Jim Egan on the Mortgage Gap That's Dividing America

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1:53Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, there's been this very long running now, it feels, conversation about the health of the American consumer. Yes. You've seen all that commentary, right? So you see these headlines that are like consumer debt at a record high. And you see some of the sentiment surveys, which have for the past two years been coming in pretty bad. They started to look kind of bad when all the tariffs were announced again. They've improved a bit since then. And yet, consumers seem to, you know, pretty much keep doing what they've been doing for a long time, which is spending, buying houses, things like that.

2:33Well, they're spending for sure. But this is the thing. There's all this dismal sentiment data everywhere you look. And yet, by and large, you know, you read like CEOs, you look at the retail data, et cetera. It's not like that terrible. Companies seem to be doing fine. But there are pockets of the economy clearly that are softening. There is rising inventory of homes. This is like one of the huge stories in the economy. So there are clear areas where high rates and stuff are having an effect. But to your point, like it has not been some sort of linear story of people are depressed and the economy is falling.

3:06But you're right. We have seen some signs of softening. And so, you know, we have to ask, is it going to be different this time? Is it the start of some sort of real deterioration in the health of the U.S. consumer? I have also seen some very interesting stats recently, specifically about consumer lending and mortgages and things like that. I've seen, for instance, that existing home sales are down 1.9 % year to date and have recorded the lowest volumes by count at this point in the year since 2009. And when you hear those, you know, since 2009 dates, you start to get a little worried, right? This is definitely the case.

3:46I saw something, I think it was from Redfin. They said there was a record gap between sellers and buyers in the housing market right now. Look, this is one area where the high rates environment, like there's clearly something going on. We haven't gotten like big, you know, and rates shot up in like late 2021 or whatever that was. Do you know what, by the way, this occurred to me last night. 2021 is kind of a long time ago now. Like, no, I was thinking about this last night because it's sort of a cliche to point out that the pandemic 2020 was a long time ago. But some of those really pivotal years where we got the surge of the rate hikes, we got the surge in inflation, even that's starting to fade into history a little bit.

4:27I don't know. Maybe just last night I was thinking about getting old. And, Joe, time is a flat circle. That's all I'm going to say. But there's something like, you know, house prices didn't fall off a cliff when rates hiked dramatically, which was a surprise to some. Like some people thought, okay, they're hugging rates dramatically. The housing market is going to be affected. The housing market is the U.S. economy. Therefore, the U.S. economy will fall off a cliff. That did not happen. But there has been this slowdown. And lately, we've been seeing like, okay, like rates are still high. Even with talk of rate cuts, et cetera, they're still high.

4:58And there's clearly this sort of accumulation of household inventory, these imbalances that are emerging. I don't know. Maybe we will get price declines. What's going to happen? Well, I'm glad you brought that up because we actually do have the perfect guest. We're going to be speaking with someone who was very, very correct in calling that we wouldn't see a massive house price. I thought he was wrong. I didn't say it at the time, but he came on the podcast like, we're not going to say. And I was like, there's no way. I'm glad I didn't say this. Why? I never get anything wrong because I don't state predictions because you don't have opinions.

5:25But as a matter of professional accountability, when we were interviewing him in my head, I was skeptical. All right. Well, that's a big mea culpa from Joe. Okay. Without further ado, then we are going to be speaking with Morgan Stanley housing strategist, Jim Egan. He's been on the show quite a few times before. And here's where I produce my disclaimer, which is that stat that I just quoted about existing home sales actually came from one of his recent notes. So Jim, welcome back to the show. Thank you so much for having me back. It's an honor to be here. I'm going to start. Actually, I'm going to go back in time for a second.

5:58Let's just start. Why has the American consumer been so resilient? And it's kind of funny because you see people even talking about it still. So we just had corporate earnings and there was this funny comment from the Amex CEO where he basically said, our card members say they don't have any confidence in the economy, but they keep spending, which is pretty funny to me. But why this strength? Yeah. So I think there are a number of different things driving the underlying strength in the consumer. We do a lot of work across our debt analysts in Morgan Stanley Research with our economists to kind of try to tie these positive macro numbers to some of the things we're seeing on a more micro level.

6:35And look, the unemployment rate, we're at 4.2%, very low unemployment rate. It's been low for a few years now. And on top of that, you've had an incredible amount of wealth growth. There's been volatility in markets recently, but whether it's home prices at record highs and the record amount of equity that homeowners and 65 % of Americans are homeowners, the equity that they have in their home or the wealth they've been able to gain from appreciating financial assets, that's contributed to consumers' ability to spend. This tracks completely with me because I'm anxious about the state of the economy.

7:10I read all the headlines like everyone else. But, you know, like I own a home. I bought a home. I have my retirement account. It seems to be doing fine. Despite my anxiety, I don't think I'm like changing my behavior in any way. And I think another piece to that when we think about just the consumer balance sheet, One of the statistics that gets quoted all the time is the just debt service ratios, the debt service to income. It's above where it was in 2021, but it's still at some of the lowest levels we've seen in the past couple of decades. The capital C consumer, the holistic balance sheet of the consumer, that still looks healthy.

7:43We don't think that the consumer holistically is over levered. There might be some pockets of pressure, but we don't think they're in aggregate over levered. Yeah. So this is exactly what I wanted to ask you. because one of the things that I've been sort of internalizing from recent years is this idea that the aggregate hides a lot of stuff happening in the tails, right? And the question, I guess, is always when the tails start getting fat enough that they start affecting the whole. And this is one reason why your recent research really caught my interest. And I actually wrote it up in the AllBots newsletter.

8:14But you are starting to see some pockets of strain. Describe what you're examining right now. Yes. So thank you for writing that up, visibility was very much appreciated. No, thank you for producing it, honestly. And I think what we're seeing, and this is something as part of my role at Morgan Stanley, I work on the teams that look at auto credit within asset-backed securities, credit cards, all of those other consumer products. And one of the, I'll call it apparent contradictions that we were seeing was the macro consumer data that we were just discussing, incredibly healthy. Consumer keep spending.

8:49And then we're seeing delinquencies climb. Delinquencies climbing with the unemployment rate as low as it was, that was something that we had been asked to explain a fair amount of times. We're trying to find better data to explain. And so the impetus behind that report was to kind of say, look, subprime auto delinquencies have been climbing to a point where they're higher now than they've been at any point. I mean, some metrics they're above where they were in 2008, 2009 at their prior peaks. Now, there are some apples to apples issues there, but you'll see those numbers. Prime auto delinquencies have started climbing.

9:23Unsecured consumer delinquencies are up. They're not at local highs, but they're up. And so from a pockets perspective, we are seeing a little bit of those delinquencies climb. I just want to explain the terms really quickly, but what's the official definition of delinquency? So delinquency, as we're talking about it here, is somebody who is 30 days past due on their loan. So we'll either talk about it in terms of 30 days or sometimes 60 plus days, but you've missed at least one or two payments on a debt instrument, whether that's an auto loan, we'll look at it for mortgages, credit cards, and so on and so forth.

9:59So this is really important though, because in the aggregate, things are mostly fine, but we're seeing this rise across different categories, which is not entirely intuitive. So what you're saying is that there are these tales, there are these sources of stress, but that they're not a function of credit worthiness. What are they a function of? Might not be a function of aggregate credit worthiness. And that's when it comes into looking at these statistics that we need to use to think about just kind of broadly how the economy, how the consumer is going to move forward. But I mentioned debt service ratios, right?

10:33When we think about what's brought debt service ratios down to kind of some of the lowest levels we've seen in decades, the mortgage market plays a big role. The largest piece of debt on any household balance sheet that owns a home is almost certainly going to be that mortgage. And the lock-in effect that we've heard in the housing market, that's a function of the fact that a majority, an overwhelming majority of mortgage debt in this country, 30-year fixed-rate mortgages, most of those borrowers were able to take out that mortgage at historically low rates in 2020, 2021. The effective rate on the outstanding right now, 4%.

11:06Prevailing mortgage rates, 6.8, 6.9 % as we're in this studio today. So when you think about two thirds of the country are homeowners, their effective rates at 4 % are dragging down that payment. Only 60 % of homeowners even have a mortgage. So 40 % own their home free and clear of any debt. They're not contributing to the numerator. And the 35 % of households that are renters, rents don't count as debt service in these equations. They're contributing to the denominator in terms of the income piece of this calculation, but they're not adding to the service piece, right? And, or the debt service piece.

11:39And so that's all helping to drag this down and potentially missing a few pockets of specific borrowers that are under a lot more pressure than those aggregate numbers would suggest. Just to be clear, so is the story that the stress is building basically among the unfortunate people who have a mortgage, but don't have a Zerpia mortgage? I think when we started to see delinquencies climb, and this is two to three years ago, we started to see it subprime borrowers. And those tend to be borrowers who in this post-GFC past 15 years, lending standards have been tighter, more likely to be renters. We're not capturing rent.

12:16And so their payments are getting tougher. But then to your point now, over the past 12 to 18 months, now prime delinquencies are moving higher. These are households that are much more likely to be homeowners. And what we think we're seeing there is exactly the dynamic you're talking about, If you bought a home prior to 2021, let's say you bought in 2016, median priced home, 20 % down, prevailing mortgage rates at the time, that was a 30-year fixed rate mortgage. Most homeowners who bought at that time refinanced at record lows in 2020, 2021. And if we just assume that their incomes have been growing along the levels that median household incomes have been growing for the past 9 to 10 years, their monthly payment as a share of their income is 8 % to 9 % today.

12:59anybody who bought before 2021, that median household, we think that payment is probably below 12%. If you bought the past three years, as rates moved materially higher, your monthly payment as a percentage of your income, median household, probably 24 to 26%. This is like the most important state in the world. Yeah. This is like you have the haves and have nots of renters versus homeowners, but you also have the have and have nots in homeowners themselves. Yes. And so we think that the Joint Center for Housing Studies at Harvard, right, they have some great statistics on affordability and they will qualify 30 % of your income as the threshold for are you cost burdened on shelter.

13:38So 24 to 26%, we're not saying that those homeowners are cost burdened, but they're spending two to three times more of their monthly paycheck on that mortgage than somebody who was fortunate enough to buy prior to 2021, which you'd think has to be crowding out something. And maybe that's, it hasn't been spending, that's clearly been the case from the data that we talked about earlier, but maybe it's these marginal payments on other debt service products. Thank you.

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16:39And I'm curious if we're still seeing an impact from that particular or as much of an impact from that particular dynamic, or are we at the point now where people are thinking like, well, maybe mortgage rates aren't going down anytime soon. And so I'm just going to bite the bullet and do something new. So if I were to take a 10 ,000 foot view and answer your question, the lock in effect is clearly still playing a role, right? If we look at overall inventory levels as a share of the outstanding housing market, the chart still looks like there's a typo given how low inventories are. But I can't sit here like I have been able to in the past and say, we're at historically low inventories, right?

17:21We are starting to see, to the point that you're making, we are starting to see for-sale inventory volumes move higher. Year over year, inventory volumes are up almost, it's almost 18 consecutive months now, almost a year and a half. They're up almost 20 % from those lows. And while that's still below where we were in the fourth quarter of 2019, below where we were when rates picked up massively and inventories kind of retrenched, That's still a pretty healthy increase where we're starting to see a little bit more supply come on the market here, despite the fact that the lock-in effect remains 250.

17:54Who's selling? Is it just eventually like, what is the source of the inventory? Is it that people who have needed to sell for a while are finally capitulating and you know what, I finally got to sell this house? Is it that there are some marginal buyers who have dropped out because they've been waiting? I don't know. What is the source of this inventory? And this is the longest inventory growth since the GFC, right? It's the highest percentage change when I look at year-over-year growth. Okay. Like what we just saw with the most recent data that came in, it's now the biggest it's been on a year-over-year basis since the GFC.

18:24It's also the second largest it's been in the history of the data, which goes back to the early 1980s. The second largest what? Streak? A year-over-year growth. Oh, okay. Like just in terms of how much we're up. Now, the question as to who is selling, I'd argue probably one of the more important questions in the housing market right now. Yeah. So it's a question we're trying to answer, but it's one that's a little bit more difficult to answer. We can identify at this point where the inventory is picking up more, right? You look in states like Florida has some of the steepest increases. Texas has had some pretty steep increases and we get a lot of questions, for instance, in Florida, cost of insurance increasing?

19:07Are the ancillary costs of homeownership? Is that forcing inventory? We don't know if that's the case. We can't empirically prove that right now, but I think you combine that with 2021 was a long time ago. Yeah. This was my realization last night that actually 2021 was not yesterday. Yes. And these people have been, the lock and effect has had people stuck in their homes in a lot of instances for probably longer than they wanted to be. Growing families, both in terms of number of children as well as larger children, like just growing needs for more space. If those, for lack of a better word, if those dreams have been delayed, like maybe the realization that rates might not come down all that much.

19:45Maybe it's time to do that. And home prices are up 50 % since March of 2020. Like over the past five years, you have a 50 % growth in home prices. It's insane. Like perhaps those homeowners with that equity might be just a little like marginally more willing to list. Yeah, the economics make a little bit more sense. Yeah, this is right. Yeah. Wait, can you talk a little bit more since we're all about digging into the aggregate and finding the different tales here? Can you talk a little bit more about the different pockets and geographical differences between what you're seeing in supply and home prices?

20:17Yes. So we've been trying to figure out what are the most, because we talk about home prices nationally. The housing market is so hyper local that those national numbers are helpful, but they don't describe the dynamics that are going on at the ground level at any individual place in the country, right? And so when we look at the growth in inventory, looking at it year over year, looking at it since the fourth quarter of 2019 before the pandemic started, you're seeing the sharpest increases in the South, right? Like you've seen it in Florida, you've seen it in Texas, a couple of states that show up a little bit more on the year over year numbers are Colorado, North Carolina.

20:53When we look at the implications from a home price perspective, what we've seen to be more, at least statistically significant for now, are places where either those inventory levels are higher, highest compared to the fourth quarter of 2019, which you have New Orleans, 11 of the top 14 MSAs from that perspective are in Florida or Texas. And that's where you're seeing softer year over year home price growth, or in some instances where you are actually seeing prices come down on a year over year basis. The other side of that coin is the Northeast. It's New York. It's New England. It's the northern Midwest.

21:26Those are places where inventories are still falling. Inventories are far shy of where they were in the fourth quarter of 2019. And to put all of these percentages into context, nationally, inventories are down, I believe it's 28 % from the fourth quarter of 2019. So to talk about places where inventories are actually up relative to 4Q 2019, that is an outlier relative to national numbers. This conversation wasn't on the record, but I'm going to quote him anyway. I was talking to my friend Connor Sen. He writes for Bloomberg Opinion. Hopefully he doesn't mind me quoting him. We were talking about this phenomenon of the fact that inventories are very tight in the Northeast.

22:04And one of the things that he said was that, and again, I don't think he told this to me for publication, but maybe he's written about it. So I'm just going to take a risk that it's okay to quote him from a chat that I had with him. But I want to give him credit. But that there is this natural longstanding migratory pattern in the U.S. of people moving essentially to the Sunbelt from the northern. And that the way he characterized it to me is like imagine a university town in which suddenly for a few years no one moves out of the town after graduation, how inventories would rapidly diminish. And that because of the lock-in, the mortgage lock-in, you're not getting the same sort of migration out of the cold areas to the southern areas.

22:46And so people are like stuck in the cold areas basically. And that is – does that resonate as a reason for why vacancy rates would be very low or inventory rates in the northeast would be very low right now? So from the data that we've looked at, his comment around migratory patterns, they didn't start in COVID when people like moved to the southeast. They were happening before that. Yeah, that's right. That makes sense to me. I don't have the specific numbers to completely agree with that as a research journalist on air. But what I can say as well, which could be contributing to that, we've talked demographics in the past.

23:19Yeah. And one of the underlying trends in the housing market has been the fact that we're now at a place where over one out of every three homes, over 33 % of the housing market, is owned by people over the age of 65. And when you look at where, yes, there's Florida and there's Arizona and there's South Carolina. But when you look at where they're more concentrated as a percentage of the housing stock in particular, it's in the Northeast. It's in New York. It's in New England. And we've rerun this analysis post the pandemic. Their tendency to age in place has continued to get more and more prevalent.

23:51So I think you combine some of these trends and this is what you're left with. The Northeast is nice. I'm just going to put that out there. Nothing wrong with the Northeast. Okay, so we're talking about an increase in delinquencies, a slight pickup, even in prime borrowers. But we're not seeing foreclosures yet. And I think that's an important differentiator. But what would you expect to be a sort of catalyst, I guess, for things getting worse? And since we keep bringing up the great financial crisis in this conversation, I mean, back then, people were too indebted, too over-levered. And when house prices started to fall, they couldn't keep up and everything basically collapsed.