Once in a while, those of us who live humbly have our day in the sun. This is usually when there is some sort of crisis and all the saving and planning we did pays off. The first 6 months of the pandemic felt like this. Those of us who were cautious, conservative and adaptable, adjusted to the work from home and cooking most of their meals well. Others struggled. But change is inevitable for all of us. It’s easier to embrace it than fight it.
Usually though, the good times return along with the frenzy that accompanies them. So it was very quickly last year with the stock market. Another area that has been red hot is the housing market. The booming housing market coupled with a booming stock market are two of the greatest ironies of the pandemic. While many low income workers face eviction without government intervention, white collar workers are snapping up homes like mad, taking advantage of some of new historic lows in interest rates. Their kids are gambling their savings on Bitcoin and Tesla shares (for diversification of course) through Robinhood.
I can’t remember a time when workers have been so oddly bifurcated. It’s been called the “boom in the gloom”. For many white collar workers, except for not being able to go out, it’s like there is no recession. Others are struggling to survive while the virus rages and businesses remain shut. Past booms were more inclusive: anyone could buy stocks during the dot com boom and the mid-2000’s housing boom was partially driven by lenders pushing into the less credit worthy portion of the market. The climb back from the Great Recession was long but eventually saw one of the strongest job markets in history.
During the pandemic though, it’s like we took every policy tool from the Great Recession and put it on steroids. QE was bigger, the bailouts were in the trillions and this time main street got direct low rate or forgivable loans through the SBA. The fact that the incoming administration is talking about another $1.9 trillion in addition to the $2 trillion package passed last year is seemingly unbelievable given that in 2008 Congress nearly balked at an $800 billion package which ended up being paid back for a profit.
By The Numbers
I often blog about the stock market and also about how housing policies in places like my home town of NYC create many of the market distortions that make the housing stock not only unaffordable but of poor quality. The housing market nationwide however, had resumed its gentle increases a few years ago after the disaster of the housing crisis. You didn’t really hear any more stories of underwater borrowers or waves of foreclosures. Things seemed to be moving along relatively orderly until the Fed slashed rates back to zero when the pandemic started.
The 10 year treasury note, which is the anchor for mortgage rates, hit an all time low of 0.32% in March of 2020. As of the first week in January, 30 year fixed mortgage rates hit an all time low of 2.65%. Take these low rates coupled with the fact that home buyers on the high end of the income scale have remained relatively well employed has created a recipe for huge home price increases.
The unemployment rate for those 25 and over with a college degree has fallen from 8.4% in April 2020 to 3.8% in December of 2020. This come down coupled with the desire for more space from white collar workers has pushed up suburban home prices across the nation. One study found that across 90% of the housing markets nationwide, home price appreciation was outpacing wage growth. That study also found that housing prices increased over 10% year over year in three quarters of the counties they studied.
Inequality Will Continue its Increase
For some time now, the West and in particular the US, has been experiencing a perception of increasing inequality. There are some dissenters to this theory but no matter what you believe, I think we all can admit that economic inequality is one of the dominant public narratives. This situation is not going to help that perception and is very likely to worsen it. Consider two examples.
The first is a server at a local restaurant in a relatively large city. Friday nights and Saturday nights they make the majority of their tips and their income for the week. If bars are open late they may start work at 8pm and not get off until after 4am. These are the busiest nights and it’s likely hectic, demanding, loud and stressful. Rent for a humble apartment may take up more than 50% of your pay. This person may get around that by having roommates or living with their parents. There is little thought given to saving because it just isn’t in the cards after bills and some small entertainment is considered. Then comes the pandemic and this person is out of a job for a number of months through no fault of their own. 6 months later the owner may throw in the towel and tell the workers not to come back. Hard choices have to be made: skipping out on rent or moving in with family may be in the cards.
Contrast this with a white collar worker in 2020. They started 2020 out with their office routine, following up with clients and meetings. The pandemic shifted things to work from home and there was some initial nervousness but once people adjusted, they realized work could continue and the pace picked back up. Now however, they were saving even more money than before from not commuting, not going out (maybe at that same restaurant where the server worked) and eating all their meals at home. This fortunate worker has $150,000 in retirement savings stashed away and kept right on investing through the pandemic. They also own their home, let’s say it’s valued at $300,000, which already gives them a net worth as a stage of 40 times the net worth of a renter. This worker, just going about his or her routine of socking away in their 401(k) and simply living in their home may have seen their retirement savings increase 18% along with the return on the S&P, and saw their home value increase 10%. Without even considering savings, this person’s net worth increased by $57,000. She’s thinking of refinancing her mortgage with the low rates and getting cash out of her home.
These examples are the stark contrast on a micro scale that’s being played out all over the country on a macro scale and will likely continue to feed the political turmoil of those angry people that feel they haven’t gotten a fair shake in life. When interest rates drop to these levels, coupled with a structural shift in the economy, it can produce some big winners and losers. Those with assets and jobs that can survive the pandemic are big winners in this situation. Those retired as well, who have again seen the value of all their assets; bond, stock and real estate, increase.
Those with few assets and those where the pandemic has shifted jobs away from their industry may be forced to reinvent themselves in new industries with new jobs. This takes time to play out and may involve additional school, training and debt. I
Rates Are the Key
Yet when it comes to housing prices, rates remain the big driver. To give you an idea of how big a difference rates make, consider that as recently as November 2018, we were looking at 30 year fixed mortgage rates approach 5% on average. The fall in share prices that year produced a rush to safety and rates began to fall again. By the time rates hit 2.65% in early January, we’ve experienced over a 200 basis point decline in rates over about 2 years.
To put this in context. Consider someone who makes $100,000 a year with little or no debt (for argument’s sake). This person has saved $60,000 for a down payment on a home and is looking to buy in late 2018 with rates around 4.65%. According to the convenient calculator provided by Google, this person can afford a home with a maximum value of around $480,000.
This same person with the same profile by the beginning of 2021, having done absolutely nothing different, can now expect to purchase a home at around a maximum value of $562,000, almost 17% higher than before solely due the difference in rates. This, I suspect is the math that is really driving home prices. Suddenly, for the same monthly payment, you can increase your buying power by 17%.
If it’s rates that are behind the reason why prices are increasing faster than income, it’s because the same income now has higher price purchasing power. It seems every time we think we have hit the lowest mortgage rates on record, the market surprises us again. But this also means that rates are the key to a pullback.
2021 is going to be the real test of this. Morgan Stanley, among others, is already calling for increased and sustained inflation above 2%. Some of the relative inflation increases we are bound to see in the summer are because we’re essentially starting from a deflationary base in 2020. We shouldn’t be fooled by this. But if expectations start on inflation start to change in late 2021 or early 2022, all bets are off and we could quickly see rates reverse. This would send housing prices down and the cost of mortgages up. The economy as well as the stock market may take a hit from this, hurting the same people it is helping now. The key will be not only for the Fed to keep rates low as they have promised but for inflation expectations not to unexpectedly go the other way.
We often forget the politics around the Fed and inflation in the 70’s. At that time the Fed presidents vocally remained committed to reigning in inflation. Yet the reality was, politically, people were not yet collectively ready to face what would really kill off inflation: sustained high rates that would send the economy into a difficult recession. So the country bounced along, ensuring inflation until Paul Volcker was able to muster the support of Reagan to kill it off. One of my biggest worries is that given our political divisions, coupled with a generation that has not had to experience the effects of high inflation, that we too could lack the collective resolve to kill it off before it becomes a real problem in the economy. Time will tell on this but in the mean time, if you have some assets, enjoy the boom.
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