tension right now.
Basically, the US pulled the big flex, and they were like, “We’re just going to take your US reserves.” They basically did that at the flip of a switch. Now, Russian and US relations are worse than most other countries, but I imagine that other countries around the world are looking at that and thinking, “Man, we don’t want that to happen.” They’re not necessarily saying they’re going to get rid of all their US currency reserves, but they’re saying, “Wow, if the US is willing to do that to Russia, maybe they would do that to us too, and it would be smart for us to diversify away from that.” We’ve also seen a lot of trading with Russia recently in different currencies. The trading between the Chinese currency, the renminbi, and the Russian currency, the ruble, has increased 80 fold since the 2022 invasion of Ukraine, so we’re already seeing some of these countries, obviously Russia, trading in other currencies other than the USD.
The last player here I want to mention is Saudi Arabia. Again, they’re at the center of the petrodollar system. But just a couple of months ago at the 2023 World Economic Forum, for the first time in 48 years, Saudi Arabia’s finance minister said, “The nation is open to trading in other currencies besides the US dollar.” If Saudi Arabia starts accepting trade in other currencies, it could have a negative effect on the dollar’s role as the global currency in international trade, because as we’ve been talking about, oil and gas trades are massive. They’re a huge part of the economy. If Saudi Arabia starts using a different currency, they’re not necessarily saying that they’re going to stop using the USD. I want to make that clear. They’re basically saying they’re open to using other currencies in addition to the US dollar, but even that still could have an impact.
Whether we’re talking about Russia, Saudi Arabia, China, the rest of the BRICS countries, a lot of countries are signaling that they want to end or at least reduce their dependence on the US dollar. We need to answer the question, “Will it happen?” All this intention around the world to dethrone the US dollar, or at least create parity. Again, I want to say people aren’t necessarily saying they’re not going to use the US dollar, they want to end this dominance that the US has, and there’s a lot of intention to that. It seems grim, but we don’t know if that’s actually going to happen. To be honest, I’m going to get to the point really quick here, and then I’ll explain why.
From everything I’ve read and researched over the last several weeks, it seems that replacing the US dollar is going to be very difficult. The first question is, who will replace the US dollar? Because most competitor currencies face limitations that the dollar simply doesn’t have. First, the size of the economy of the country supplying the currency really matters. Reserve currency status is closely dependent on the issuing country’s economy, and as we’ve talked about, the United States economy, which is roughly $21 trillion, is the largest in the world measured by nominal GDP, and that is followed by China, which is the second-biggest economy in the world, which comes in just under $15 trillion. So it’s about two-thirds of the US economy’s size. China theoretically could be in the second position here in terms of economy, but I’m going to talk about some of the specific restrictions that China faces in the near future.
But just so you know, other GDPs, like Japan, which is one of the biggest economies in the world, is only $5 trillion. That’s huge, but it’s a quarter of the US. Germany is under $4 trillion. The UK is under $3 trillion. India is at $2.7 trillion. I’m just saying all these numbers so you’ll see that although these countries have large relative economies relative to the rest of the world, when you compare them to the US, they are still relatively small. That’s factor number one. It’s just the size of the GDP. The US is dominant. China is about two-thirds of the side, so feasibly they can, and we’ll talk about that in just a second. But first, I want to talk about the euro.
The euro is the second-biggest reserve currency. Again, it’s about 20%. US is 60%, so it’s about a third. But adoption of the euro as the world currency just doesn’t seem that likely. First, the euro is a really strong currency. It is widely used for trade in Europe. It’s viewed as safe and stable. But the fact is that the eurozone together is not a single country. It is a unification of dozens of countries and therefore doesn’t have a single fiscal policy. This lack of a unified fiscal policy limits its ability to produce enough euro denominated assets to satisfy global demand, so that is a really big restriction. The second one is that Europe and US are really close allies. They often work in partnership. Switching to the Euro would not necessarily offer any additional protection over the dollar for countries like Russia, India, Brazil, or China who are trying to hedge their dependence on the US. Moving from the US to the Euro probably doesn’t really offer them the protection they want because the US and the eurozone tend to act really closely together.
That’s the reasons why economists don’t believe the euro is likely to be adopted. Let’s turn to China, and why China isn’t likely to be an alternative at least anytime soon. First, the thing China does have going for is the size of its economy. Again, second-biggest economy in the world, and China is really trying hard to establish its currency as the global currency, but it has a problem. It has a lot of order, known as foreign exchange controls, in place. In China, companies, banks, individuals, they have to comply with what is known as a, quote, unquote, “closed capital account policy.” This basically means that money cannot be freely moved into or out of the country unless it abides by strict foreign exchange rules. Some people would call this currency manipulation or exchange rate manipulation, but basically, China has very strict rules about how its currency is used, so that is not very attractive for countries that are not China. They don’t want to be dependent on a currency that is really closely monitored and manipulated by the Chinese government.
China has these capital controls in place so it can control the value of its currency. By becoming the international reserve, China would have to give up that control over the value of its currency, and that would expose it to both unwanted appreciation and/or depreciation devaluations basically of their currency. China has said that they are going to liberalize its foreign exchange market. They’ve said that to the World Trade Organization, but those changes are being introduced gradually, and until they come into play and other countries see them being implemented, it seems unlikely that the Chinese currency is going to be picked up in a major way that could actually rival the US.
It will probably grow in terms of its share of currency reserves, but it’s probably not going to challenge the US right now. The third thing is, yes, the BRICS countries have said that they plan to introduce a new reserve currency that could compete with the US, but they haven’t even done that yet, and that’s a long way off. I think it would take years and years, even after they introduce it, for it to compete with the US, so that’s just something we’ll have to keep an eye on. This could obviously change, but as of now, I haven’t found any research that really supports the idea that the US dollar is being threatened in the immediate future. Long term, there is definitely a chance that the US loses ground as the dominant currency, but in the immediate term, it doesn’t look like this really pressing issue.
Now, over the long term though, let me just get back to that and say that many economists speculate that we could be heading towards a, quote, unquote, “multipolar” or more plurality in the terms of currency reserves where different currencies are competing to be the major reserve currencies in the world. Now, if that happens and the US does lose some of its basically “market share,” quote, unquote, like its share of global reserves, it could create some issues in the US. Remember, back at the beginning, I talked about some of the benefits of being the world’s reserve currency, and some of those were reversed, so that could increase borrowing costs for the US. It could lessen power projections and influence on the global stage. Remember, we saw how the US basically inserted some influence by seizing US reserves from Russia, so if countries are doing that less, the US would lose that ability, and it could also create competition for currencies.
That’s actually not something we’ve seen in quite a while, competition to be the dominant currency. Basically, for the last 80 years, most of the world has basically just accepted the USD, but we don’t know what would happen if different countries were sort of competing to try and be that reserve currency. The last time we saw this was back in the inter-war years between World War I and World War II, when the US and Britain were actually competing, and it created a lot of instability and difficulty for trade. Obviously, it’s a very different world than what it was 90 years ago, so we don’t really know exactly what that would happen, but there is obviously some risk if there is competition. There are some benefits. Some economists think that there are some advantages. Basically, less dependence on the US dollar would lessen the global impact of US financial issues.
As we saw in 2008, the global recession that rippled, really, all over to every country in the world started in the US, and the reason it was able to ripple out to all these other countries and cause this big global situation was because the whole world is dependent on the US dollar and the US economy, so less dependence could actually help stabilize the global economy, but not necessarily help the US, but just basically, it wouldn’t ripple out. That could help the US in some ways because if US has a financial crisis but, say, Africa, Europe, Asia, and South America are still doing really well, that could lessen the severity of a recession or financial crisis in the US because there’s growth elsewhere in the world.
The other advantage is, it could lessen imbalances in the US and help reduce trade deficits. It could also incentivize the US to close its spending deficits a little bit because borrowing would be more expensive, so there are some advantages, there are some trade-offs. But basically, we don’t really know because the last time the US dollar was not the dominant reserve currency was before World War II, and the world has changed so much that it’s really difficult to speculate what’s going to happen. That is where we stand today. Let me just summarize what we’re talking about right now. The US is still the dominant reserve currency by a very large margin, and there is no current evidence that another currency is coming along to replace the US dollar anytime soon. There definitely will be people trying. That seems evident that other countries are going to try and increase their influence as a reserve currency, but those contenders seem to have a long way to go.
To me, and this is just my gut feeling, this is just after studying this for a couple of weeks, my gut feeling is that it does seem likely that the USD will probably lose some share as a global reserve in the coming years, given that other nations have stated their intention to reduce their dependence on the USD. But this doesn’t necessarily mean that the US dollar will be replaced as the number one currency. It just basically means that there might be some more parity. We don’t know how bad or maybe good that might be right now because it’s just something that hasn’t happened in so long.
But I think the comforting thing to me is that it will probably happen slowly if it happens at all, so there will be time for the global financial system to react. The reason I think this is because right now there just isn’t really a good contender challenging the US dollar in a real way, and until one gains momentum, it just doesn’t seem like this is going to be a pressing issue. But of course, that can change. Now that I’ve learned about this, I find it fascinating. It’s something I’m going to be following into the future, and I will certainly update you all if there is anything that comes up that you should know about.
Thank you all so much for listening. We appreciate it very much. If you have any feedback about this, please hit me up on Instagram, where I’m @thedatadeli. You can also send requests or ideas for shows there as well. If you like this particular episode, please share it with a friend. Share it on social media. We’d love for you to help us spread the word about On The Market and help other people just like you better understand the housing market and better understand the economy. I’m Dave Meyer, and I’ll see you again next time.
On The Market is created by me, Dave Meyer, and Kalin Bennett, produced by Kalin Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jindal. A big thanks to the entire BiggerPockets team. The content on the show On The Market, are opinions only. All listeners should independently verify data points, opinions, and investment strategies.
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Opinion: tools for landlords to help low-income tenants
The federal Housing Choice Voucher (HCV) program is a powerful tool to help low-income families find apartments they can afford, but the program isn’t reaching its potential because far too few landlords participate in it.
Landlords who refuse to participate cite several reasons, including what they regard as undue regulatory burdens and concerns about tenant “quality.”
Fortunately, lawmakers of both parties are proposing legislation that would relieve pain points for landlords while providing new incentives for them to participate. The challenge at hand is ripe for bipartisan action.
The HCV program currently provides rental assistance to 2.3 million households. Due to federal funding limitations; however, only one in four eligible households receives a voucher and the waiting lists to get one are often very long. Even with a voucher, a low-income family can find it extremely hard to locate an affordable apartment because so few landlords participate in the program.
Some landlords don’t accept vouchers
In fact, a 2018 Urban Institute study found more than 70% of landlords in Fort Worth and Los Angeles did not accept vouchers. Even more strikingly, over 80% of landlords in low-poverty areas in Fort Worth, Los Angeles and Philadelphia did not accept them. The latter figure is particularly disturbing because vouchers are supposed to enable low-income families to move to low-poverty, higher-opportunity neighborhoods.
Why don’t landlords participate? The Department of Housing and Urban Development (HUD) surveyed them and heard complaints about:
HUD enticing landlords
To its credit, HUD recently took steps to entice more landlords to rent to voucher holders. For instance, the Department raised its estimates of Fair Market Rents, which increases the maximum value of a voucher in a geographic area and, thus, the revenue that landlords receive from voucher holders after renting to them.
Also, HUD has expanded Small Area Fair Market Rents, which sets voucher amounts at a neighborhood level rather than a metropolitan area level. That increases the value of vouchers in high-rent relative to low-rent neighborhoods, enabling voucher holders to live in more expensive, higher-opportunity neighborhoods if they choose to.
Congress has helped, as well. In 2016, lawmakers directed HUD to add 100 PHAs to its Moving to Work (MTW) Demonstration program – which enables PHAs to design and test innovative strategies to help residents with housing and other needs, and which exempts PHAs from many public housing and voucher rules. Currently, according to HUD, 126 PHAs participate in the MTW program.
Now, Senators Chris Coons (D-DE) and Kevin Cramer (R-ND) have introduced the bipartisan Choice in Affordable Housing Act, which proposes to give landlords a host of new incentives to participate in the HCV program.
Specifically, the bill would offer a financial bonus to PHAs that retain a dedicated landlord liaison to manage PHA-landlord issues and disputes. The bill would also reduce the burden of inspections by enabling landlords to meet voucher inspection requirements for their units if they were inspected in the past year. Importantly, it includes some direct incentives, including signing bonuses to landlords in low-poverty areas and security deposit assistance to protect against damages.
In enacting reforms, the administration and Congress should not require PHAs to do more work to improve the implementation of the HCV program without giving them greater resources; their staff capacity is already very limited and unfunded mandates will further burden them.
The HCV program is highly effective, but its reach is far too limited. Increasing the program’s impact should be an urgent, bipartisan priority. New incentives for landlords to participate, as well as enhanced flexibilities for PHAs, would prove a win-win for landlords and voucher holders alike.
Dennis C. Shea is the executive director of the J. Ronald Terwilliger Center for Housing Policy. Owen Minott is senior policy analyst for housing and infrastructure at the Bipartisan Policy Center.
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The Housing Market “Signals” That Predict Where We’re Headed in 2023
The housing market shoots up different signals every so often. For most investors, though, these fly under the radar. But for data-driven housing market experts like Mike Simonsen, these signals are hard not to notice. If you want to know where prices will go next, when inventory could spike, and whether or not demand will start to fall (or rise), you MUST know what these signals are and how to find them. Today, we’ll let you in on the not-so-secret way to predict housing market moves so you can invest better than the rest.
Altos Research’s Mike Simonsen didn’t start as a housing market enthusiast. He was in Silicon Valley, working with data, just trying to buy his first overpriced house. But, through getting his foot in the door of real estate, he uncovered that no one had the data he needed to make better investments. So, he started Altos Research to finally give real estate investors, realtors, and everyday homebuyers the tools to make their best buying decisions.
Over the past seventeen years, Mike has been analyzing, segmenting, and qualifying housing market data for some of the most prominent investors in America. And now, he’s here today to share his time-tested secrets with you. No matter your skill level, you’ll be able to pinpoint the housing market signals Mike showcases so you uncover where the market is moving before the masses. Whether you’re an investor, homebuyer, realtor, or renter, this data will help you build wealth better than ever.
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A bull year is ahead for MSR trading
The trading volume of mortgage-rights servicing (MSRs) so far this year is on pace to meet or exceed last year’s robust mark, when MSRs on some $1 trillion worth of home loans exchanged hands — then fueled by the spike in interest rates, industry players say.
As of late April 2023, mortgage interest rates, though still volatile, have been on a downward trajectory since the start of the year. That should be a drag on MSR pricing and trading, given MSR values tend to decline as interest rates drop because lower rates prompt more refinancing — lowering the long-term payout for the asset.
That trend, however, is not materializing in the market so far, according to several MSR market experts interviewed by HousingWire. The main reason for that is that the bulk of the MSRs now being traded are linked to solidly underwritten mortgages originated in 2020 and 2021, when interest rates were in the 3% range — hence they represent quality MSRs that are now at very low risk of prepayment.
“Given the volume that we’ve seen in the market so far this year, I expect another really strong year in [MSR] brokerage activity,” said Mike Carnes, managing director of the MSR valuation group at the Mortgage Industry Advisory Corp. (MIAC). “We hit nearly $1 trillion dollars last year, and I would say you could potentially have another $1 trillion year this year.”
Carnes said MIAC currently has in the pipeline MSR offerings worth a total of some $14 billion — based on the total loan balance serviced — with deals representing about $4 billion of that total slated to close this month. That figure doesn’t include a pending deal in the works that he said would “significantly move that number.”
Tom Piercy, managing director of Incenter Mortgage Advisors, said there is “a tremendous amount of capital focused on MSR assets” now, with a good mix of buyers and sellers — including banks and independent mortgage banks (IMBs) as sellers and buyers, plus there is a healthy mix of institutional players (including insurance companies, private-equity firms and real estate investment trusts, or REITs) bolstering the ranks of buyers this year.
Piercy said Incenter has some $130 billion in MSR offerings that have gone to bid so far this year or are in the pipeline, including public bulk-auction offerings and private directly negotiated deals.
“When you look at our numbers right now relative to where we were a year ago, we are certainly on track to replicate it [last year’s healthy performance], and we may even exceed it given some of the deals in the pipeline,” Piercy said. “We have been very pleased with the manner in which this market has responded since the anticipation earlier in the year of this being a buyer’s market.
“There is a tremendous amount of capital committed to this space, which is creating, I think, competitive factors that have maintained an elevated pricing market.”
Among the active buyers prepared to participate in the market, according to industry observers who spoke with HousingWire, are the following:
• Annaly Capital Management [a REIT that controls Onslow Bay Financial].
• Bayview Cos. [which controls Lakeview Loan Servicing].
• Rice Park Capital Management.
• Prophet Capital Asset Management.
• Voya Investment Management.
• Mr. Cooper (formerly Nationstar Mortgage).
• Rithm Capital (also known as NewRez);
• Two Harbors Investment Corp.
Of course, there are many other players active in the MSR market, including banks and IMBs. In fact, according to mortgage-data analytics firm Recursion, leading the charge in bulking up their all-agency MSR portfolios (involving Fannie Mae, Freddie Mac and Ginnie Mae loans) between the end of 2021 and April of this year are the following lenders:
The growth in the lenders’ MSR portfolios includes both servicing retained on new loan originations as well as MSR acquisitions. The lenders rank among the top 10 in terms of market share in the all-agency MSR market, according to Recursion’s data.
Lenders among that top 10 that recorded a decline in their MSR portfolios over that same period include Wells Fargo, Rocket Mortgage and United Wholesale Mortgage (UWM), according to Recursion’s data.
Nick Smith, founder and CEO of Rice Park Capital Management, said his firm is an active buyer in the MSR market this year, adding that there is a huge supply of attractive MSR assets in the pipeline that he expects will be traded over the next 12 to 18 months.
That includes, he said, some $1.5 trillion (UPB) in legacy MSRs from loans made in 2020 and 2021 primarily by IMBs. Some active bank sellers are in the market as well — such as Wells Fargo, which announced recently that it had finalized a deal to sell some $50 billion in MSRs.
“So, you’ve got a $1.5 trillion [in legacy MSRs expected to trade] which is like the rat going through the snake, plus you’ve got the new production volume [at current market rates] that’s going to trade, let’s call that $1 trillion to $1.25 trillion,” Smith said. “… It’s a really low-risk, high-quality asset that I would say, for investors, is sort of a dream asset to buy.”
Not everyone is bullish on the MSR market, however. Ben Hunsaker, a portfolio manager at Beach Point Capital Management, an alternative-credit investment firm, said MSR prices are too high now “relative to other asset classes.”
“Prepayments [via refinancing] can get a lot faster,” he said. “They can’t get a lot slower.
“Expenses [due to rates and inflation] can get a lot higher, and so it feels like MSRs are priced pretty tightly in the grand scheme of investable assets in 2023.”
Azad Rafat, senior director of MSR services at Mortgage Capital Trading (MCT), said his firm, in conjunction with advisory firm Prestwick Mortgage Group, has marketed four MSR offerings so far this year valued in total, based on UPB, at $838 million. Rafat said MCT typically works with smaller MSR offerings under $1 billion.
At least another two MSR offerings to date, with a combined value of about $1.4 billion, were marketed exclusively by Prestwick, bid documents show.
“We’re seeing very much interest from private equity funds, or companies backed by private equity funds,” Rafat said. “That’s the typical players [MSR buyers] we’re seeing right now.”
Rafat added a note of caution about the future course of the MSR market, however, or at least its unknowns. The biggest of those unknowns is whether a recession is in the offing. If so, that could impact borrowers’ refinancing choices as well as the value of MSRs — assuming the downturn is severe enough to prompt an increase in loan-prepayment speeds even among legacy borrowers.
“Consumer debt has risen from $11 trillion to $12 trillion to a little over $16 trillion as of the end of 2022,” he said. “The question is how much will that [increasing debt] put pressure on them to refinance, even though it’s difficult for them to give up those 3% loans?
“Right now, the whole industry is under the assumption that those prepayment speeds are going to remain low for a long time. The question is what will happen when you have a recession [and rates likely decline further].”
Smith concedes that both current MSRs as well as the huge pool of MSRs tied to low-rate legacy loans from 2020 and 2021 will be impacted by declining interest rates. But he adds that because the legacy-loan MSRs are now so far out of the money in terms of refinancing, interest rates would have to decline drastically from where they are now to drag down MSR pricing significantly.
“If rates drop 100 basis points from here [to the low 5% range, as the Mortgage Bankers Association predicts will happen by year’s end], the legacy MSRs go down by 4% [in price] while new [prevailing-rate] origination [MSRs] go down by 25%,” he said. “It’s just a much different order of magnitude.
“So they [legacy-loan MSRs] have a big buffer, and even though rates dropping … will have a negative price impact, it’s dampened. There is much less price volatility for rate drops for those MSRs, compared with new-issue stuff.”
Carnes points out that of the estimated $10 trillion-plus in mortgage originations from 2020 and 2022 “over $8 trillion of that was originated in 2020 and 2021.”
“There’s still a significant amount of saturation of that legacy product,” he added. “Even if interest rates go down by around 150 basis points from where we are today [to around 4.5% from the low 6% range now], these Covid-era originations [some at rates below 3%] are still out of the money and not at significant risk for refinancing.
“… Right now, there’s a good number of buyers in the market, including some new buyers, and as long as the demand for MSRs remains strong, I think so too will the value of MSRs. It’s a very attractive asset, particularly the legacy MSRs.”
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The US Dollar Isn’t Going Anywhere (Here’s Why)
The US dollar is in danger. For decades, trading in USD (US dollars) has been the standard for almost every country on the planet. Thanks to America’s consistent economy, stable government, and growing global market share, the USD has become the most sound currency on earth. But things are starting to change. USD dominance is being threatened by BRICS countries (Brazil, Russia, India, China, and South Africa), looking to ditch the dollar for a currency they control.
But why are most countries trading in USD? When was USD chosen to be the world’s reserve currency? And what does “reserve currency” even mean? Dave Meyer breaks it down in this episode of On the Market, as he details the history of USD dominance, the post-World War rise of a reserve currency, and why the “petrodollar” may be losing steam as other economies grow larger.
Dave will also go in-depth on the economic effects of leaving a USD standard, when the USD could be replaced, which currencies are competing, and why dollar dominance (probably) won’t be over anytime soon. American or not, decoupling from a USD standard could have huge effects on your investments, wealth, and spending power.
Dave:
Hello, my friends, and welcome to On The Market. I’m your host, Dave Meyer, and today it’s just me. We’re going to be doing an episode where I deep dive into one of the most requested topics we’ve ever had, and I’ve actually been surprised about how many people have reached out to me about this topic because it is not actually directly related to real estate, but it is a huge economic question that, of course, impacts investors and real estate indirectly, so I do think it is a really worthwhile and pretty fascinating topic to talk about. What we’re getting into today is all about the United States dollar and its position as the dominant reserve currency in the world. The reason so many people seem to be asking about this of late is that there has been a lot of news about this topic recently, that has prompted the question.
Just a couple of weeks ago, France and China completed their first natural gas transaction using Chinese currency instead of US currency, which is a really big deal for reasons we’re going to get into. We’ve heard the, quote, unquote, “BRICS nations,” which are Brazil, Russia, India, China, and South Africa. They’ve announced that they’re going to start exploring a new reserve currency to challenge the US dollar. Saudi Arabia’s finance minister has said that they’re willing to trade oil in non-dollar denominations, so there is a lot going on with regard to the United States dollar’s position as the global currency. Of course, this is an important question, and it’s really interesting because, honestly, the US dollar has been the dominant world currency for every one of our lives since the mid 1940s, and we’ll get into that story in a little bit. But basically, none of the people, myself included, anyone listening to this really knows or understands a world where the United States dollar is not the dominant currency.
Basically, none of us have lived through that. Maybe we have a few listeners who are in their 80s, which would be great. Hopefully that’s true, but something tells me that’s a limited number. But most of us basically take for granted that the US dollar is the dominant reserve of currency, but maybe, given all of the news that we’re hearing, we shouldn’t. That’s what we’re going to talk about today. We’re going to get into how the US dollar became the dominant world currency. We’re going to talk about removing the US dollar from the gold standard back in the 1970s. Why being the dominant reserve currency in the world even matters in the first place. We’ll talk about why the USD dominance is under threat right now. Could the US dollar realistically lose dominance, and when might that happen? If that actually happens, what might happen in the United States if the USD is no longer the world reserve?
There is a lot to this, and I’m super excited to get into it. But we have two housekeeping items I just need to get to quick. First, a big thank you to Pooja Jindal. Currency is not my area of expertise. I do have a pretty good understanding of economics, but currency, not my real focus, so I spent, actually, a few weeks expanding my knowledge about this topic before recording. Pooja, who is an On The Market researcher, did an incredible job helping me create this episode. She has a master’s degree in economics. She’s also in real estate in Southern California and is just generally amazing, so a big thank you to her.
Secondly, the whole reason this episode exists is because listeners, just like you, requested it. I got a ton of people reaching out to me on Instagram for this episode. If you have other thoughts for shows that you want to hear researched and discussed, hit me up. I am on Instagram @thedatadeli, that’s T-H-E D-A-T-A D-E-L-I, and I am pretty responsive there, so if you have ideas for the show, let me know. But let me just tell you a couple of guidelines. When we’re making these shows, we want to make them broadly appealing. We are not going to go do some deep dive into a really specific market. I’m sure you’re interested in what’s going on specifically in your area, but this show is meant to help investors from coast to coast, so make it really broad.
Secondly, we also want broad questions, not necessarily opinion. This episode got made because people reached out and asked. They said, “Is it possible the USD loses world dominance, and what could happen?” They didn’t say the USD is losing world dominance. That’s an opinion. Our goal on the show is to explore these broad questions and try to be as objective as we can about them. Those are my two hints. If you want to get something you’re interested in made into a show, make it broad, make it a good question, and we’ll take seriously any requests that you have.
All right, so we’re going to get into the whole situation with the US dollar, but first we’re going to take a quick break.
Speaker 2:
(singing.)
Dave:
To understand what is going on with the US dollar today, we need to look a little bit backwards and establish a little bit of context, understand a little bit of history, we’ll make our conversation about what’s going on right now a whole lot easier. The first question we need to answer is, “What the heck in the first place is a reserve currency?” Because, as I’ve said, we’re talking about the US dollar being the, quote, unquote, “dominant currency.” What we’re really talking about when I say being dominant, I’m talking about being it the dominant reserve currency. Reserve currencies are currencies that are not currently in circulation. It’s not like these are being spent out at a store. It’s not cash held in your wallet or in a business’s bank account. It is currency that is held in a country’s central bank. Most major economies, most major countries in the world have a central bank. In the United States, we call ours the Federal Reserve, which is a very commonly discussed topic here on On The Market, but most major economies have a central bank.
There’s one in Europe. There’s one in China and Japan. All over the world, these countries have central banks, and they control monetary policy. The specific reason that central banks across the whole world hold currencies in reserve is basically to facilitate international commerce and trade. It’s a complicated topic, but basically, if two countries who are trading with one another are using the same currency, it makes it a lot easier for them to trade with one another. There are also secondary benefits for holding foreign currency reserves. Basically, different governments can stabilize their own currency and their exchange rate when needed. But basically, most sophisticated economies hold currency reserves, and every country decides for themselves which kinds of currency they want to hold and reserve. But across the entire world, most central banks are very heavy in US currency.
As of 2022, which is the last data I could find for this, but I think it’s probably still pretty similar, the USD, and just as a side note, I’m going to be calling the US dollar, the United States currency, USD, throughout this episode. I’m basically just talking about our currency as Americans. As of 2022, the USD was about 59% of total reserves throughout the world. That sounds like a lot, and it is a lot because the next highest is just a third of that. The euro, which is the second most common reserve currency, only holds 20% of reserves across the world. US is almost 60%, Euro is at 20%, so those two combined, the United States dollar and the euro, are 80% of the reserve currency in the entire world. Third, we have Japan, which drops all the way down to 5%. Then we have Great Britain, and we also have the Chinese renminbi, which is only about 3%. It’s fifth place, but it’s only about 3%. We’re going to talk about China in a little bit.
What you need to know right now is that the US is truly, truly dominant in terms of reserve currencies. Just for context here, 60% is huge because the US has about 4% of the world’s population, really punching above its weight class there. The US economy is by far the biggest in the world, still. It makes up about 20 to 25% of the world’s GDP, but yet it makes up 60% of the world’s reserve currency. The USD is huge in terms of reserves even compared to the United States major role in the entire global economy, and being the major reserve for the world does have both benefits and a few drawbacks. The major benefit is that it reduces transaction costs. Basically, when you’re trading with another country, if the reserve currency you’re using is your own currency, like it is for the vast majority of deals the United States does, it reduces the transaction costs, which is obviously beneficial.
Second, it lowers borrowing rates for the United States government. This is just basically supply and demand because so many countries want United States currency, which are often held in the form of US bonds. The US can issue bonds and treasury bills at a lower interest rate. So many people want it. That’s really high demand. That means that they can offer it at a lower price, which means the US tends to be able to borrow at very low interest rates.
The third benefit, which we’ll talk about a bunch, is that it actually provides some leverage over other countries. If you control the reserve currency in the world, it allows you to exert power in some interesting ways over other countries, which is something we’re going to talk about a lot and is one of the major reasons why dollar dominance is being called into question right now.
There are a few drawbacks. Generally speaking, most economists believes the benefits of being the world’s reserve currency outweigh the drawbacks. But I do want to just mention that there are some drawbacks, and basically, it can lead to loose spending due to cheap borrowing. Like I said, the US government can borrow at a very low rate and run a deficit relatively easily compared to other governments. I’m not saying that’s necessarily a good thing. I’m just saying, compared to other governments, they can run a deficit relatively easily, and that can lead to the negative impacts of debt. Basically, you can have asset bubbles and large government debt, both of which we’ve seen in the United States in the 50… In the 80 years, excuse me, that the USD has been the dominant world currency.
That is just a primer on reserve currencies and what they are. We’re going to get back to reserve currencies in a little bit and what is happening to the US role as a reserve currency. But first, it is helpful to understand how the United States became the dominant player in terms of reserve currencies, because this is going to help us later understand if and how the emergence of alternative reserve currencies will impact the US. Here’s a very brief overview of the history of dollar dependence. If you’re interested, you can learn way more about this. If you’re a nerd like me, I found this really interesting. I knew a little bit about this, but I dove really deep into it, and it’s a pretty fascinating story. There’s actually a great Planet Money podcast episode. If you don’t listen to that podcast, it’s an NPR production. You can check it out. It’s Planet Money number 553. They go all into basically how this happened if you want to learn about this in more detail. But let me just give you a brief background.
US dollar dependence or the dominance of the USD as a currency goes back to the Bretton Woods Monetary Conference back in July of 1944. Basically, back then, it was after D-Day, the allies were starting to feel pretty confident that they were going to win the war. It’s still a good year away, but they were starting to feel confident that they were going to win the war, and they were turning their attention to how they were going to rebuild the world economy after World War II. 44 different countries sent representatives to this giant hotel up in Bretton Woods, New Hampshire. That’s why it’s called the Bretton Woods Monetary Conference, and the system that came out of it is called the Bretton Woods System.
It’s a long story again of how they argued, who the key players were, but basically what happened at the end of this conference is an agreement that lasted for almost 30 years. In this agreement, they decided that the United States would basically be the dominant world currency. The US’ role would be to fix the value of the US dollar to gold at $35 an ounce. This basically returned the United States to the gold standard, which, if you haven’t heard, the gold standard is basically when a currency like the USD has a corresponding amount of gold held in reserve. For every dollar paper money out there circulating, there was a corresponding dollar’s worth of gold held in reserve by the US government. That is the gold standard.
The US had been on the gold standard for a while, but they moved away from it during the depression in the 1930s. But in 1944, at the Bretton Woods Monetary Conference, the US agreed to go back onto the gold standard, and in exchange, other countries would essentially peg their currencies to the dollar. Everywhere in the world, people knew the US dollar could be exchanged for an agreed-upon amount of gold, and the other countries would set a fixed exchange rate to the US dollar. This agreement put the USD at the center of the currency world because it meant that other countries had to hold USDs in reserve to maintain their exchange rate. Remember, we just talked about how countries before could really choose what reserves that they wanted to have in their central bank, but this agreement for most of the major economies in the world meant that they really had to focus their currency reserves on the US dollar. This is basically how dollar dependence started across the world.
This went pretty well for the US for a while. It helped the US enjoy an enormous economic expansion in the 1950s. It also allowed the countries, including the US, to participate more easily in trade with one another due to the stability of exchange rates. For a while, it actually went pretty well. However, problems started to arise in the 1970s. The US basically no longer had enough gold to back all of the dollars held abroad. Almost all countries in the world needed USDs as reserves because of this system. For each of those dollars out there, the US needed real gold to back it, but it just didn’t have enough gold. There were also some other factors that were impacting the value of the dollar. Inflation was starting to pick up in the late 1960s, and that was eating away at the perceived value of the dollar.
The US started to run a deficit due to an increase in domestic spending and to fund the very expensive Vietnam War that had been going on for a while and was ongoing. Basically, the system was no longer working very well. To solve this problem, the president at the time, Richard Nixon, decided to devalue the US dollar relative to gold. He intended, back in 1971, just to do this temporarily, but the whole system basically collapsed over about a year or two after he did this, people lost faith in the system. After Bretton Woods System collapsed, basically, no other countries were no longer obligated to fix their currencies to the dollar, and they were no longer obligated to hold the USD in reserve. As a result, many economists anticipated that the dollar’s role abroad was going to decline. But instead, what happened was in the decades following the end of the Bretton Woods system, the dollar actually became even more dominant globally.
There were a lot of complex reasons for this, but let me just give you some of the highlights. First and foremost, to make a good reserve currency, you’ve got to have a big economy. The US is, by far, the biggest economy in the world. It is still, like I said, 20 to 25% of the world’s GDP, but back in the ’70s and ’80s, it was actually even bigger, so there was a good reason why people wanted to stick with the USD as the reserve. Secondly, they already had a lot of USDs in reserve, so moving might have just been a hassle unless there was an attractive alternative. Third, there wasn’t really an attractive alternative. We also saw a couple of different things. High interest rates in the 1980s made the US treasuries very attractive for an investment in the US in the 1980s was really high because the US was in a major economic boom. Lastly, there was a system, the pseudo-system set up that is known as the petrodollar system.
We’re going to get back to this in a little bit. I just want to call it out now, but basically the petrodollar system is an agreement where all oil and gas transactions, which you probably know are huge in nature and scope, are conducted in United States dollars. Saudi Arabia, one of the biggest oil-producing countries, up until recently, has always, always, for the last 50 years, even since the collapse of the Bretton Woods System, when they are selling oil, they sell it in USDs. A lot of countries need to buy oil from Saudi Arabia or for other countries that participate in this petrodollar system, so that gives countries across the whole world a very strong reason to be holding USDs in reserve. Even after the Bretton Woods System, the USD remained the dominant currency reserve, and how dominant it is has certainly fluctuated over time. It’s been 50 years. But again, the USD is still, by any estimation, the dominant reserve. But I do want to say that it has been declining.
The dollar share of global foreign exchange reserves fell below 59% back in 2022. It’s hovering around 59% from what I understand. But back in 1999, for example, so almost 25 years ago, it was about 71%, so this has been a long but relatively slow decline. Again, the US is still three times higher than the Euro, 12 times higher than Japan, and 20 times higher than China, so it’s still really dominant. But obviously, there is a reason this stuff is in the news, so let’s get into what is actually happening now because there’s been all this buzz about the USD losing its dominance.
There are a bunch of reasons we’re going to get into, but the theme among all these reasons is that other major economies just don’t want to be entirely dependent on the United States Reserve. There are certain downsides for every country that is not the US in being reliant on the US. Countries, basically, if they have more diversity among their currency reserves, they can reduce their exposure to currency fluctuations, interest rate changes, and economic instability from the United States, and that can reduce the risk of financial crisis or financial contagion like we saw in 2008. Let’s just look at a couple of the key players here who are talking about diversifying away from the US.
The first is China, and China has been actively looking to establish its currency globally, and this has been going on for several years now. This is not necessarily a new thing. There has been a trade war with China over the last six or seven years or so. As that is heated up, China has increased its focus on moving away from the USD or being entirely reliant on USD. Something notable happened just a couple of weeks ago. Back in March of 2023, China and France completed China’s first settlement for a liquid natural gas trade in March of 2023. Basically, they used the Chinese renminbi rather than USD, and this is one of the first big gas trades in the last 50 years that has not used the USD. Remember, I was talking about the petrodollar system and how basically all oil and gas trades have been using the US dollar.
China and France basically just completed a trade that did not use the US dollar, so that’s one of the reasons you’re hearing about this in the news. The second reason you’re hearing about this in the news is the, quote, unquote, “BRICS countries,” which again stand for Brazil, Russia, India, China, and South Africa. There are five of the largest emerging economies in the world, and basically, these five economies have announced that they intend to develop a reserve currency. That won’t depend on the USD or the Euro. This, and I’ll explain why the euro’s in there too in just a minute, but I just first want to say that this actually hasn’t happened yet, but they’ve been talking about it a lot. There is an intention to pursue a new reserve currency. Brazil has actually already begun to accept trade settlements and investments in Chinese currency, the renminbi.
Actually, while I was researching this over the last couple of weeks, the president of Brazil came out and gave a big speech about how they intend to get away from using the US for all of their trade, so they seem pretty serious about this, but it hasn’t happened yet. The third major thing that’s been going on in relation to dollar dominance is the Russia-Ukraine War. In the wake of Russia’s invasion of Ukraine, the US government actually seized the US dollar reserves of the Russian Central Bank, and that was worth nearly $300 billion. The US just seized it. They took it. That was an enormous amount of money. That was the accumulated savings of Russian nation, and it was a really strong illustration of the risk other countries are taking by holding the US dollar, because obviously, the Russian government, the US government, there’s a lot of tension right now.
Basically, the US pulled the big flex, and they were like, “We’re just going to take your US reserves.” They basically did that at the flip of a switch. Now, Russian and US relations are worse than most other countries, but I imagine that other countries around the world are looking at that and thinking, “Man, we don’t want that to happen.” They’re not necessarily saying they’re going to get rid of all their US currency reserves, but they’re saying, “Wow, if the US is willing to do that to Russia, maybe they would do that to us too, and it would be smart for us to diversify away from that.” We’ve also seen a lot of trading with Russia recently in different currencies. The trading between the Chinese currency, the renminbi, and the Russian currency, the ruble, has increased 80 fold since the 2022 invasion of Ukraine, so we’re already seeing some of these countries, obviously Russia, trading in other currencies other than the USD.
The last player here I want to mention is Saudi Arabia. Again, they’re at the center of the petrodollar system. But just a couple of months ago at the 2023 World Economic Forum, for the first time in 48 years, Saudi Arabia’s finance minister said, “The nation is open to trading in other currencies besides the US dollar.” If Saudi Arabia starts accepting trade in other currencies, it could have a negative effect on the dollar’s role as the global currency in international trade, because as we’ve been talking about, oil and gas trades are massive. They’re a huge part of the economy. If Saudi Arabia starts using a different currency, they’re not necessarily saying that they’re going to stop using the USD. I want to make that clear. They’re basically saying they’re open to using other currencies in addition to the US dollar, but even that still could have an impact.
Whether we’re talking about Russia, Saudi Arabia, China, the rest of the BRICS countries, a lot of countries are signaling that they want to end or at least reduce their dependence on the US dollar. We need to answer the question, “Will it happen?” All this intention around the world to dethrone the US dollar, or at least create parity. Again, I want to say people aren’t necessarily saying they’re not going to use the US dollar, they want to end this dominance that the US has, and there’s a lot of intention to that. It seems grim, but we don’t know if that’s actually going to happen. To be honest, I’m going to get to the point really quick here, and then I’ll explain why.
From everything I’ve read and researched over the last several weeks, it seems that replacing the US dollar is going to be very difficult. The first question is, who will replace the US dollar? Because most competitor currencies face limitations that the dollar simply doesn’t have. First, the size of the economy of the country supplying the currency really matters. Reserve currency status is closely dependent on the issuing country’s economy, and as we’ve talked about, the United States economy, which is roughly $21 trillion, is the largest in the world measured by nominal GDP, and that is followed by China, which is the second-biggest economy in the world, which comes in just under $15 trillion. So it’s about two-thirds of the US economy’s size. China theoretically could be in the second position here in terms of economy, but I’m going to talk about some of the specific restrictions that China faces in the near future.
But just so you know, other GDPs, like Japan, which is one of the biggest economies in the world, is only $5 trillion. That’s huge, but it’s a quarter of the US. Germany is under $4 trillion. The UK is under $3 trillion. India is at $2.7 trillion. I’m just saying all these numbers so you’ll see that although these countries have large relative economies relative to the rest of the world, when you compare them to the US, they are still relatively small. That’s factor number one. It’s just the size of the GDP. The US is dominant. China is about two-thirds of the side, so feasibly they can, and we’ll talk about that in just a second. But first, I want to talk about the euro.
The euro is the second-biggest reserve currency. Again, it’s about 20%. US is 60%, so it’s about a third. But adoption of the euro as the world currency just doesn’t seem that likely. First, the euro is a really strong currency. It is widely used for trade in Europe. It’s viewed as safe and stable. But the fact is that the eurozone together is not a single country. It is a unification of dozens of countries and therefore doesn’t have a single fiscal policy. This lack of a unified fiscal policy limits its ability to produce enough euro denominated assets to satisfy global demand, so that is a really big restriction. The second one is that Europe and US are really close allies. They often work in partnership. Switching to the Euro would not necessarily offer any additional protection over the dollar for countries like Russia, India, Brazil, or China who are trying to hedge their dependence on the US. Moving from the US to the Euro probably doesn’t really offer them the protection they want because the US and the eurozone tend to act really closely together.
That’s the reasons why economists don’t believe the euro is likely to be adopted. Let’s turn to China, and why China isn’t likely to be an alternative at least anytime soon. First, the thing China does have going for is the size of its economy. Again, second-biggest economy in the world, and China is really trying hard to establish its currency as the global currency, but it has a problem. It has a lot of order, known as foreign exchange controls, in place. In China, companies, banks, individuals, they have to comply with what is known as a, quote, unquote, “closed capital account policy.” This basically means that money cannot be freely moved into or out of the country unless it abides by strict foreign exchange rules. Some people would call this currency manipulation or exchange rate manipulation, but basically, China has very strict rules about how its currency is used, so that is not very attractive for countries that are not China. They don’t want to be dependent on a currency that is really closely monitored and manipulated by the Chinese government.
China has these capital controls in place so it can control the value of its currency. By becoming the international reserve, China would have to give up that control over the value of its currency, and that would expose it to both unwanted appreciation and/or depreciation devaluations basically of their currency. China has said that they are going to liberalize its foreign exchange market. They’ve said that to the World Trade Organization, but those changes are being introduced gradually, and until they come into play and other countries see them being implemented, it seems unlikely that the Chinese currency is going to be picked up in a major way that could actually rival the US.
It will probably grow in terms of its share of currency reserves, but it’s probably not going to challenge the US right now. The third thing is, yes, the BRICS countries have said that they plan to introduce a new reserve currency that could compete with the US, but they haven’t even done that yet, and that’s a long way off. I think it would take years and years, even after they introduce it, for it to compete with the US, so that’s just something we’ll have to keep an eye on. This could obviously change, but as of now, I haven’t found any research that really supports the idea that the US dollar is being threatened in the immediate future. Long term, there is definitely a chance that the US loses ground as the dominant currency, but in the immediate term, it doesn’t look like this really pressing issue.
Now, over the long term though, let me just get back to that and say that many economists speculate that we could be heading towards a, quote, unquote, “multipolar” or more plurality in the terms of currency reserves where different currencies are competing to be the major reserve currencies in the world. Now, if that happens and the US does lose some of its basically “market share,” quote, unquote, like its share of global reserves, it could create some issues in the US. Remember, back at the beginning, I talked about some of the benefits of being the world’s reserve currency, and some of those were reversed, so that could increase borrowing costs for the US. It could lessen power projections and influence on the global stage. Remember, we saw how the US basically inserted some influence by seizing US reserves from Russia, so if countries are doing that less, the US would lose that ability, and it could also create competition for currencies.
That’s actually not something we’ve seen in quite a while, competition to be the dominant currency. Basically, for the last 80 years, most of the world has basically just accepted the USD, but we don’t know what would happen if different countries were sort of competing to try and be that reserve currency. The last time we saw this was back in the inter-war years between World War I and World War II, when the US and Britain were actually competing, and it created a lot of instability and difficulty for trade. Obviously, it’s a very different world than what it was 90 years ago, so we don’t really know exactly what that would happen, but there is obviously some risk if there is competition. There are some benefits. Some economists think that there are some advantages. Basically, less dependence on the US dollar would lessen the global impact of US financial issues.
As we saw in 2008, the global recession that rippled, really, all over to every country in the world started in the US, and the reason it was able to ripple out to all these other countries and cause this big global situation was because the whole world is dependent on the US dollar and the US economy, so less dependence could actually help stabilize the global economy, but not necessarily help the US, but just basically, it wouldn’t ripple out. That could help the US in some ways because if US has a financial crisis but, say, Africa, Europe, Asia, and South America are still doing really well, that could lessen the severity of a recession or financial crisis in the US because there’s growth elsewhere in the world.
The other advantage is, it could lessen imbalances in the US and help reduce trade deficits. It could also incentivize the US to close its spending deficits a little bit because borrowing would be more expensive, so there are some advantages, there are some trade-offs. But basically, we don’t really know because the last time the US dollar was not the dominant reserve currency was before World War II, and the world has changed so much that it’s really difficult to speculate what’s going to happen. That is where we stand today. Let me just summarize what we’re talking about right now. The US is still the dominant reserve currency by a very large margin, and there is no current evidence that another currency is coming along to replace the US dollar anytime soon. There definitely will be people trying. That seems evident that other countries are going to try and increase their influence as a reserve currency, but those contenders seem to have a long way to go.
To me, and this is just my gut feeling, this is just after studying this for a couple of weeks, my gut feeling is that it does seem likely that the USD will probably lose some share as a global reserve in the coming years, given that other nations have stated their intention to reduce their dependence on the USD. But this doesn’t necessarily mean that the US dollar will be replaced as the number one currency. It just basically means that there might be some more parity. We don’t know how bad or maybe good that might be right now because it’s just something that hasn’t happened in so long.
But I think the comforting thing to me is that it will probably happen slowly if it happens at all, so there will be time for the global financial system to react. The reason I think this is because right now there just isn’t really a good contender challenging the US dollar in a real way, and until one gains momentum, it just doesn’t seem like this is going to be a pressing issue. But of course, that can change. Now that I’ve learned about this, I find it fascinating. It’s something I’m going to be following into the future, and I will certainly update you all if there is anything that comes up that you should know about.
Thank you all so much for listening. We appreciate it very much. If you have any feedback about this, please hit me up on Instagram, where I’m @thedatadeli. You can also send requests or ideas for shows there as well. If you like this particular episode, please share it with a friend. Share it on social media. We’d love for you to help us spread the word about On The Market and help other people just like you better understand the housing market and better understand the economy. I’m Dave Meyer, and I’ll see you again next time.
On The Market is created by me, Dave Meyer, and Kalin Bennett, produced by Kalin Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jindal. A big thanks to the entire BiggerPockets team. The content on the show On The Market, are opinions only. All listeners should independently verify data points, opinions, and investment strategies.
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Housing inventory still near record lows
We only have 2.6 months’ worth of housing inventory in the U.S. after coming off the single biggest home-sales crash year in history. That is where we are today in America. As expected, existing home sales fell from February to March since the previous month’s report was intense.
We have a workable range for 2023 sales in the existing home sales market between 4 million and 4.6 million. If we are trending below 4 million — a possibility with new listing data trending at all-time lows — then we have much weaker demand than people think. Now if we get a few sales prints above 4.6 million, then demand is better than the initial bounce we had earlier in the year.
To get back to the pre-COVID-19 sales range, we need to see existing home sales trend between 4.72 – 5.31 million for at least 12 months. That isn’t happening. We are working from a low bar, and as I have stressed over the years, it’s sporadic post-1996 to have a monthly sales trend below 4 million. In the chart below, with the red lines drawn, you can see how different the sales crash in 2022 was compared to the last two times rates rose and sales fell.
From NAR: Total existing-home sales – completed transactions that include single-family homes, townhomes, condominiums, and co-ops – fell 2.4% from February to a seasonally adjusted annual rate of 4.44 million in March. Year-over-year, sales waned 22.0% (down from 5.69 million in March 2022).
Last year we had a significant sales decline for the existing home sales market, which got worse as the year progressed. When looking at year-over-year data for the rest of the year, we have to remember that the year-over-year sales declines will improve just because the comps will get easier. That will pick up speed toward the second half of 2023 and we could see some positive year-over-year data toward the end of the year.
NAR: Year-over-year, sales waned 22.0% (down from 5.69 million in March 2022).
One aspect I didn’t like to see in this report is that the days on market fell and are back to under 30 days. This is the reality of our world: total active listings are still near all-time lows and demand so far has been stable since Nov. 9, 2022.
As we can see in the data below, the days on the market fell back down to 29 days. I am hoping that it doesn’t go lower than this. For some historical context, back in 2011, this data line was 101 days.
NAR: First-time buyers were responsible for 28% of sales in March; Individual investors purchased 17% of homes; All-cash sales accounted for 27% of transactions; Distressed sales represented 1% of sales; Properties typically remained on the market for 29 days.
When I talk about stabilization in demand since Nov. 9, I am looking at purchase application data since that date, and — excluding some holiday weeks that I don’t put any weight on —we have had 15 positive prints versus six negative prints in that time. So, while the chart below doesn’t look like what we saw in the COVID-19 recovery, it has stabilized.
I put the most weight on this data line from the second week of January to the first week of May. After May, traditionally speaking, total volumes usually fall. Now, post-2020, we have had three straight years of late-in-the-year runs in this data line to mess everything up. However, sticking to my past work, I have seen eight positive prints versus six negative prints this year. So, I wouldn’t call this a booming demand push higher, just a stabilization period using a low bar.
NAR: Total housing inventory registered at the end of March was 980,000 units, up 1.0% from February and 5.4% from one year ago (930,000). Unsold inventory sits at a 2.6-month supply at the current sales pace, unchanged from February but up from 2.0 months in March 2022.
Total housing inventory, while up year over year, is still near all-time lows, and monthly supply is also up year over year. However, as we all know, housing inventory reached an all-time low in 2022, so you need context when talking about the year-over-year data. As we can see below, from 2000, total active housing inventory rose from 2 million to 2.5 million before we saw the massive stress spike in supply from 2005 to 2007.
The NAR data looks a bit backward, so if you want more fresh weekly data, I write the Housing Market Tracker every week on Sunday night to give you that information.
One thing higher mortgage rates have done for sure is that home-price growth is cooling down noticeably since the big spike in rates. That growth isn’t cooling as much as I would like, tied to my years 2020-2024 price-growth model for a stable housing market. However, I will take what I can get at this point.
NAR: The median existing-home price for all housing types in March was $375,700, a decline of 0.9% from March 2022 ($379,300). Price climbed slightly in three regions but dropped in the West.
The most shocking data we have seen in the housing market since the big crash in home sales is how low inventory still is in the U.S. — except for those reading HousingWire or listening to the HousingWire Daily podcast.
Remember, inventory channels are different now because credit channels in the U.S. are different post-2010. Also, demand has stabilized since Nov. 9, so when we talk about housing in the U.S., let’s use the data that makes sense.
Stable demand, low housing inventory, and no forced sellers are why we created the weekly Tracker, to focus on accurate data and what matters most to housing economics and the U.S. economy.
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Opinion: ADU buyers are adjusting to new landscape
Accessory dwelling units, or ADUs, saw a surge in popularity during the pandemic, when rock-bottom interest rates stoked the skyrocketing interest in adding elbow room for everything from home offices to fully appointed living spaces.
But the pandemic is now over and interest rates are way up. So, what’s happening with ADUs now? The short answer: a lot. But the landscape is changing, and ADU buyers (and ADU builders and makers) are adapting to it. Here are a few of the key trends we’ve been watching.
Customers are interested in going bigger
ADUs still max out at about 1,000 square feet, so “big” is, as always, a relative term. The interest in the smaller structures that were hot sellers during the pandemic has ceded ground to a surge in inquiries about ADUs with bathrooms, kitchenettes and the full suite of HVAC, plumbing, and electrical service.
Increasing costs associated with higher interest rates are, however, tapping the brakes on conversions to sales of these full-featured ADUs, and that’s understandable. In early 2022, people were locking into 3% and 4% interest rates. Now those numbers are more like 8% or 9%.
For a fully appointed, $240,000 ADU, a 30-year loan with an 8% interest rate costs over $600 more per month compared to the same loan with a 4% rate. The sharper focus on cost is now boosting interest in modular factory-built ADUs, which tend to be less expensive and faster to build than custom onsite construction.
Still, an ADU is a big investment, and potential customers are thinking harder before pulling the trigger. All that said, ADUs still pay off for many homeowners – it just depends on the ROI of a specific project.
ROIs are tough to calculate, but there are rules of thumb
Look around the web and you’ll find that ROI estimates (and rules of thumb to help estimate ROI) for ADUs are all over the place.
A Porch.com study found that homes with ADUs are, on average, priced about 35% higher than those without ADUs. Homelight surveyed real estate agents who found ADU ROIs to be neutral to negative, depending on the location. Assuming the ADU is a full-time rental, Symbium estimates that the ADU owner’s property value will increase by 100 times the monthly rent on the ADU.
While many customers are interested in adding an ADU for full-time rental, most seem keen on developing a flexible space for personal use as private, detached quarters for visitors and a short-term rental when it’s convenient for them.
The majority don’t plan to rent out their ADUs full-time, so let’s use the ADU cost as a foundation for estimating return.
All-in, ADUs typically cost about $400 per square foot – and that includes site work, the foundation, utility hookups, and so on, according to our estimates. We’ve also found that, in the eyes of real estate markets, a detached ADU’s floor space adds to the total square footage of the main dwelling. We’re also seeing the greatest interest in ADUs in neighborhoods with real estate values in the $600 to $800 per square foot range.
So from the narrow perspective of short-term real estate valuation (that is, excluding potential rental income), you’re looking at 1.5x or better ROI in those markets. Conversely, if you live where real estate goes for less than $400 a square foot, you may see a flat to negative ROI.
Permitting is getting easier, but there’s progress to be made
City leaders are now familiar with ADUs’ potential to address a longstanding, stubborn nationwide urban housing shortage – particularly when it comes to affordable housing. The list of urban centers that have embraced or are in the process of embracing ADUs is long and growing (see Denver, Austin, Los Angeles, and Seattle as examples).
In broad geographic terms, ADU hotbeds, such as California and the Pacific Northwest, are being joined Colorado, the metropolitan Washington, D.C. area, North Carolina, and Georgia. More liberal ADU zoning is playing a role in all of these places.
Zoning is, as a national trend, liberalizing, with housing-starved cities leading the way. But cities consist of neighborhoods, and the acceptance of ADUs can boil down to a neighborhood’s or homeowners association’s delineation of parking, setbacks, and other requirements.
The often hyperlocal nature of ADU permitting can act as a deterrent to potential ADU buyers, who lack the expertise (or the time and energy) to navigate the regulatory maze. ADU builders are stepping into the void as part of another trend.
ADU builders are working toward a turnkey vision.
To build an ADU is to build a small house. That involves permitting, financing, and managing all the details related to the physical infrastructure: surveying, grading, foundation work, tying in electrical and plumbing lines, and so on. There are many moving parts.
Most people interested in building ADUs have jobs to be able to afford them. However, they’ve got limited time to digest and work the details.
Leading ADU builders are establishing in-house teams and networks of external partners to help customers get ADUs built with minimal time and effort. That includes offering competitive financing, tracking the vagaries of local permitting and then helping customers through the permitting process. And, in the case of manufactured ADUs, the teams are vetting local contractors and packaging third-party bids for onsite work. The vision is to offer customers a hassle-free (or at least minimal-hassle), turnkey ADU-construction process.
That vision is still under construction, so to speak. But for homeowners and the cities and towns they live in to reap the many rewards that ADUs promise, it’s one well worth pursuing.
Jeremy Nova is the founder of Studio Shed.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the editor: sarah@hwmedia.com
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Mortgage apps decline as first-time buyers pull back from the market
As the banking crisis stabilized last week, mortgage rates increased, reducing borrower demand for home loans. However, with limited for-sale housing inventory, these higher rates are primarily challenging for potential first-time homebuyers.
Overall, mortgage applications fell last week by 8.8% from one week earlier on a seasonally adjusted basis, per the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey.
This was a reversal of the previous week’s trend, when homebuyers’ loan demand increased by 5.3%. The MBA survey, which has been conducted weekly since 1990, covers over 75% of all U.S. retail residential mortgage applications.
“Last week’s increase in mortgage rates prompted a pullback in application activity. With more first-time homebuyers in the market, we continue to see increased sensitivity to rate changes,” Joel Kan, MBA’s vice president and chief economist, said in a statement.
The MBA survey shows the average interest rate for 30-year fixed-rate mortgages with conforming loan balances ($726,200 or less) increased to 6.43% from 6.3% last week. Rates on jumbo loans (greater than $726,200) rose to 6.28% from 6.26% on a weekly basis.
Regarding the jumbo space, the spread between the jumbo and conforming 30-year fixed rates widened slightly last week to 15 basis points, tighter when compared to the past year, according to the MBA data.
“As banks reduce their willingness to hold jumbo loans, we expect this narrowing trend to continue,” Kan said.
At HousingWire’s Mortgage Rates Center, the Optimal Blue data shows rates at 6.50% on Tuesday for conforming loans, up from 6.39% the previous Tuesday. Rates for jumbo loans increased to 6.62% from 6.48% in the same period.
“Banking stress in the markets have gone away, so the bond market just bounced higher from a key technical point,” Logan Mohtashami, HousingWire’s lead analyst, said. “As long as the economy stays firm, we will bounce back and forth on rates.”
Loan types
The MBA data shows that purchase apps declined by 10% from one week earlier on a seasonally adjusted basis, and refinancings were down 5.8% in the same period. Refis comprised 27.6% of the total applications last week, up from 27% the previous week.
Meanwhile, mortgage apps declined by 6.9% in the conventional market, but decreased by 14% in the government space.
The Federal Housing Administration (FHA) share of total applications increased to 12.7% last week from 12.3% the week prior. The U.S. Department of Veterans Affairs (VA) share fell to 11.7% from 12.8% in the same period. The U.S. Department of Agriculture (USDA) share remained unchanged at 0.5%.
“Affordability challenges persist and there is limited for-sale inventory in many markets across the country, so buyers remain selective on when they act,” Kan said. “The 10% drop in FHA purchase applications, and the increase in the average purchase loan size to its highest level in a month, are other indications that first-time buyers have pulled back.”
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New American cofounders talk expansion, prospects for 2023
In a cyclical mortgage industry, hedging is key to maintaining a buffer against losses. For New American Funding (NAF), the country’s 33rd-largest mortgage lender, hedging is how the company was able to manage through the troughs of the mortgage business cycle, Rick Arvielo, co-founder and CEO of NAF, said in an interview with HousingWire.
“We’re always looking for hedges,” Arvielo said. “The outside distributor retail is a hedge against the call center in the different environments. Servicing is a hedge against origination.”
Since launching as a call center in 2003, the California lender has expanded into the outside distributed retail model with a target on the purchase mortgage market, serviced its own loans and developed its tech stack in-house.
But there have been rough points for the lender recently, too. As rates increased in 2022, the California lender laid off nearly 1,000 staff to cut costs and meet shrinking demand in the industry.
However, NAF said it is done with rightsizing and has been adding more employees this year. When rates start to trend down, the company expects to add more loan officers, call center staff and operation staff.
With increased M&A activity in the industry, NAF hasn’t ruled out the possibility of acquiring a regional lender with an established customer base, either.
“Yes, I’d love to acquire a smaller, independent regional player (…) Anything in the Northeast, kind of above the Carolinas, we really don’t have anything. The northern part of the United States – you get above the Arizona, Colorado market – we don’t really have much there,” Arvielo said.
Read on to learn more about New American Funding’s business model of outside distributed retail, their in-house tech stack rebuild, its expansions plans and prospects in 2023.
This interview has been condensed and lightly edited for clarity.
Connie Kim: NAF’s business model of a call center and the outside distributed retail business seems like a hedge against when the rates are low and when the market pivots to purchase mortgages. Now that the market has turned, do you see any challenges for your purchase call center agents? Because there are retail LOs building that in-person relationship with their real estate agents and financial advisors.
Rick: The way people purchase homes is going to be different tomorrow than today (…), so we developed a network. When we get a borrower that comes in online, we do our good work to get them qualified to buy a home – these are mostly early stage buyers.
That referral process is an age old, where the real estate community will give up a third of their commission for being delivered a qualified, pre-approved borrower that came out of the relocation world. The borrowers became more sticky with us, (and) then we were able to accomplish profitability to originating the purchase business through the call center.
That journey took about two years. We dabbled under the hood from mid-2016 to about mid-2018, and then really started to perfect it. And that’s why that business is bigger today than the refi call center, because rates are higher, so you don’t have a lot of refi opportunities.
Kim: So the model focuses on connecting the retail LOs and the call center agents together to bring up that efficiency to target the purchase market. It’s a different audience that NAF is targeting via the outside distributed retail channel and the purchase call centers.
Rick: Yes. If I could just add one little bit, we took it a step further. We realized through our analysis that a lot of these borrowers, even though they started the journey online, they really want to work with an in-market agent. The call center is going to be the in-market agent’s best friend.
We set up a program called LBC – which is local buyer connect, where an in-market agent can choose to join the purchase call center for a percentage of their business.
Kim: NAF bought Marketplace Home Loans in 2018. Are there plans to acquire a regional purchase lender?
Rick: I would love to take looks. It’s not something that we’ve really done. We’re in the process of talking to some of the business brokers out there to get some looks.
Anything in the Northeast, kind of above the Carolinas, we really don’t have anything. The northern part of the United States – you get above the Arizona, Colorado market – we don’t really have much there.
Texas is a big one for us. We do a good job in El Paso, Texas. But outside of that, we really don’t have much in Texas.
Florida, we’re okay, but I can see us filling in some geographies there. Nebraska and Louisiana. I could go on with a lot of these states that we just don’t really have a presence in at all. We have almost nothing in Illinois.
So the short answer is yes, I’d love to acquire a smaller, independent regional player, so long as it’s not in a region that I already have well covered with leadership.
Kim: One of NAF’s priorities is on lending to the Hispanic community. While Hispanic homeownership continues to grow, high DTI ratios is a main stumbling block to getting mortgages. What are some of the ways NAF is assessing credit risk for potential Hispanic homebuyers?
Patty: I’ve been underwriting the creditworthiness of Hispanic homebuyers the exact same way since 1994. We pretty much just adhere to Fannie Mae, Freddie Mac and the Department of Housing and Urban Development’s guidelines. You know, we’ve had to argue some points with every agency at some point. We still do a large percentage of manual underwrites.
Part of the process of the way we credit underwriting is that if we do hit a stumbling block, it’s not an automatic denial [for us]. We go back to the borrower and ask if they have a cosigner, if they can source the downpayment or if they can get additional funds. So it’s really just a slow play to close. A lot of lenders don’t want to do that.
Rick: It does deserve noting that Patty started the initiative for Latino lending back in 2013. But in 2016, Patty was challenged when was speaking one time from a Black gentleman who said, “What are you doing for African Americans?”
We’re basically replicating what we did in the Latino communities that got us a little bit of notoriety.
Kim: NAF has been building its in-house tech stack since its inception. Can you share some of the features that paid off? What are some of the features that NAF is building?
Rick: We built our system out, called Bank Review, but it’s 20 years old. It’s a flat system. Architecturally, we needed to essentially start over, and we couldn’t really do it with the resources onshore.
We decided to bite the bullet and actually form our own business in India. We literally did it from scratch [in March, April 2022]. We got an office and we currently have about 100 technicians in India.
They’re a lower-cost provider and we still have our onshore teams, because that’s absolutely vital to success. Now we’re going back through our tech stack, and we’re literally rebuilding it from the ground up, to be able to take us for the next 20 years.
Kim: It was a hard year for the production side, but what really kept a lot of lenders stay afloat was the servicing sector. NAF has been servicing its own loans. How did that help your firm’s business? Are there any plans to sell some of that?
Rick: We’re always looking for hedges, so it was very intentional to build this asset. When you start bringing a lot of African American and Latino borrowers into your servicing, we started with subservicers like everybody else. But they’re not equipped to deliver the level of service that those borrowers need.
We would have endured losses like everyone else had we not had the servicing business, because it’s a $65 billion servicing portfolio at this point. So it does throw an awful lot of cash. And the last thing in the world I want to do is to spend all the money I’m earning in servicing, but that’s why we did it. We did it to give ourselves that hedge.
We’ve been servicing our loan for maybe six years now, and we have sold servicing just to raise cash. We sold a grand total of about $3 billion out of $65 billion, and that’s a cumulative of what we sold going back years.
Kim: I believe it was in November 2022 when NAF said it laid off more than 900 employees. Were there additional layoffs in 2023? Is NAF done rightsizing?
Rick: I think we’re probably done rightsizing. You lose people through attrition, too. That’s very common, especially in a call center.
We haven’t had layoffs for this year. We were knocking on the door of 5,000 employees, and I think we’re probably at about 3,600 or so.
Patty: We’re actually up this year in employee headcount. We’re growing quite a bit. There are support staff that come along with them (loan officers). So bigger teams or a team will bring their operations people.
I would say that out of the last 11 years we’ve been doing distributed retail, outside of just initially growing and how crazy it was, this is the busiest I’ve been in recruiting since then.
Kim: I often hear that mortgage volume will be similar to last year, but more back-end loaded. What are your thoughts on this for NAF’s origination volume?
Rick: I wouldn’t say it’s going to be anything like last year. I think what you’re going to see in 2023 is a gradual rise; I don’t think it’s going to be big pops. My biggest concern, to be honest, is inventory.
Inventory is lighter now than I think it’s been in decades. Part of that is because of the government not letting foreclosures happen. There’s a foreclosure process for a reason. It feeds inventory to the market that benefits the new first-time homebuyers. If you don’t let that dam kind of break, all you’re doing is hurting the new family formation and the new homeowners of tomorrow.
The minute rates drop into the fives, you’re going to see real estate activity heat up, and you’re going to see house prices just start to pop again.
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MISMO to launch working group to create eHELOC standards
MISMO, the real estate finance industry’s standards organization and a subsidiary of the Mortgage Bankers Association, plans to launch a working group that will create standards for Electronic Home Equity Lines of Credit (eHELOC).
The launch of the working group comes at a time when HELOCs are an increasingly popular choice for homeowners who want to tap into their home’s rising equity while protecting their existing low mortgage rates.
Given that HELOC organizations are more streamlined than closed-end lending, there is greater importance for the adoption of electronic closing documents, MISMO said last week, calling for participants to join a new development workgroup (DWG).
“The new eHELOC DWG will collaborate with industry participants, government agencies, and other stakeholders to complete the analysis to determine eHELOC standard feasibility and prepare a roadmap of artifacts that would be needed to standardize this across the Digital Mortgage ecosystem,” David Coleman, president of MISMO, said in a statement.
The working group will consider high inflation and elevated rates in the development of the product, MISMO said. Meetings will be conducted regularly via conference call.
Unlike closed-end eNotes, which have limitations on the substance of the note, eHELOCs are not “negotiable instruments,” so they contain more, and greater variation of, substantive terms, according to MISMO.
Standardizing these electronic closing documents, as a result, would allow for increased interoperability of HELOCs – easing the onboarding process as the assets are sold or transferred between parties.
While HELOCs continue to set the stage as flexible products that provide quick access to financing for a multitude of uses, including home renovations, debt consolidations or emergency purchases, severe contraction across the lending industry in the fourth quarter of 2022 affected HELOCs in terms of origination volume.
The volume of HELOC loans declined by 17% to $60.1 billion in the fourth quarter of 2022 from the previous quarter’s $72.3 billion, ATTOM, a real estate data provider, reported. However, fourth-quarter origination volume was still up by 27.4% from $47.2 billion in Q4 2021.
Overall, HELOCS accounted for 20.7% of all loans in the fourth quarter of 2022, nearly five times the 4.6% level from the first quarter of 2021, ATTOM reported.
Depository banks have dominated home equity lending for years, but nonbank lenders seeking volume are increasingly targeting HELOCs. Among the nonbanks that either have or plan to introduce HELOC loan products are United Wholesale Mortgage, Rocket Mortgage, Guaranteed Rate, loanDepot and New Residential Investment Corp. (rebranded as Rithm Capital).
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Opinion: The little things mean a lot in mortgage operations
While a mortgage business’ battle against margin compression is seemingly endless, that fight is less noticeable in times of surging revenue. This year, thus far, has been anything but that. The decline in mortgage volume, along with increasing rates and uncertainty about the months ahead, have amounted to a scramble for revenue and a continual push to reduce expenses.
For most businesses, the focus on cutting costs has centered around a few main areas. Staffing and service levels have been the most obvious casualty, as layoffs and job cuts have become prevalent. Mortgage firms have also focused on becoming more efficient and reducing other types of overhead, including fixed costs, like office space, and travel budgets or similar items.
Automation is not the only answer
In a break with traditional behaviors during down cycles, many mortgage businesses have continued their drive toward automation, albeit selectively, and perhaps slowly. However, it still appears that lenders are focusing their technology investments on the point of sale.
This comes as no surprise. There is ample data to suggest that consumers want speed and convenience in the origination process. A 2020 ICE Mortgage Technology survey confirmed this, reporting that 58% of borrowers were affected in their decision making by the presence (or lack thereof) of an online application.
In addition, 55% of homeowners reported that a “simpler application” process was greatly appreciated. That same survey found that 99% of lenders believe technology can improve the application process, and 74% believe tech could simplify the entire mortgage process.
Lenders are increasingly seeing a transformed “big picture.” But it still appears that the emphasis is on the big systems — with the focus on Point-of-Sale (POS) and Loan Origination System (LOS) technology especially. And yet, there are numerous smaller things in the established mortgage production process that add up to a huge opportunity to speed the transaction and reduce costs.
The refinance wave of 2020 and 2021 made clear that the various leaks and clogs in the operational process can grease the skids toward leaving money on the table. This happens by and large when multiple 3rd party vendors become involved or when the process is managed (or handed off) manually.
In slow or even healthy purchase markets, these points can put a lender at a competitive disadvantage and constrict margins unnecessarily.
The little things that can mean a lot
In the typical mortgage workflow, there are multiple points where more lenders could redirect their focus for greater efficiency — and that efficiency need not come from technology investment alone. In fact, if a system doesn’t fit a workflow properly or delivers redundant or unnecessary features, technology can even further burden the operation.
However, whether it be through improved QC; a reshuffling of staffing; use of a more efficient third party provider; better operating policies or training; or, yes, the use of proper technology, too many lenders and mortgage-related businesses have yet to address and receive the full benefit of improving a number of “little things” in their operations.
These points of focus include data collection and entry at any stage of the process. They could also include improving the post-closing process. Customer service and communications between partners, vendors and clients could also be brought forward light years through any number of means.
Vendor management, be it in the valuation, title insurance or closing process, offers a number of opportunities for increased efficiency and decreased cost. And don’t forget TRID-related procedures — many of which were cobbled together on the fly during the chaos following a short implementation period mandated by regulation.
By the numbers: How much the little things can cost
A case study of TRID-related processes can demonstrate how much fat remains to be cut in the name of improved margins and increased efficiencies. And, in particular, closing fees.
Many lenders and originators spend little, if any, time thinking about how they gather accurate closing fee data, such as transfer taxes or recording fees, even though these vary from state to state, county to county and even city to city. And yet, numbers quoted inaccurately on the LE could lead to curative penalties.
These can, and do, add up.
While this industry has a significant dearth of accurate and deep data — at least at the public level — the Federal Reserve’s Consumer Compliance Outlook found in 2020 that inaccurate closing cost details and cash to close calculations were one of most common lender TRID violations.
Even the Consumer Finance Protection Bureau (CFPB) has acknowledged that TRID adversely impacts the operational costs of lenders.
While the TRID data available to the public is almost non-existent, some estimates suggest that as much as 90% of the mortgage loans produced have some form of TRID violation. And let’s not forget that TRID violations — apart from curative fees for mistakes or inaccuracy — can range from fines of $5,000 to $1,000,000 per day in extreme cases.
Setting those penalties aside, we wanted to know how much lenders paid in curative fees as a cost for their operational inaccuracy or inefficiency. To find out, we polled dozens of mortgage lenders in 2022 and compiled the results.
We were surprised to learn that the average cures per file for those who manually researched and updated their fee data was $40 to $80 per file. After installing improved processes to address their closing cost quotes, the same lenders reported improvement, with the averages dropping to $20–$40 per file.
We also determined that lenders using effective closing fee technology averaged one inaccuracy requiring a cure out of every 22,000 fee estimates or quotes.
Finally, we know that the average time to close remains above 50 days. This also represents costs ripe for improvement across the board. Much of that delay starts with the little things: the time between voicemails between a loan processor and title agent; the time it takes for an appraisal report to be produced; the time (and possibility of error or inaccuracy) it takes to find an order that’s been emailed and type it into the production system. And yes, the time and cost associated with manually determined closing fees.
Now, more than ever, the little things are adding up for lenders. But they also provide an incredible opportunity to improve the way the industry does business going forward.
Jim Paolino is the CEO & Co-Founder of LodeStar Software Solutions, HousingWire Tech 100 company.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the author of this story: Jim Paolino at jpaolino@lssoftwaresolutions.com
To contact the editor of this story: Sarah Wheeler at sarah@hwmedia.com
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