WE’RE HEARING that the change in interest rates from ever-decreasing to something else—two weeks ago, we learned that weekly mortgage rates jumped the most in a week since 1987—is a short-term phenomenon, but also a long-term one. Washington doesn't recognize yet what this will mean, since most policymakers have never functioned in anything but a declining-rate environment.
How long have rates been falling? A very long time. Thirty-year-fixed mortgage rates have been falling consistently since 1982. Interest rates in general, benchmarked off prime rates, have been coming down since late 1980. Whenever policymakers, whether real estate ones, bond market ones, equity ones, or really any economic type, hit a bump or made a policy mistake, lower rates would bail them out (and by extension all of us) very nicely. But nearly all economists say those days are over, and not just for a few years; some think macro rates move in a single direction every 25-40 years before they reverse. The period from 1950 to 1980 saw a general rise in prime rates. In all probability, we just finished a 30-year down trend.
Note to Washington: the vast majority of our policymakers working today have never seen, or navigated, a rising-rate environment.
Simply put, policy mistakes will not only not get bailed out—they will be gravely compounded. Even assuming no policy mistakes, up-rate turbulence will rule the realm. At the end of June, agency MBS investors saw the worst quarterly damage since 1994. PIMCO’s $268 billion total return fund saw its biggest-ever quarterly loss. And jumbo securitization markets seized up due to the sharpness of the rise. All this was precipitated by a Federal Reserve signaling that the massive buying of GSE MBS might be slowing or, someday soon, headed toward an end. In fairness, the magnitude of the abrupt rate jump was overdone in the near term, and the jumbo market will loosen again. And hedging strategies have become more adept over the years. But make no mistake: rate increases will force difficult marketplace adjustments, and to add insult to injury, economists will almost certainly fall short in their predictions of how quickly rates rise over the next one to five years.
From now on, any legislative or regulatory move that increases costs has to be viewed with greater caution. Even the FHFA g-fee hikes, which have had a clear pathway in a declining rate environment, will receive renewed scrutiny now, especially among Democrat lawmakers concerned with affordability. FHA reform legislation will be scrutinized more carefully. GSE reform legislation will be also, since every option increases mortgage pricing—it’s just a question of how much. Basel III mistakes, too, will be much more costly. CFPB regs, which aren't costless, will need a true cost-benefit approach—something the CFPB should embrace now. And if this all goes in the wrong direction, a major legacy of the current administration will be permanently lost ownership opportunities among those demographics giving the president his largest electoral margins. Republicans wanting to contest anew for the youth and Latino votes (Republican core voting blocs are aging out) will care, too.
Some final, detailed clarity about mortgage money. The macro rate environment will force higher mortgage rates as the economy improves. Then the Federal Reserve MBS program, which will have to end someday, will add additional hikes, even if major new players arrive to soak up this MBS supply (the GSEs are no longer in that game—a trillion dollars have to land somewhere.) The regulatory world is adding another layer of higher prices. And if Washington adds yet another layer of mortgage rate hikes (say, via botched GSE reform) then we'll see mortgage rates no one today can imagine. No one is talking about this. Yet.
OK, but homebuyers can afford this, some say. No one has a right to a 4% mortgage when we, and our parents, had mortgages at 7%, 8%, 9% or higher. True in theory. What has changed, regrettably, is the level of student debt among the young. From a recent Washington Monthly article about the difficulty of young buyers accessing the credit markets:
"According to the Federal Reserve Bank of New York, the total outstanding balance on student loans has nearly tripled since 2004, with roughly 42 percent of 25-year-olds holding student debt."
This means the large echo boom bulge of young people, which might otherwise continue to heal our nation's housing markets, has less ability to take on higher mortgage rates. A 5% mortgage to them might be the same as an 8% or 9% mortgage to a prior generation. They can rent? Sure, millions of them will have no choice, and will vie with each other for the rental units. Anyone remember what many considered to be housing's most pressing problem during the 1980s, before lower rates ameliorated it, an early salve of the just-ended 30-year trend? Rising rents that trapped families and sapped their limited budgets.
Except now the price elevator will keep going up. Welcome to your brave new world.
Rob Zimmer is with the Community Mortgage Lenders of America.