Global Economic Update with Doug Duncan

Thank you very much.

Uh, great to be here. All right.

So, um, you've probably noticed

that interest rates go up.

Uh, they do go up and, uh, they go down too.

Probably that's the part you're more

waiting for at the moment.

Um, but I thought I would start, uh, with rates

because, um, we're,

we've ended 40 years of declining nominal interest rates.

So, uh, for those, uh, who were

thinking about markets back in 1979 when, uh,

Volcker was appointed the, uh, chairman

of the Federal Reserve, um, that process

of attacking inflation, which had moved mortgage rates up

to about 18%, then with small,

um, backups,

the next 40 years were either declining nominal interest

rates, or for the last decade, roughly flat interest rates.

So we've moved into an era where nobody in senior management

of any financial institution has actually,

or in many other corporations, uh, has actually managed

that company in a period of rising interest rates.

And we saw a very rapid rise in interest rates, in fact,

historically fast as the Fed responded to the rise,

um, of inflation.

So they're not done with that.

So the question is, uh, what happens next?

Well, one of the, one of the things that, um,

we had been telling people for six

or eight years is the fact that, uh,

there is no senior management in most corporations

that has experience in rising rate environments

that we should expect some accidents.

Uh, and so we did have some accidents.

We, uh, they were named Silicon Valley Bank, um,

silver Gate, uh, first, uh, Republic.

These were institutions that got captured by

technologic change that took place in addition

to the decisions they'd made on in terms of investment

during this very low, uh, uh, particularly the last decade

of very flat interest rates.

The technologic change that took place was

Silicon Valley Bank failed

because in six hours,

$42 billion left the bank.

Uh, just think about that for a minute.

Six, six hours, $42 billion left.

That institution. That's a dramatic change from, uh,

the movie that you watch, uh,

every Christmas with Jimmy Stewart.

And, uh, and the thrift, it's a little bit different.

It's still going on today,

but I think it's Jim Bianco

who runs a investment advisory firm in Chicago

that called Bank Walk.

So people aren't running to take their deposits banks,

but they are walking as they, they realize they can get 5%

or better in terms of their deposits.

They're moving them out of banks, which are not able to pay

that much because they have a liquidity problem.

So, I'll come back to the banks in a little bit.

Uh, this is a, a, a chart that shows

the administratively set interest rate by the central bank,

the federal funds rate target,

and removing inflation from that number.

So the, the line that moves around a lot,

that's the inflation adjusted interest rate.

And you, what you can see is only in the last, uh,

few months has that interest rate been positive.

So the Fed had been very consistent in saying,

we're gonna hold rates higher for longer,

and didn't get as much attention.

But Chair Pollett also said, we won't believe that, uh,

interest rates have normalized until all inflation.

The entire, uh, yield curve of, uh, interest rates

is, uh, positive from a yield,

from an inflation adjusted perspective.

In other words, all real rates were positive.

That's only been in the last few months

that that's been the case.

So, while the Fed has been raising rates from a perspective

of financial conditions, we were not yet tight.

Well, that's changed in the last month.

The the market has gotten the message,

it's also gotten another message.

And here's the question I think you have to answer.

If you're going to form a perspective on

what do the interest rates mean,

the economy has performed more strongly than

expected in the second, and probably also in the third

quarter when we get that data in. Chair

Powell talked about that in his last press conference,

which I assume you all watch, right?

That's like a cocktail party for economists.

Get the drinks out, parse the words.

So the other thing that, uh, that he said, uh,

in addition to interest rates being, uh, higher

for longer, was, uh, that, um,

they're, they're gonna continue to run off their portfolios

of treasuries and of mortgage backed securities.

Irrespective of what else is going on.

Now, they can change that,

but, uh, that's sort of lost, uh, a headline,

um, cache.

But we're ramping up the amount of treasuries

that are being issued to fund the huge

deficits that we're running.

Uh, the Fed is running off its supply

of mortgage-backed securities,

which is actually increasing the amount.

So if the question is, is the rise in rates

a function of stronger than expected

and expected future growth of the economy, or is it

because the, there's such a huge volume of treasuries

that are gonna have to be funded that yields are gonna have

to increase to attract investors?

That's a, that's a, a fundamental question that you have

to answer, and it will,

it will suggest which direction you

think the economy is going.

If you look at our forecast, you'll see our bet is

it's this huge volume of debt that has to be funded,

that is requiring increased yields in order

to attract investors to fund it,

and that's driving the entire yield curve higher.

Um, that also suggests the risks

of recession are greater than the alternative,

which would be that we're,

we should expect stronger economic growth going forward

as opposed to weaker economic growth,

which would not include a recession.

If you look at the Feds, um, they put out their summary

of economic projections.

It's a document that you can download.

It's 12 or 15 pages that includes all

of their assumptions on the

economy and all of those kind of things.

And the infamous dot plot, which is a plot of

where the mem-, individual members

of the federal open Market committee think they will have

to go in terms of interest rates.

And, and in that, in the most recent release,

they very clearly expect, uh, a soft landing.

And they, there's a pretty good argument for that.

But it's all, uh, conditioned around, is this

the top line in this chart?

Is it gonna go another quarter of a point higher or not?

That's in our model,

because we think there will be a mild recession in

the first half of next year.

We do not have the fed raising rates again,

but we also don't have them cutting rates

until the second half of next year.

Just as a, a little bit of a preview,

so this is the 40 years of declining interest rates that,

that I mentioned to you,

and you can see just how dramatic the recent

rise in interest rates is, uh, compared to any

of those ups or downs, starting in about the 1982 timeframe.

So one other thing about that, uh, 1979 to 82 period

when, when inflation was running at those very high levels,

the Fed attacked Volcker when he came into office,

attacked him aggressively, got about, uh, seven months

of recession and a, a downturn

in both inflation and interest rates.

So the Fed actually eased a little bit,

and inflation took off again, and they had to tighten again.

And that time, instead of seven months recession,

they got 18 months of recession with unemployment

that rose well over 10%.

So one of the things that Powell

Chair Powell is focused on is not seeing a repeat of

that double dip recession.

That's where the, the phrase double dip

recession that you may have heard.

That's where that came from, was that time period.

So one of the things that he's anxious to expunge

is the chance that the Fed eased inappropriately,

saw a resurgence of inflation,

and then had to tighten again with more severe consequences.

The second thing that he is leaning against

is what's called the Greenspan put.

So Greenspan was asked about a house price bubble,

and he said, well, uh, we, we can't know for sure

what's a bubble and what's not a bubble, but what we can.

And so we don't know how to pop it or if we should pop it,

but if it there is one

and it bursts, we can step into the market

to cushion the downside.

So what has happened subsequently is, uh,

Chairman Bernanke and, um, Chair Yellen, uh, supported

that same issue.

When there would be disruptions in the market,

they would ease quickly to what,

what we would call socialize the costs, uh, of,

um, of the whatever was causing the downturn.

I believe that Powell is also attempting to rid the market

of the belief that the Fed will always do that,

and instead let market conditions, both the supply

and demand for credit in the marketplace.

Uh, and the risks related to that credit be the mediator

as opposed to the, the central bank socializing, uh, the,

uh, the cost.

Uh, um, so he's been adamant about

returning to the fed's 2% inflation target, uh,

and that's why he is been making the contents higher

for longer, because every time they would make a rate

increase the forwards,

that is the interest rate expectations you would see in the

market would talk about cuts in the near term.

Um, and he is, he now, I think,

has finally convinced the market they don't intend

to ease anytime soon.

So I mentioned the feds, um,

and I should have changed the, the, uh, acts

or the vertical axis on the right hand chart, that this is

the treasury, uh, uh, balances

and the mortgage backed security balances.

They're head held on the federal reserve's, uh,

balance sheet, and they have a policy in place

as those securities mature, they are not replacing them,

so they're reducing the size of their balance sheet.

They haven't set a target for exactly how large they want it

to be when they're finished.

Um, and interestingly, the last two

or three press conferences, it hasn't really gotten any

questions about that, which, um, is interesting.

Um, I've been, I have a reporter, uh, that is one of the,

that's a friend that's one of the White House reporters.

And so I've been, uh, hinting strongly about

what would be a really great question for the next,

so far no good, uh, which just means, uh,

that my friend is a good journalist, I guess.

Um, the, in the case

of the Mortgage-backed security portfolio, they've said,

we don't want to hold any going forward.

So they're the intent,

and they have a formal policy statement that says

that they will let that portfolio run off.

Now, the problem is that the mortgages that back,

the mortgage backed securities, that they hold average

about 3.5% in terms of the coupon rate.

So they're going nowhere anytime soon.

So very slow runoff of the Fed's balance sheet.

So the difference in the, in the these bars that you see,

the light blue, uh, mean, the total length

of the bar is the amount that would have

to run off based on their cap.

The dark blue is the amount that actually ran off,

and the light blue shows how much slower

it's running off than what the Fed would like

to see in terms of runoff.

The treasuries, they will always hold treasuries, and

before they bought mortgage-backed securities treasuries are

the only thing that they ever really had in their, uh,

in their, uh, portfolio.

The reason for that is treasuries don't advantage a

particular sector

of the United States mortgage-backed securities,

do they affect housing?

Right? So it's, in a sense, it's a preference toward housing

relative to other parts of the economy.

Treasuries are not specific in terms of the way

that they affect any, uh, individual sector.

So they would like to get rid

of the sector specific benefits

and go back to treasuries, which are neutral

to the different sectors.

So I mentioned, uh, the, our view, which is that

the reason rates have risen as they have is the market both

recognizes the Fed is going to stay higher for longer

and recognizes there, there is a massive amount

of deficit funding that has to take place,

and it will be supplemented by the runoff, uh,

from the Fed's own portfolio.

The, so this, this shows our public debt,

and it goes all the way back to World War II,

and you can see that at the present time,

the public debt in real terms, exceeds the level

of the public debt relative to our national income

when we were fighting the peak of World War II.

And if you look at the, the interest expense on that debt,

we are now paying more in interest expense on

that outstanding debt than the entire Defense Department.

I just have to believe that's likely to be a subject

of debate in the next, uh, set of congressional

and presidential elections.

It's pretty, pretty amazing.

We're backed up against happy hour.

Otherwise, I wouldn't show you this chart,

and I realize also I'm in the way of that.

So I'll try to move things along.

That red line is a regression line through

the relationship between deficits and unemployment.

If unemployment goes up, deficits go up

because tax proceeds fall, uh, unemployment goes up.

So unemployment compensation rises.

So there are some automatic stabilizers that happen when

unemployment runs up and they increase the deficit.

Then when we're out of recession, tax proceeds rise.

Some of those automatic expenditures fall

and the, the, uh, relationship between unemployment

and deficits go in the other direction.

That's a very predictable relationship.

Up until 2016, and starting at that time

and continuing to today, you can see

how we've moved away from that long run relationship

between deficits

and unemployment to a whole new level of, uh,

of deficits relative to unemployment.

Unemployment's 3.8%, and we're running deficits

and have a accumulated debt the size

of when we were fighting World War ii.

It's just awfully hard to, to suggest

that there shouldn't be some turmoil

about this in the political arena.

So that's a another example of why we believe that, uh,

the issue with interest rates is this huge demand

to fund, uh, treasuries.

Uh, it's not only the United States,

this is in that circumstance.

I know we have some folks that, uh,

do some international relocation.

So I, I dropped in a couple

of charts on some international issues.

Um, the, the US and the eu, uh,

and Japan are all in the category of rising, uh,

outstanding, uh, uh, debt relative to,

to their national income.

And you can see just

how far we've come over this time period from, uh, from,

uh, the, over the last, um, I guess it's, uh,

23 years.

Um, huge, huge increase.

The, it's also the case

that we're not the only ones that had inflation.

So you, you'll see the other central banks in the developed

world have been increasing interest rates just as we have

fighting the same issues of inflation, uh, as we have.

So all of those on the far right hand side of the chart,

that's all the central banks raising rates.

In terms of the foreign holders of treasuries,

the foreigners, uh, foreign investors

have not been increasing recently their share of yes, debt.

So what that suggests is that debt is going to be, uh, have

to be absorbed by domestic investors.

Another reason that I think you're seeing that rise, uh, in,

uh, interest rates as they're requiring higher yields,

the some, China is the single biggest investor

in US treasuries.

Some people have suggested, well, what if China wants to,

uh, punish us and sells our treasuries?

Well, they would actually be punishing themselves as well.

We don't really see that as likely to happen,

because if they sold into the market, uh,

that would raise yields in decline, drop prices,

and, uh, they would actually book in some cases losses on

their treasury investment.

So we don't see that as likely,

but what they have done is stopped increasing the treasuries

they've bought, and they are actually

buying mortgage-backed securities.

So in that sense,

they're replacing the Fed in funding the US housing market

through the securitization market.

They're not the only one doing that,

but that's been a substitution that they've made,

which has actually been beneficial for the housing market.

Um, this just says inflation is coming down,

but it's not down to the fed's 2% target yet.

This, uh, is the,

if you look at the second purple bar,

the second longest one,

the top one just adds together all the things that added

to growth in the second quarter.

That next Purple bar shows the contribution

of consumer spending to economic growth.

And each of the purple bars is something that added

to growth and is, so you can see far

and away the biggest contributor

to growth in the second quarter was the consumer.

And we have the same view as Chair Powell,

because he said in his press conference, he said, the thing

that has surprised us in the second quarter is the strength

of the American consumer.

That surprised us too.

We had expected, uh, the, uh,

some softening in consumer spending as the Fed is tightening

and slowing the labor market and slowing wage growth.

We had expected more slow down than what we have seen.

So the economy grew at about two,

a little more than 2% in the second quarter.

We actually think in the third quarter

it may grow more than 3%.

So why are we suggesting

that there would be a recession

at the beginning of next year?

Well, in part

because, um, the

consumers are not done spending the transfers

that they got in the course of the pandemic,

and that huge buildup in federal debt

that you saw was actually in many ways

a transference of debt from consumer balance sheets

to the public balance sheet.

If you look at what households did with the money

that was transferred to them, dramatic declines in debt,

on credit cards, in debt, on autos, uh, in,

uh, debt of other forms.

So consumers actually took a lot of that money.

Instead of spending it, I actually paid down debt.

Well, it was deficit funded, so

that meant debt rose on the public balance sheet.

So, uh, in addition to that,

you probably noticed mortgage rates fell.

That's economist humor.

Um, 3%.

I'm not sure anybody in here two

or three years ago would've predicted 3%

mortgages, but that's what you got.

People took advantage of that,

and there wasn't a lot of cash out refinancing, which means

that they were lowering their,

lowering their monthly payment

and increasing their disposable income in the process,

which when you added those, the transfers they got,

and that benefit from lowering their monthly payment,

that gave a lot more resilience than

to consumers than we anticipated in the way that we tried

to calculate, uh, where our households were gonna go.

Now that all of

that suggests why the Fed put in their summary

of economic projections that we're gonna get a soft landing,

but there are some indicators

that have been very highly correlated in the past

with, uh, recessions.

And so I'll give you a couple of those as part

of the explanation why we think we're headed

for a mild recession.

I'll, then, I'll define mild recession.

So this is, uh, the, uh, indexes for services

and manufacturing that's a, a monthly,

um, a monthly measure.

And, uh, while services are still positive in terms

of the attitude about what will happen to growth,

the clearly the, uh,

manufacturing sector has been in recession,

I didn't put housing on here.

Housing also from a, from a, uh, level

of activity is really in recession, uh,

as well, pretty significantly.

Uh, so this, we forwarded the, the slides before.

The most recent, uh, employment, uh, numbers.

The most recent employment numbers were actually a big

surprise on the upside.

We added 336,000 jobs when the expectation was

for probably about 120,000 jobs.

So that, that's another, um, another thing

that the Fed will weigh pros and cons.

If it's stronger than they think to get inflation down

to 2%, that means they'll raise, uh, another time.

This, this shows you the magnitude

of the increase in savings for households.

And then where since since the middle of 2021, you can see

that, uh, savings have fallen below the long-term rate

as consumers were spending off, uh, that, uh,

that big buildup in transfers

that they received during the pandemic.

You can also see the distribution by groups.

So there's five quintiles

of income groups low moving from low income on the left

to high income on the right,

and you can see that the two lowest quintiles

of income earning households have spent all of the,

the savings and the now you're seeing credit card balances

run up, uh, you're seeing, uh, uh, uh,

delinquencies start to pick up on credit card balances.

You're starting to see higher income households move toward

debit cards and away from credit cards, which is a measure

of conservatism on their part.

You're seeing, uh,

delinquencies in auto loans start to pick up.

Uh, so there are signs

of stress on the consumer side starting

at the lower income levels, uh, and, and moving up.

But, uh, the other side of that coin is the,

because of the pay down of debt relative to their income,

even though those balances are moving up, they're still not

where they were in 2019, which is part

of the reason you've seen us move our forecast

for when the recession will occur out into next year.

As consumers, uh, uh, continue

to spend off those excess savings

and some of these numbers, uh, start to move up.

Um, this is, uh, seriously delinquent, uh,

loans a a bit of an uptick,

but certainly nothing like we've, uh,

like we saw back in the great financial recession.

Uh, corporate profits, uh, are, uh, moving down.

That's usually a precursor for an economic slowdown.

I talked a little bit about the banks.

Uh, it's, um, we are not

through the whole regional banking issue,

but I'll, if you wanna talk about that in the q

and a, I'll come back to that.

Let me jump ahead. The, the, that banking situ,

uh, situation is, uh, resulting in tighter bank credit,

which is usually a leading indicator

of an economic slowdown.

So another reason why we're in the mild recession camp.

All right, here's, um,

I talked a little bit at the outset about interest rates.

One of the very predictive, uh, predictive,

uh, relationships is a very high correlation

between an inverted yield curve,

meaning short interest rates are higher than long interest

rates, if that occurs, and it's a deep inversion

and it lasts for a long time, there's no instance

in post World War II that it did not lead to a recession.

It is correlation, it's not causation,

but it's a very strong correlation.

This has been inverted for a long time and deeply,

and, uh, from our perspective, we don't have a reason

to believe that ultimately won't, we won't see,

uh, a, a recession.

Uh, this is another indicator

that has a very high correlation with recessions.

The, the, uh,

conference board's leading economic in indicator index,

and it's been negative for about, uh, 16 months.

And that has never happened since World War ii.

That it, we did not have a recession.

Uh, so a couple of the strong correlated, uh,

factors clearly pointing toward recession.

I I put in, uh, measures of the dollar

for the folks that do international, uh, relocations.

The, the increase increase in interest rates in the US

and the stronger than global growth prospects

of the US have led to a very strong dollar.

Uh, now, you know, that has pros and cons, uh,

but at the present time, if you're thinking internationally,

you're operating in a market which is, uh, which is going

to be, uh, centered around a very strong dollar,

and that will be that wave for a while.

This, I think, is my last international slide.

So, one of the, a number of years ago

I was giving a speech in, uh, uh, Alabama.

And talking about manufacturing and, um, and the q

and a section, uh, that was one

of many things I talked about in the q and A section.

A gentleman stood up in the back of the room

and he said, so what are you gonna do about all those

US manufacturing jobs moving overseas?

I said, well, when I drive back to the airport,

I'm gonna go past the BMW plant

and I'm gonna tell them to go home.

It was a little bit cheeky,

but what it, what I was, uh, wanting then subsequent

with my comments to say was, if you compare relative levels

of GDP between the US and other countries,

and then you look at the foreign direct investment

by others in the US

and compare it to what the US invests overseas,

we get a very good deal

because we have a very large economy.

It's a very strong economy over time.

So we actually, relative to our sizes,

we attract a lot more investment to the US than overseas.

Now, a lot of its high tech

and part of the implications of the high tech movement was

that it eliminated a lot of manufacturing jobs

and a lot of manufacturing jobs did move overseas for, uh,

based on the difference with within, with wage rates.

And I did patch up the relationship

with the guy from the back of the room,

but I was, I wanted

to make a point about understanding global economics.

And the US actually gets a really good deal, uh,

from a global perspective.

Our, you can see in our GDP we two, 2024

minus 2%, two tenths of 1% growth.

So when we talk about a mild recession,

what we're saying is about a half over a threequarter time

period, about a half a percent total decline in GDP

unemployment running up to, but not past about 5%.

Now, if you went back 25 years

and you asked a bunch of macro economists,

what do you think about an economy with 5% unemployment?

They would say, well, that's full employment today.

We've been operating at under 4%

for a very long time period.

There really aren't any precedents for that.

Um, and there's a whole bunch of reasons,

but if, if unemployment only rises to something

around the 5% level, uh,

and we only lose about a half a percent of GDP in

that timeframe, it, that will be a mild recession.

But it will bring interest rates down as that,

as we get into the depth of that, uh, of that recession.

So if you look at our forecast, you, you see,

Look at our, our, when I show you the mortgage rate,

the mortgage forecast, you'll see that, uh,

we see a pickup in activity in the second half of 2024.

Alright, housing. So one

of the things I always tell people that they'll ask me,

why have you spent your career in real estate and mortgage?

Uh, part of it is, um, that

I'm interested in housing quality.

'cause I grew up in a house without plumbing

and in Minnesota in January,

the whole outdoor facilities question

that will make you appreciate plumbing if nothing else.

Um, but in reality,

every human on the planet puts their head down on some kind

of real estate every night, and that will always be true.

So it's a part of the human condition to me

that makes it in infinitely interesting.

Uh, and there's lots of difference between wake the ways

countries, uh, uh, structure their housing policies

and all those things, but they all have them

because it's an innate part of the human condition.

So, um, it's a good place to be. It has its ups and downs.

I said at the outset, interest rates go up and,

but they also come down, uh,

and you saw a very long time period of them, uh, going down.

Now you've seen a period where they've gone up.

It's been a rapid adjustment and painful,

but they will come back down.

And the average 30 year fixed rate mortgage

from 2000 from, uh, World War II out to the year

of 2000 is 6%.

So they're actually closer

to normal than they were two years ago at 3%.

They're actually closer to normal today, but it's painful

because of the speed of adjustment,

because interest rates can move that fast,

but incomes don't move that fast.

So even though the rate of inflation is clearly slowing,

and it's down probably on an annualized basis to around 3%,

you'll read the headlines

that say people are still very unhappy about inflation.

Well, that's because prices went up and stayed there.

So even though they're flattening out at that level,

incomes have not caught up to that.

It's the same thing in housing, that

that interest rate has risen much faster than household

incomes have risen,

which has created serious affordability

challenges in the housing space.

It's, it's, you don't have to take a class in economics

to figure that out, right?

But the good news in the US is demographics are still very

positive for housing.

So the millennials have not

yet reached peak first time home buying age.

They're still more to come,

and they are the largest population

group that we've ever had.

Um, and so we talk a lot about the boomers

and the boomers aging in place.

That's been a, a issue on the supply side.

And then we talk about the millennials being the new

largest, and nobody ever talks about the Gen Xers.

So let me give the Gen Xers a little airtime.

They're the ones with the 3% mortgages, right?

Okay, that's, they've locked in that 3% mortgage.

So, um, I coined a phrase, I was, uh,

testing it on some of the staff back here, um, to prove

that economists can be linguistically clever.

I coined the phrase the geospatial redistribution

of real estate values like that.

Well, okay, so what I was trying to say is, look, the

pandemic we're part of what we're working

through in the economy is the

after effects of the pandemic, which I don't think will be

through for another three or four years.

But one of the things that happened in the pandemic was

this was not an economic variable.

This was a health variable.

And so people who might have been planning two

or three years in the future to move if they were able,

might have moved that up to make a move to get more space,

either within the house or around the house

or in the community to protect them from the threat

that was this, uh, this was this disease, this virus.

And so we could actually track the flow from,

because when you make an application,

you apply from a particular address, you apply the address

to which you're attempting to move.

We could actually track migration of people

and see what was happening

to apartment buildings in central cities,

to suburban apartments, to, uh, housing

close in or urban housing, suburban housing.

We could actually see people move.

Uh, it stimulated both

by lifestyle.

In other words, a lot

of them were in a place where they had children.

They wanted to move with the children

That were gonna do it anyway, within a couple of years.

Or, um, they, uh, received, uh,

income transfers

that they'd been saving some money when they took the income

transfers on top of that, it was enough

to get them to be able to move.

And so what happened was you saw four years

of business done in a two year time period.

You, a whole bunch of people move forward in time.

And if you didn't make money in the real estate business

between the middle of 2020

and the middle of 2022,

you were probably in the wrong business.

Now, if you didn't save money that you made during

that time period to spread it out over these two years,

you may not be in the business, right?

But basically that was part of what happened.

And it changed values of real estate

depending on the geography.

So you think about people being working from home.

We, we said in Fannie Mae, we have about 10, uh,

we have about 8,000 employees.

And in three days we went from in-office to working remote.

Amazingly nothing broke.

It was pretty, pretty amazing from my perspective.

But if you think about the household's perspective on that,

you have now given them a real income increase.

All those travel commuting costs now are income to you.

So when you tell someone, okay, game over, come back

to the office, you're saying we're going to cut your pay

is in any surprise, there would be resistance to that.

Plus people relocated making some assumptions, maybe

invalidly, but we don't think you're gonna see

a big reversion back to, to, uh, where, where, uh,

we were previously.

We think it's going to be permanently a hybrid situation.

So let's think. Now you,

you went five days to work from home.

Now the company says two days come back saying, well,

I could move a little further out.

If I only have to commute two days, I could move further out

where housing is less expensive.

I could get more space. I might be

willing to make that trade off.

So that's part of

what happened was people moved a little bit further out.

They got a little bit more house.

They were willing, if they only had to drive

commute into the central business district two days a week

instead of five, that was a

compromise they'd be willing to make.

Now, if you're an apartment building owner

and some of these people have left the apartment buildings

to buy houses, now put some pressure on your

rental income, right?

Particularly if the presence

of all those five days a week worker in

that space supported, uh, things like restaurants

and bars and dry cleaners and things like that.

Now you're only there two days a week.

Some of those businesses might go away, the health clubs,

there might be some reduction in health clubs.

So some of the amenities around

that apartment building might have declined.

So the value of that property might change as well, right?

So I'm trying to justify the geospatial redistribution

of real estate value.

I'm making this all up, but really that's, that's, that's

what has happened

and is continuing to happen, is people are trying to adjust.

What's the other piece of it?

The business has to decide,

do we get the same productivity out of those workers

who are working on a hybrid basis as when we got them

in the office five days a week?

If not, ultimately businesses have to adjust compensation

to productivity, they're forced to.

That's where profits come from, right?

And so that part of the measurement is still underway.

And so you're seeing different businesses taking different

approaches to that.

So me at Fannie Mae, now, if I have a a job opening,

I have to designate, is this job per per permanently remote?

Is it hybrid or is it in office?

So that when I hire into that position, the candidates

will know this is either a permanently remote job,

which means if everybody has to come to the office, I have

to pay their expenses to bring them to the office.

Uh, or if it's hybrid, then they can, they can be encouraged

to come sometimes typically within the company, we,

we don't have in, in Fannie Mae at present,

our policy is you cannot ever require an employee to come

to office unless they're designated

as a full-time in-office job.

And that's a lot of security and maintenance

and some of those kinds of, of folks

that keep the plant running.

Um, but we can set incentives for people to come.

And interestingly, people do like to spend time together,

but they don't feel like it needs

to be five days a week, right?

And so we're, we get, uh, lots of folks

that do come into the office for a day or two, uh,

and they will usually, uh, uh, make a plan.

I'm coming here because you are coming here.

So people put on their calendar,

I will plan on being in the office on these days

so you can match up who that you would like to work with.

All of that's still in ferment in my view.

That's why I said we think that the

after effects of the pandemic will be three to four years

to, before we actually know the full implications of it.

Hopefully that makes some sense.

All of which is to say real estate still has value

and always will, but it may change.

This basically shows

with the rise in interest rate at the rise in house prices.

We are at something like, uh, 35 year,

uh, um, low level of, uh, affordability

for, particularly for entry level, uh, home buyers.

So you're well aware of the supply issues, uh,

the boomers aging in place.

The boomers now knowing you can use your iPad

to get home healthcare, which only extends the amount

of time that you can, that you can age in place.

Uh, now, now you've added to them the Gen Xers

who have 3% mortgages.

And I would argue a lot

of them will actually become investors.

'cause when they decide to move from that house,

the payment at a, on a 3% mortgage is sufficiently low,

that rents in that area are probably a thousand

dollars more a month.

So they will keep that property, uh, and rent it out

and use, either use it as extra income

or if they have to buy another house with a mortgage,

they can use that a thousand dollars rent payment

to subsidize a higher interest rate mortgage

on another property.

So I would argue you're gonna see a bunch

of Gen Xers who are gonna be investors.

Um, what this has done is put a lot

on the back of the builders.

So a quick segueway back to the, to the feds running off

of its mortgage-backed securities portfolio

and how that interacts in the mortgage space.

So the majority of home mortgages are funded

through the mortgage-backed security market mostly probably

knew that the, when mortgage rates passed 7%

for the first time in the last year,

you saw the MBS market suddenly sort

of freeze up for a couple of days.

And then within a week you saw lenders offering two one buy

down interest rates.

Why did that happen? Because no investor was going

to buy a mortgage backed security backed by 7% mortgages

because as soon as the fed eased interest rates,

when they got to their 2% target,

or we saw that mild recession emerge,

which brought rates down,

all those loans would prepay 'cause you.

And so a bunch of those people

who are buying houses at 7%

mortgages saying, well, that's fine.

I've got the cash right now.

I might get stressed in a couple of years,

but the Fed will be easing rates will

come down, I'll refinance.

What's the problem? But in the mortgage backed security

space, you had to buy

that interest rate down on the coupon on

that mortgage backed security.

Otherwise you make the investment today in 12

months from now, it might be gone.

So, uh, the builders really got that.

And because of the, the boomers aging in place,

the Gen Xers not offering their homes for sale,

the supply side was on the back of the builders.

But the builders as a result of that, had strong margins.

They were very profitable in this time period.

So they had profit to give to do those two one buy downs

or 2% buy downs permanently, as opposed to

what is traditionally the case,

which is they offered finished basements

or granite countertops

or, you know, paneled, uh, garages or something like that.

But it was their recognition that their customer now

importantly included a big segment of first time home buyers

who are different than move up buyers.

It the move up buyers typically are looking

for finer attributes.

Entry-level buyers are looking for bedrooms, a kitchen,

bathrooms, and a garage.

And not much more than that.

So the builders first struggled to build

to entry level buyers

'cause it wasn't their, their typical place,

but they also recognized

that first time buyers' biggest problem is down payment

and affording the payments.

And so they went to the interest rate as opposed

to attributes of the house.

So that, that was kind of the dynamics that took place,

which is very different than any other cycle

that you will have seen.

And it led to a lot of confusion in the press

about what was going on.

But it was that combination of factors

that actually changed the market in a way

that was very unfamiliar, uh, in terms

of the historical housing cycle.

Hopefully that makes some sense.

That column on the right, about 90% of all people

that have a mortgage today have an interest rate

that's three percentage points

or more below the current market rate.

So when people talk about the lock-in effect, um,

that's what they're talking about.

People are not gonna give up that, that, um, mortgage.

But we, a lot of headlines were written about that.

So we actually surveyed to find out is it true

that you're unwilling to move because of the interest rate?

Turns out that other thing I was talking about

before with support from the interest rate was the biggest

change that was life change we're we wanna move

to a place we have kids, we want more space, we can do it

supported by this low interest rate,

but it's something we were gonna do anyway.

We just moved it forward in time.

That was actually the bigger effect as opposed to just

because of the interest rate.

So we put a blog out on that.

Um, it's, by the way, we have lots

of research on the website.

It's all free. There's no paywall or anything.

Um, and we do lots of surveys of consumers to try

to understand things, especially when we see a headline

that doesn't exactly meet our intuition.

Then we will survey, um,

and, uh, find out what consumers say.

We started this back in, uh, June

of 2010 when we read all the headlines about millennials

learning the lesson of their parents

that if you buy a house, you get

foreclosed on and lose all your money.

And so the stories were the millennials want 300 square foot

apartments with amenities.

And we're like, really?

It was a human nature change

that dramatic from the great financial crisis.

So we surveyed them.

The first month that we surveyed, 92%

of millennials said we eventually wanna own a house.

That was interesting. So we said, why the disconnect?

Well, it turns out that that expansion was the most urban

centric job growth of any post-World War II, uh, expansion.

So if you were gonna have a job,

you were gonna be living somewhere in proximity to that job.

You're gonna be in a 300 square foot

apartment in an urban center.

'cause that's where the jobs were.

And you couldn't afford a house yet at that point anyway.

But as their incomes increased

and their credit improved,

they eventually started buying houses.

And in 2014, we said,

next year the millennials will be driving

the demand curve in housing that is 2015,

and by the way, there's gonna be a supply problem.

And people said, you guys are nuts.

'cause we'd just come through this massive wave of,

uh, foreclosures.

But the builders stopped building

and demographics kept moving.

And so we're still in that

after effect of the shutdown

of housing production post great financial re uh, recession.

You can look at this on your own time.

What we wanted to show was

that the very high cost markets have seen house prices come

down, but it's partly as a result of the fact

that people moved to lower cost areas.

So those, those heat charts show you that shift in,

in population, uh, related to housing.

Uh, so then you can just finish up the, the last, uh, chart,

um, just, uh, gives you the full picture

of our, um, of our forecast.

Lots of other things that that's if you, if you don't go

to happy hour, you stay in here.

We could have a class project, I suppose,

but I, I, I wouldn't necessarily recommend that.

But that's our story and we're sticking to it.

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