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Housing Market Crash?


Article by Ken Shinoda: Barrons.com


About the author: Ken Shinoda is a portfolio manager with Jeffrey Gundlach and Andrew Hsu of the DoubleLine Total Return Bond Fund.



In the depths of the pandemic lockdowns, some feared housing price and mortgage implosions on a scale of the 2007-2009 financial crisis. At the time, I wrote that would not be the case. Today, with home prices up over 35% since March 2020 and a rate-tightening U.S. Federal Reserve on the inflation warpath, fears of a housing and mortgage apocalypse are arising anew. In my view, while housing prices might pull back 10% or more in some regions, a nationwide collapse on the scale of the financial crisis remains highly unlikely.


Home prices answer to three masters: supply, demand and affordability. Comparing pre-pandemic to post-Fed panic, I have yet to spot the riders of the housing apocalypse.

Entering the pandemic, supply was low, demand was rising on powerful demographic forces (millennials hitting prime age for household formation), and affordability was high largely thanks to historically low mortgage rates.


Today with inflation the highest in 40 years, the Fed is raising interest rates at a pace not seen since the 1990s. Mortgage rates have more than doubled from their lows to close to 6% last week, a level not seen in over 13 years.

Higher interest rates and home prices have turned affordability from a tailwind in 2020 to a headwind. Mortgage payments as a percentage of median income have jumped to the highest level since 2005.


As if those headwinds weren’t bad enough, the housing market likely is sailing into a recession in 2023. If so, the resulting increase in unemployment would lead to a drop in near-term demand and maybe more supply if job losses compel people to sell homes or to enter foreclosure.


Recession or not, housing activity clearly is slowing. In May, existing-home sales declined 3.4%, building permits 7.0%, from the prior month. Mortgage purchase applications are also well below last year’s levels. New home sales rose 10.7% in May but are expected to decline as rising rates ease housing demand.

Could these readings presage outright regional price corrections on the order of 10% or more? Certainly. In my view, however, a deeper pullback on a nationwide level is unlikely.


The supply of homes remains near historical lows with existing inventory for sale at only 1.16 million and housing starts at only 1.55 million. Combine this shortage with over a decade of underbuilding relative to population growth and the demographic demand from millennials, the second largest generation since the baby boomers. Result: a shortage of both housing to buy and to rent.


To put matters into perspective, existing inventory of homes prior to the financial crisis peaked at 3.89 million in 2007, and housing starts were 1.18 million. By those metrics, around 3 million more homes were on the market entering one of the worst recessions since the end of World War II, leading to a 10% unemployment rate and 2 million foreclosures hitting the market. Demographics were also deteriorating at the time. It was the proverbial perfect storm. Far too much supply, far too little demand.


Indeed, one of the main drivers of the price collapse during and after the financial crisis was the wave of foreclosures. That supply tsunami swamped demand. For years afterward, not even the affordability conjunction of low mortgage rates and low prices could lift prices. Supply was just too overwhelming.


At the time, some borrowers became what was known in the mortgage industry as “strategic defaulters.” With many having put no or little money down on their homes as their properties sank under water, they made a monetary decision to stop paying their mortgage. In many instances, they could walk away and rent the place next door for half their mortgage payment.


But in the years since, underwriting standards improved dramatically. Most mortgages now have mandatory down payments. Furthermore, through the passage of time, borrowers paid down principal. In parallel, starting around 2012, home prices began rising steadily and have accelerated at double-digit rates over the last two years. Today, home equity stands at $27.7 trillion nationwide, its highest recorded level in history. Borrowers won’t walk away from equity. Even in the belly of the financial crisis, borrowers who had more equity in their homes going into that recession exhibited lower default rates than those who had bought at or near the peak with little or no money down.


Rising unemployment rates can lead some homeowners to sell, increasing supply. But another mechanism exists that can help borrowers stay in their homes during tough economic times. Nationwide forbearance programs put in place during the pandemic allowed borrowers to miss payments, remain in their homes and then return to paying their mortgages after a certain period of time with the missed payments largely moved to the back of the loan. Foreclosure starts actually dropped due to these programs. In the event of economic stress, I expect these forbearance programs would be activated again, helping to keep Americans in their homes and stemming price-depressing foreclosure supply from coming to market.


Homeowners shouldn’t be surprised to see a slowdown in housing activity and a drop in home prices. Regions with median income insufficient to sustain median home prices are the most at risk. But a nationwide collapse doesn’t seem to be in the cards thanks to the supply picture and the positive changes in the mortgage ecosystem over the last decade.




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