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Where to start with housing markets? Look around the world and the stories are playing out in different countries at different speeds. Activity is lower, affordability is far worse, but prices are only down a little bit despite... well, everything.
The US market is freezing up, but this is nothing like 2008 because most mortgages are long term fixed now. Sub-prime lending has been curtailed. The same ingredients just aren't in the mix.
But that doesn't mean that higher rates won't cause prices to fall.
A fast recession is needed to 'save' the housing market, because a recession would send rates lower and make housing more affordable. But save it for who...? The housing 'savers' or the next generation?
Housing holds a unique and special place in society. Just buying a bunch of houses and renting them out really shouldn't be an investing (or saving) strategy if incentives are properly priced.
If you invest in companies, the returns are generated by productive activity (most of the time), and an expectation of yield is justifiable. You're a company. I lend you my savings (invest), you use the capital to grow and generate higher returns. Everyone wins.
But low interest rates distorted everything and made investing in government bonds highly unattractive. Housing became that safe investment (with an actual yield) that government bonds were supposed to be.
While you can have some sympathy for anyone who chose to save via property over the last decade or so, it's clearly a 'misuse' of spare capital from a societal perspective.
The following principle still applies, but we've taken it way past the point of democratising wealth 👇
"It was once a given that governments supported home ownership because it is the primary vehicle to democratise the wealth of the nation, minimise wealth inequality and empower families in their working life and retirement"
This graphic (source unknown) captures many of the factors that affect house pricing 👇
On balance then, and being very British, we're all in a spot of bother. Much of societal wealth is tied up in house prices, but home ownership needs to be less concentrated in order to share that wealth around, especially for the younger generations.
It would be nice to adjust gradually, keep prices stable and let wages catch up to home prices and normal interest rates. But it doesn't look like that's going to happen.
If we look at the US, the housing market is starting to loosen, but there are plenty of ways to keep things ticking over and bridge the gap between high rates now and (hopefully?) lower rates in future.
Rate Buydowns 👇
This creates a more competitive market for anyone looking to sell. Cash buyers are back in the driving seat.
Inventories are starting to increase too....
BCA Research note that "US residential fixed investment (home building) has slumped by 20 percent in the past year – a rate of decline that puts it on a par with the major housing recessions of 1990, 1980, 1973, 1965, and 1951" 👇
Housing recessions matter because they are the ‘canary in the coal mine’ for economy-wide recessions. Not all economic recessions follow housing recessions, but most housing recessions presage economic recessions.
Housing recessions are the canary in the coal mine for interest rate induced economic recessions. This is because, just as the canary is hyper-sensitive to toxic gases, housing investment is hyper-sensitive to interest rates.
In the current cycle, housing investment will likely slump from its recent 25 percent overshoot to a mirror-image undershoot. Given that it has already fallen to just below its structural trend, we can expect a further 10-15 percent contraction.
But the US situation is very different to other nations. Take the UK, where the housing market is something akin to a religious institution.
This Goldman Sachs chart shows a key US/UK difference 👇
Most of those US mortgages are long term-fixed (at low rates), while in the UK, they're mainly fixed for 1-5 years.
If prices fall by 10 to 15% in Britain, the media will start a campaign for the government to do something about it. Every daytime chat show will become a variation of this...
It's going to be insufferable. Especially as housing market weakness will likely spread to the rest of the economy...
Goldman explains the three main channels "through which housing affects real GDP growth" (we'll just call it 'the economy')
- (i) lower residential investment
- (ii) a drag on consumption via mortgage affordability
- (iii) wealth effects from lower house prices reducing household spending
(i) Lower residential investment can pass by relatively un-noticed for a while.
(ii) GS: High rates increase mortgagors’ interest payments, reducing their disposable income. Because many mortgagors have low savings balances, they are unable to “smooth” consumption, and their spending responds strongly to changes in income. Savers receive higher interest income, but their consumption is not as sensitive to this change.
Basically, more of your paycheck gets swallowed up by the mortgage payment so you've got less left over to spend in the 'active' economy.
Anyone with excess savings is usually at a point of peak consumption so increases to their income via higher interest rates paid on savings don't incentivise them to spend any more than normal. Aggregate spending drops.
(iii) People feel poorer because their net (paper) worth falls.
Sweden will be an excellent case study and potential 'leading indicator' for the rest of the world as refinancing windows loom larger. The vast majority of Swedish mortgages will need to be refinanced at higher rates this year.
Which implies that disposable income and consumption will fall too 👇
The UK has a slightly longer time buffer to play with. Most mortgages were fixed in the 1-5 year window. Theoretically at least, the adjustment will be more gradual.
Then we take a look down under. The Aussies. Keep in mind what GS said earlier about the housing channel as an important route to slow the economy and reduce spending (and inflation).
Then read this... 👇
The chair of APRA has revealed he is open to changing bank rules on home loans if the Australian economy deteriorates, ensuring banks do not “choke off” credit and upset home prices further.
What the RBA takes with one hand, APRA will give back with the other...?
In Canada, they've got their trigger rate shenanigans to contend with as well 👇
It's a high wire balancing act. Each country has their own somewhat unique challenges to deal with. But the direction of travel remains clear.
An economic slowdown, probably ending in recession later this year as mortgage payments rise and the effects of global tightening really start to bite. The big unknown is if governments will intervene and try to micromanage the downturn.