This Is What 7% Mortgages Will Do To the Housing Market

Episode Summary

Executive Summary: The episode examines why the U.S. housing market is behaving unlike past downturns: mortgage rates have surged, affordability is at record lows, and sales are slowing sharply, yet prices may not crash because most homeowners hold fixed-rate mortgages and are locked in at low payments. The discussion focuses on inventory shortages, tight credit, demographic shifts, and how MBS market mechanics are pushing mortgage rates above Treasury yields.

Main Topics: Why this housing cycle is unusual (Priority: 5/5): Jim Egan argues that several key housing indicators are at unprecedented or multi-decade extremes, especially affordability, mortgage-rate acceleration, and sales weakness. The lock-in effect and fixed-rate mortgages (Priority: 5/5): Because over 90% of outstanding mortgages are fixed rate, existing homeowners are insulated from higher rates and are reluctant to sell, limiting forced supply. Inventory as the main determinant of prices (Priority: 5/5): The conversation repeatedly returns to supply: low listings, limited distress, and underbuilding support prices even as transactions fall. Why the market may avoid a 2008-style crash (Priority: 4/5): Unlike the GFC, there are few adjustable-rate resets, credit quality is strong, and distressed sellers are scarce, reducing foreclosure-driven price pressure. Mortgage-rate mechanics and MBS market structure (Priority: 4/5): Mortgage rates are rising faster than Treasuries because MBS investors are short volatility and major buyers such as the Fed and banks have stepped back. Demographics and household formation (Priority: 3/5): The episode explains how millennials and Gen Z drive demand through headship rates, while boomers may eventually become a source of supply. Homebuilding and renovation response (Priority: 3/5): Builders are likely to slow production despite structural underbuilding, while locked-in homeowners may instead spend on renovations or improvements.

Key Arguments: Housing affordability has deteriorated faster than in any period the speakers and guest could find, even worse than the GFC comparison period. The current market is different from 2004-2007 because most mortgages are fixed rate, so existing owners are not seeing their payments reset upward. The 'lock-in effect' keeps current owners from selling because moving would mean taking on a mortgage 200-300 basis points higher. Home prices can hold up even if sales volumes fall sharply, because tight inventory prevents enough distressed transactions to force a broad price collapse. True price weakness would likely require forced sellers, unemployment shock, or rising foreclosures; those conditions are not present now. Mortgage rates are elevated relative to Treasuries because MBS investors face high volatility and fewer buyers, especially with the Fed in QT and banks pulling back. New home construction is constrained by a backlog and a likely pullback in starts, despite long-run underbuilding estimated in the millions of units. Demographic demand remains important, but the biggest near-term risk to prices is an unexpected increase in supply, especially from older homeowners selling sooner than expected.

Data Points: Mortgage-rate increase: Over 300 basis points since the beginning of the year - Used to describe the jump in mortgage borrowing costs driving affordability deterioration Monthly mortgage payment: Up over 50% year over year - On the median-priced home, before accounting for incomes Income-adjusted monthly payment: Up 46% year over year - Affordability calculation including incomes GFC affordability deterioration: Never exceeded 30% year over year; capped in the 20s - Compared with the current cycle’s much larger shock Fixed-rate mortgage share: Over 90% of the outstanding mortgage market - Key reason current homeowners are insulated from rate hikes Existing-home listings: Never lower than earlier this year in data back to the early 1980s - Illustrates historically tight inventory Months of supply: Around 4 months - Total months of supply for existing and new homes, versus total sales pace Seller-market threshold: Below 6 months of supply - Rule of thumb used to characterize a tight housing market Existing home sales forecast: Below 2014 levels in base case - Morgan Stanley forecast for the coming period Home price forecast: Down 3% year over year by December 2023 - Revised forecast reflecting slower sales and weaker forward expectations Case-Shiller monthly change: Negative in July for the first time since 2012 (seasonally adjusted) - Early sign that price growth is turning negative in some markets Metro price declines: About 3-4 percentage points down month over month in some cities - Examples included California, Denver, Seattle, and Portland Homeownership rate: 65% to 66% - Current rate; guest does not expect a return to early-2000s highs Early-2000s homeownership rate: 69% to 70% - Peak levels the guest sees as unlikely to return Housing underbuilt estimate: 2 million to 6 million units - Estimated structural housing shortage Single-family starts: Back to 1997 levels (12-month trailing) - Shows builders have not returned to GFC-era peak construction Units under construction (multi-unit): Back to the 1970s level - Highlights strength in multifamily construction pipeline Boomer-held owned homes: About 33% today, up from 25% in 1980-2012 - Shows a growing concentration of housing stock among older owners Boomer tenure: Roughly 54% moved in before 2000 - Potential source of future supply if aging-in-place changes Refinance activity: Down 90% - Shows how sharply the refi market has collapsed in the higher-rate environment Mortgage spread reference: Mortgage rates near 6.75%-7% - Speaker cites current U.S. 30-year mortgage levels Fed interest-rate outlook: Additional 25 bps hikes at November, December, and January meetings - Morgan Stanley economics team view that reduced expectations for affordability relief 10-year Treasury forecast: 3.75% for mid-next-year - Used to explain continued pressure on mortgage rates

Pivotal Quotes: "The structure of the mortgage market itself is very different today than when we compare it to 2004 to 2007." — Jim Egan: Explaining why the current affordability shock may not produce a GFC-style crash "They are kind of locked in at their current homes at these lower rates." — Jim Egan: Describing the lock-in effect on existing homeowners "What we think you're going to see is a market that kind of stalls out here." — Jim Egan: Summing up the likely outcome: lower sales without a proportional price collapse

Implications: Expect a frozen housing market: fewer transactions, weak refinancing, and tighter affordability, but not necessarily a crash. Prices hinge mostly on whether inventory rises unexpectedly; mortgage-rate mechanics and supply are the key watchpoints.