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July 2, 2020

Did Coronavirus Break the Housing and Mortgage Market? How Your Bank Should Respond


Relationships | Challenges | Coronavirus

Flashback to February, 2020 … On paper, the U.S. economic picture was at historic highs, with the top economic indicators of inflation, low unemployment, strong housing demand, consumer spending, and high consumer confidence all seemingly to be “unstoppable forces.” How, then, with what seemed like a blink of an eye, did the Coronavirus, which we will call the global “immovable object,” cause the economy to drop to its knees? And, more specifically, did this drop break the housing and mortgage market? If so, how can it be fixed, and what can your financial institution do to embrace your community in its time of need?

 

How the Economy and Business Cycle Works

First let’s gain a better understanding of how the economy and the business cycle work. The “business cycle” is the term used to describe the expanding and contracting pattern of the U.S. economy. Throughout history, wars and plagues have been blamed for economic swings. In 1819, the French economist named Jean Sismondi proposed the idea that economies go in cycles based on production and consumption. When business activity is strong, the output of business, known as “GDP,” or Gross Domestic Product, rises, and the economy expands until it reaches a peak where people are not as willing to spend, thus leading to a surplus of goods and services.

When production of goods and services continues to outpace consumption, a downward contraction in the economy begins. This downturn is classified as a recession if it lasts two consecutive quarters. When this downturn continues for a sustained period, economists define this as a depression. At this point, economists disagree on the best course of action—whether government should intervene as in the bailout of 2008, or whether the market should be left to work through the rough times until ingenuity, invention, and commerce can balance production and consumption. This process has been documented in 11 cycles since World War II; the average period of time for the business cycle to go from peak to peak has been just under six years.

 

Coronavirus and the Housing and Mortgage Market

In response to the news that the Coronavirus was infiltrating the country, mortgage loan programs began disappearing, interest rates became severely volatile, and more than a few independent lenders closed for business indefinitely. As an answer, the Federal Reserve began buying $100 billion per week of mortgage debt. This sounded very similar to the 2008 economic meltdown, although the inherent wrongdoing and mismanagement from 2008 was absent. The Coronavirus response has been the most abrupt and unexpected economic adjustment the world has ever seen. The consequences of this disruption have fueled the bond market (which loves unrest in the world) to the point where mortgage rates dropped to all-time lows—perhaps too low.

But how could low mortgage rates be bad? Well, investors who buy mortgages are planning to make money on interest paid over time. They pay more than the principal loan amount up front for the right to collect that interest and calculate what they are willing to pay based on how long they think people will remain with their loan before refinancing or selling. When rates drop faster than the investor expected, lenders begin to collect their principal back without earning a profitable amount of interest. If this rate reduction persists, investors pay less and less for their mortgages, which, in turn, means they won’t be in the market. This means that lenders don’t have the liquidity needed to continue lending.

Here’s an easier way to explain the problem. Imagine that you remodeled your home with a credit card, hoping to quickly refinance to pay off your debt, but due to the unavailability of cash in the bond market, your loan approval was delayed or suddenly not possible. You now have to pay a few high interest payments—possibly a lot more than you expected. You could potentially handle this for a few months, but imagine that situation on a broad scale for multiple people and businesses across the country, and the amount of debt adds exponentially. This is why the Federal Reserve stepped in and began purchasing $100 billion per week of bond/mortgage debt. Again, there were differences from 2008 in that these purchases weren’t bail-outs; rather, they were repurchase agreements (a.k.a “repos”) that allow banks to quickly sell non-cash assets to the Federal Reserve and agree to buy them back later when the flow of cash has opened back to them.

At the same time that the Federal Reserve was working to free up cash for lenders, the federal government stepped in and offered the following relief measures:

  • The Disaster Relief Bill that provides Paycheck Protection Program loans to small businesses through the SBA to keep workers on payroll;
  • The CARES Act (Coronavirus Aid, Relief, and Economic Security), an injection of money to households to replace lost wages while businesses were closed;
  • Forbearance on mortgages (3–12 months of no payments) for homeowners from Fannie Mae, Freddie Mac, and Ginnie Mae, to assist while incomes may have been impacted by the Coronavirus. The impact on the mortgage market for this program is yet to be seen, as this could place a never-before-seen strain on the mortgage market. Ultimately, what this means is that investors who purchase mortgages have a guarantee to receive timely payments. If the homeowners cannot pay their monthly bill, Fannie and Freddie will cover the bill. If these agencies cannot pay, then taxpayers will, because the Treasury is the guarantor for these agencies.

Can you see the potential issues here? The financial markets will see the largest and fastest surge of forbearances (non-payments) the mortgage market has ever seen if businesses do not open quickly and people do not return to work.

Does all this dire news mean the country is worse off than in the 2008 meltdown? I propose that the answer is no, in many ways 2020 is much better than 2008 because the market did not cause the Coronavirus pandemic. The average mortgage being made up to 2020 was much more regulated and of higher quality than those being made from 2004–2008. Incomes, documentation, employment verification, improvements in home valuations, and underwriting standards that were put into place by financial institutions mean that whatever economic issues could arise won’t be blamed on the housing and mortgage market. We’re not facing the same behemoth that destroyed the confidence in the system from 2008. We’re facing a crisis that can be slain by taking health precautions, building strong relationships with customers, and overcoming the effects of a pandemic that can be handled much more quickly than in decades past, when news and information could not be obtained within seconds over the phone, satellite, or the Internet.

 

This is a Time to Enhance your Customer Relationships

This is not to say the road ahead will not have obstacles and get worse before it gets better, but the mortgage and housing market is in a position to be able to swiftly recover as America gets back to work. This is a time of opportunity for financial institutions to contact customers and enhance the relationships they’ve been building with their borrowers and within their communities. Financial institutions have long been looked at as the backbone within their areas to provide confidence in times of fear and uncertainty. Now is the time to reach out and openly communicate with your customers and the community by taking the time to listen to their frustrations and fears, sponsor functions that encourage outreach to those in need, and perhaps most importantly, offer education and be in plain view for the public to see. 

The heart of America has always been in its ability to recover through innovation. This pandemic will be overcome in the same way. This is a time to shine, for financial institutions to be seen as a solution to get people on their feet and garner the trust that has been built within our communities.

 

____________________

 

About the Author: Brandon Wood graduated from Brigham Young University and joined FPS GOLD as the VP of Loan Servicing Development in 2014.  Brandon began his career in the banking industry in 2001 and has worked in both commercial lending holding a $50 million commercial portfolio and managing a $250 million bank. brandonw@fpsgold.com

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