I recently had the pleasure of chatting with Dr. Mark Zandi about the state of the economy, as well as the single and multi-family housing markets. Mark is one of the foremost experts in his field, serving as the Chief Economist of Moody’s Analytics, where he directs economic research. Mark is also on MGIC’s board of directors and serves as the lead director of the Reinvestment Fund. He is also the co-founder of Economy.com, which was purchased by Moody’s in 2005.
As everyone knows, last week, Fitch downgraded US debt, from a AAA rating to a AA+. This, of course, shook up the public markets in a major way and was a cause for concern for many. However, everyone doesn’t share the same concern. Some believe that this was a play by Fitch to get some time in the spotlight. Others, like Mark, just don’t believe that this rating change will have any drastic effects.
At the end of the day, this downgrade was not on the back of any ground-breaking news. Investors in US debt have understood that the country is heavily indebted for decades at this point, and the political use of the debt ceiling isn’t anything new either. The downgrade does not change the fact that whenever there is global economic uncertainty, money will flow to US debt since it’s still one of the premier places to keep money.
Over the past year and a half, there has been continuing speculation as to where the Federal Funds Rate is going. Some people, including Mark, have been calling for the Fed to stop increasing interest rates for fear of recession. After all, the inflation that we have been experiencing is largely tied to pandemic supply chain disruptions and the war in Ukraine. Fortunately for us, the effects of these events are largely in the rearview. This means we don’t need an incredibly high federal funds rate to stave off inflation at this point. However, the Fed continues to raise rates, with a quarter-point hike in July and another quarter-point expected before the end of the year.
Mark believes that we are currently in a housing recession driven by incredibly unaffordable homes. This is supported by the fact that since the beginning of 2022, less than 13 percent of new home sales were under $300,000. Current conditions make homeownership tremendously difficult for Americans. When you couple this with the fact that nearly half of all homeowners with mortgages have rates under 4 percent, current homeowners will be incredibly reluctant to sell their homes. This, of course, leads to very little existing inventory.
Mark believes that we are going to remain in a sort of housing recession until something gives, whether that’s inventory pricing, interest rates, or income. However, it doesn’t look like any of these factors are likely to budge in the near future.
To listen to the entire episode and get Mark’s extraordinary insights, or to see our list of upcoming guests, be sure to watch or listen to the Walker Webcast.
If you have any comments or questions about the evolving economic landscape and how it is impacting the CRE space, our experts are available and fully operational to help. Additionally, if you have topics you would like covered during one of our future Walker Webcast, we would be happy to take your suggestions.
Follow us on YouTube for the latest webcast and videos.
Willy Walker: Good morning, everyone. I'm out on the West Coast and so it is still very much morning for me on this Wednesday. It is a real pleasure to have my friend, it's now becoming many, many years - decades worth of friendship that we have. But it's great. I know we've got a ton of people signed up to hear your thoughts on the markets and what's happening today.
I will say at the top, Mark, in going back and doing research for this webcast, I got to watch a lot of your public statements on CNBC, particularly over the last year, two years even, I went back four or five years ago. It was really interesting to look back at the economy pre-pandemic and what your thoughts were as it relates to where we were heading, as it relates to a potential recession back in 2019, heading into 2020. And little did we all know it was coming around the corner.
But I will say that you've been extremely prescient as it relates to a recession or not as the case might be. And you pinned that view and coming out saying that the United States likely would avoid a recession on a number of different factors that I want to talk about in a moment, but I want to talk with the biggest headline of the last 24 hours, which was the downgrade of the US debt by Fitch. Moody's is now the only outstanding rating agency with a triple-A rating on US debt after S&P lowered their rating of the U.S. in 2011. And obviously the ten year has tightened by two basis points right when the news came out and then it's now gapped out by last I looked at it, 5 to 10 basis points on the day. What are the implications, Mark, long term to this downgrade by Fitch?
Mark Zandi: Well, Willy, it's great to be with you. Thank you for the opportunity. And, yeah, I appreciate the friendship over the years, and I think decades. I can remember one event or way back when on Nantucket or something, and I can't remember where it was.
Willy Walker: Chatham Bars Inn.
Mark Zandi: Oh yeah, Chatham Bars Inn. That was it. That was it. Yeah, that was a great, great venue. That was really a lot of fun, but I really appreciate your friendship and the support.
I should say, just as a preface, I am the chief economist of Moody's Analytics. I am not in the rating agency, so I'm not speaking for the rating agency. This is just Mark Zandi speaking to you. I should also say I'm on the board of directors of MGIC, just for sake of disclosure, I'm on the private mortgage insurer.
I don't think the Fitch rating downgrade means anything, Willy. I think there's no new news. I don't think it's going to affect or change the minds of global investors in any meaningful way. I mean, at the end of the day, the U.S. is still the triple-A credit on the planet. Whether they have a triple-A rating by Fitch or not, push comes to shove, if something is going wrong in the global economy, something is going wrong here in the United States of America, money comes here because global investors know that it's money good. That if they buy Treasury bonds, that they will get their money back, principal and interest in it in a timely way.
And that's not to say we don't have our fiscal issues. It's not to say our politics aren't problematic. They are. But I will say we've had all kinds of fiscal challenges since the inception of the nation, many political challenges since the inception of the nation. And we've always made good on our debt. And there's no reason to suspect that that won't remain the case going forward.
We will, at some point here in the not-too-distant future, probably after the next election, I suspect a lot of things are coming together where we'll make, some significant progress in addressing our long-term fiscal issues and both on the tax side and on the spending side.
So, I don't think there's any consequence to this. The market reaction we're observing now, the initial reaction was yields were down, not up. I mean, a lot has happened since then. So, I don't think I read anything in terms of where the ten-year yield sits at this point in time.
Willy Walker: Help me foot that comment with your consistent statements over the last year that the U.S. wouldn't go into a recession. And one of the main reasons for that is consumer confidence. In other words, I've listened to you, and it's been fascinating to hear you basically say, look, recessions happen when people lose confidence in the economy and when they pull back, the economy goes into recession. So, as long as there is consumer confidence, you will continue to move through and not have it. And you've got more specific points below that that I want to dive into a minute.
But just as it relates to the downgrade by Fitch, I'm surprised that you don't think that that adds another sort of chink in the armor of confidence in U.S. debt that could have longer term implications to it.
Why is consumer confidence so important to holding up the economy on one side, if you will, on the equity markets and on GDP growth? And yet on the debt side, we can still sit there and say we're okay, this doesn't really mean anything?
Mark Zandi: Yeah, I mean, the average American doesn't know Fitch ratings. What does all that mean? That's what we're really talking about when it comes down to recession. I mean, recession is at core a loss of faith. Consumers lose faith that they're going to hold on to their job and they start pulling back on their spending, they run for the bunker.
A loss of faith by businesspeople that they're going to be able to sell whatever it is that they produce, and they start laying off workers and you get into this kind of self-reinforcing negative cycle.
No evidence of that at this point. There are different measures of consumer sentiment. I find the most prescient to be the measure from the Conference Board is a monthly survey. That actually rose very strongly last month as well. At this point, well above its long run historical average. So, no sign at all that consumers are on the edge of packing it in. And I don't think about this downgrade or the debt situation, nothing changed between today and yesterday and the day before and a week ago and a month ago. I don't think that's going to have an impact on people's thinking about their job, finances, the stock market, their housing values, what's the price of a gallon of regular/ unleaded? Those things people know is what drives sentiment, not a downgrade, not concerns about deficits or debt, at least not at this point.
Willy Walker: And just as it relates to sort of the amount of debt outstanding at the federal government and kind of net net debt, back of the envelope and correct me if my math is wrong here, versus if you will, you're both very deep understanding of it, as well as your real math.
About $32 trillion of federal debt outstanding. But if you back out sort of intergovernmental debt hold as well as the debt sitting at the Fed, that $32 trillion turns into about $18 trillion of kind of net net debt out to both Americans and foreign governments as it relates to real obligations of the U.S. Treasury. Does either the aggregate number of 432 trillion or the $18 trillion of net net debt concern you as it relates to the overall fiscal situation of our country? Or should we be looking at it sort of like a debt service coverage ratio of, you know, you got $23 trillion of GDP, and you've got X coming into the federal government every year and they've got plenty of cash flow to be able to service the debt. So, there's absolutely nothing to really worry about there?
Mark Zandi: At this point in time, I don't think the debt load is a problem for the economy. The best measure I think is publicly traded Treasury debt to GDP. That is close to 100%. I wish it were lower. It certainly has been driven up for some good reason, some bad reasons, you know, good reasons being pandemic, bad reason being massive tax cuts, significant increases in spending. So, it's not ideally where you'd want it, but I don't think it's an issue for the economy's performance at this point in time.
Having said that, crack open the outlook for our budget as done by the Congressional Budget Office, the CBO, the nonpartisan budgeteers. And if we don't change policy, we don't change tax policy, we don't change spending policy – ten years from now, that's going to be 120% of GDP. The trajectory of that is straight up. And then what happens is that at a point in time, in the not-too-distant future, not next year, but, you know, a decade from now, the interest payments on that debt become consequential and it starts adding to the deficits and debt. And you get into this kind of self-reinforcing negative dynamic, which we do not want to get into.
And at some point it's going to be a problem and it will manifest in the form of much higher interest rates, kind of sort of like we were in this situation back in the early 1990s. (Bill) Clinton and (Newt) Gingrich came together and did what they needed to do, and they put the train back on the tracks. We're going to do the same thing. So, I'm not worried about what the deficit debt means for the economy today, but I do worry about what it means going forward.
We do need to make changes in both tax and spending policy to address those to get our long-term fiscal situation on a more sustainable path. So, we've got some hard work to do. My sense is that probably the first step in that process will be early 2025 on the other side of the election, because as I mentioned earlier, a bunch of stuff is coming together. You know, we got to raise the debt limit again, The Trump tax cuts for high income households, they expire in 2025. There's a bunch of the spending related to Obamacare that has to be renewed by legislation in early 2025. So, there's a lot of reasons to think that that's going to be a forcing point in time for us to address our long-term problems. If we have this conversation circa 2026 or 2027, if I'm still around.
Willy Walker: I was just going to say, I hope we’ll be doing this in 2026.
Mark Zandi: We haven't addressed it then; I might be singing a different tune. But at this point I feel like it's not an issue and not a significant issue. We've got other bigger problems at the moment.
Willy Walker: Yeah. You point out, Mark, though, that you went back to Clinton and Gingrich, and I do think that many people forget that from 1995 to 2000, the Fed funds rate sat in a band of I think it was 5% to 6.25 is the band that the Fed funds rate was in for that period of time. And I think after having been in such a low-rate environment for so long, many people kind of forget that having a Fed funds rate at zero is unprecedented. But we've all gotten kind of used to it. But the economy did exceptionally well from ‘95 to 2000. We actually balanced the budget with the Fed funds rate. There was between 5% and 6.25. And so that these aren't sort of uncharted territories as we see the Fed funds rate go up to 5.25?
Mark Zandi: Great. I'm very impressed that if you had asked me what the average funds rate was between 1995 and 2000, I don't think I'd have gotten that right. That's pretty cool. But you're pretty nerdy. Nerdier than I am, I think.
Willy Walker: That's a big compliment. The reason I raised that, I mean, I do think that there's this sense that we kind of are in uncharted territories as it relates to what the Fed has done. And we just aren't. We aren't. Although the other thing that I thought was as I went back and looked and got prepared for this Mark, one of the other things that I keep hearing, that this has been an unprecedented rising cycle, that it's moved faster, quicker than ever before.
But if you go back and look at what Paul Volcker did in 1980, between July of 1980 and December of 1980, the Fed funds rate went from, I think it was 9% up to 18%. I mean, they put 900 basis points into the Fed funds rate over that period of time. And so, while all the adjustment is so difficult for people in particular in the commercial real estate industry as it relates to this adjustment and what it means for your debt service and your debt service coverage and things of that nature. We aren't sort of with the Fed funds rate at 5.25 and a ten year at four, we're sort of in a normalized cost of debt capital market that it just happens to be that for the last 12 years or so, we've been in this sort of, you know, zero interest rate environment.
Mark Zandi: Yeah, certainly on the long end, you know, a ten-year Treasury yield sitting around four, that feels like we should get used to that because that's kind of where it should be in the long run – abstracting from the ups and downs in the economy, in the business cycle.
That goes to the way thinking about my intuition is that in the long run, the ten-year yields equals the nominal potential growth rate of the economy or nominal GDP growth, and that's four: 2% real potential plus 2% inflation's that’s four. So, on the long end I feel like we're close to where we're going to be, give or take, you know, going forward. Short end obviously, that needs to right itself. So, the 5.25, 5.5% funds rate is intentionally restrictive, it’s high in an effort to slow the economy's growth and inflation. And that's working reasonably so. And that feels like to me by this time next year, inflation will be in sufficiently that the Fed will say, okay, I've done my work and I'm going to start lowering interest rates slowly at first. I don't think that they will move quickly and then I don't think they'll have to because the economy won't be in recession.
But by mid-decade in the 2025 going 2026, we should have a fund rate target that's two and a half, two and three quarters, something like that. That's what economists call the R-star, the equilibrium rate, that's the rate where monetary policy is neither supporting economic growth nor weighing against it. It's kind of neutral. But that would be normal. That's where I think in the long run, we will be where we should be: 4%, ten-year yield, 2.5 percent funds rate target, 150 basis point spread between the two is kind of - if you do the arithmetic, the long run historical average.
Willy Walker: So, I went back and looked at an interview you did on CNBC back in October, and at that time you said, maybe the Fed does 75 basis points in November, 50 basis points in December 25 in January, and then they're out. And, you know, if we'd only gone down that path, we would have avoided a significant amount of pain.
But you've been calling for a while, Mark, for the Fed to stop tightening and to stop raising rates. Right now, given where we are and there pause and then 25 basis points, what's your thought as it relates to future Fed rate increases? Do we have another one between now and the end of the year? Do you think they have to keep tightening even further given your read on inflationary pressures and what the Fed has said, what should people be thinking as it relates to where the Fed funds rate goes over the next five months?
Mark Zandi: Yeah, forecasting the funds rate, it gets a little difficult when there's a difference between what you think they should do and what they will do. I clearly thought back then that, they don't need to raise rates to 5.25 to 5% to get the job done, to get slow growth sufficiently to get inflation, because in my view, the inflation that we're suffering from is largely due to the supply shocks created by the pandemic and the Russian war and the conflation of those two things in inflation expectations. And as the pandemic and the Russian war affects go further back into the rearview mirror, inflation will moderate, and we don't need high, much higher interest rates. We don't need to push the economy into recession to get that inflation back in, that feels like what's happening now, inflation has come in quite dramatically. All the trend lines look very good, but yet the unemployment rate is still we'll get another read on Friday, but it's three and a half percent. It hasn't budged in 12-18 months. So, I just don't think they needed to raise rates. At this point they definitely do not need to raise interest rates. Then this should be the end of the story.
The other thing that I found a bit perplexing in the context of what they “should” do and what they “would” do. On the “should” side, I do think the stress of the banking system and the financial system more broadly are under or consequential and that obviously boiled over back in March and required a pretty aggressive policy response. The Fed had to step in, the FDIC had to step in, the Treasury had to step in to quell the crisis. But the tensions, the kind of the reasons for why the banking system got into trouble, haven't gone away.
And it goes back to the yield curve, the inversion of the curve and the effects it's having on their operating environment, their net interest margin. So, I view that as a significant risk or threat to my optimism about the economy that they keep putting pressure on the system. They certainly continue to raise rates and cause the curve to go even more inverted. Then at some point they're going to break something that they're not going to be able to fix quickly and we will go into recession. And again, why? You know because inflation is coming in. It's doing exactly what you would want it to do. And again, all the trend lines, you know, Willy, I forecast lots of stuff, you know, some stuff I feel very confident in. Some not so much.
The outlook for inflation coming in more. I feel very confident it's coming in because I know vehicle prices are going to decline. I know the cost of housing services are going to decline because of rent growth, which we're going to come back to. I know that electricity prices are going to come in. There can be some spanners and that creates some problems. You know, oil prices can jump and so forth and so on. But I feel very confident inflation is coming in. So, I don't think they should raise rates at this point. They don't need to raise rates. I don't think they will. But I say that they've done things that I don't think they should have done. Those last 50 basis points in rate hikes, I don't think they needed to do, they certainly don't need to go any further from this point, given what we know and given how things are playing out here.
Willy Walker: So, there's a bunch in there that I'd love to kind of double click on as it relates to all of those component parts. But let's start here in the banking sector. How sensitive to further rate increases do you feel the banking sector is to the degree that if they don't raise again, is it your view that banking sector has avoided and averted a meltdown in a crisis that we clearly saw happen in Q2 of 2023 and that the over capitalization of the banking system, while there clearly could be a small bank that goes under just for poor management, or other issues. But would you say that if you added, is there any sensitivity analysis that you and your team have done as it relates to, you know, you add another 50 basis points, another 75 basis points to the Fed funds rate, and there are some banks that start to really tip upside down given being upside down on their balance sheet. Is it that sensitive or is it more of a general view on the banking sector that it just can't afford a whole lot more?
Mark Zandi: Yeah, I think the system is under a lot of pressure and, for the moment, it's stable because of the policy response, the bank term funding program that the Fed set up. And if you look at that every week, it increases not by tens of billions – but by billions. So that means that banks are borrowing against their security holdings at par in that program and they need to do that. That's not a good sign. You want to see that coming into the system. In my view, it is under a lot of pressure. It can manage through if the Fed doesn't continue to raise rates and inflation comes in and the Fed starts easing policy by this time next year.
If they have to raise rates further or feel like they do and or they keep rates elevated for an extended period, you know, more than the next six, nine, 12 months, they take it all the way through into ‘24 or ‘25. Then the banks are going to run into a situation where they can't manage it. Right now, they're kind of managing the curve. They're keeping their net interest margin stable through hedging and matching. I mean, go take a look at JPMorgan's NIM (net interest margin) last quarter. I'm making this up, but roughly speaking, 280 basis points. It was 280 basis points the quarter before, in the quarter before that. So, they're able to manage it.
But over time, if the curve stays flat to inverted, certainly they keep raising rates and the curve gets even more inverted, given all the other things that they have to deal with, then I think it's going to become increasingly difficult. Something else is going to break and the next time it breaks, there may not be a quick fix, particularly. Here's the other thing, Willy, we're focused on the banking system, but there's this thing called the ‘shadow banking system’ out there. The other, you know, half the credit that's provided to the economy comes from banks that have come from, consumer finance companies, independent mortgage banks, REITs, pension funds, hedge funds, Sovereign wealth,, private equity firms, a whole lot of stuff. There's a lot of stress going on out there, too, and it makes it even more nerve wracking is it's not transparent, thus the moniker ‘shadow banking system.’
And if it's opaque, it's much more likely to experience some kind of funding run that the sources of funding will say, Oh, I don't really understand what's going on here, so I'm going to paint everyone with the same brush and just stop funding. And you get it's like a bank run in the shadow system. Then the question is, well, how does the Fed respond to that? What tools do they have for addressing that?
So, my broader point is, I think the system can manage through where we are if inflation comes in, as I expect, and they're allowed to be in a position where they can start easing policy by this time next year. I think we're good. You know, we're going to get through. But, you know, if they keep raising rates for whatever reason or if they continue to maintain this very tight policy for more than a year, because it goes into late next year into 2025, I fear something will break somewhere and then we'll go into recession. Then they'll be scrambling.
Willy Walker: It's a really interesting point as it relates to the shadow banking system, Mark and credit providers. I had Marc Lipschultz, the CEO of Blue Owl, on the webcast last week, and Marc and I talked about how Blue Owl has capitalized on the growth in private credit. And we talked about a chart from their annual report which just shows the number of public companies out there and then the number of portfolio companies and private equity firm portfolios, and the two charts just completely crossed one another.
Back in 2000, you had 10,000 publicly traded companies and I think the number was 1,500 companies owned by private equity firms. And now you've got 10,000 firms that are owned by private equity firms, and you've got 4,000 public companies.
And I guess one of the questions I have about that is there seems to be this sense that the federal government has an obligation to step in when the public markets are impacted. But if something were to happen in the private markets, that can kind of come and go and not sort of have government action.
But it makes me think back to long term capital management and the impact that long term capital management had on the economy in the late 1990s, that while the federal government didn't step in to prop up long term capital management, it had this ripple effect throughout the economy that really set off the dot.com downturn. Should we be concerned about the private capital markets today like we were not concerned back in the late 1990s as it relates to long term capital management?
Mark Zandi: Yeah, you make a great point. I mean, I think the Fed and other Treasury, other regulators have the ability and the tools to address problems in the traditional banking system and in terms of making sure that credit continues to flow through the banking system. They don't have the tools or even the ability, legal or otherwise under most circumstances, to step in and help out the institutions in the shadow system, including providers in the private credit markets.
Even if they wanted to, even if they felt like they had the legal right to, it's unclear how they would do that. And it's complicated. It depends on the market to market because of the dynamics and they don't really have the clear understanding or the horses to really understand what's going on in all of these different markets.
I mean, I'll give you an example, a sense of that. If you look at the leverage loan market, the private credit market, you know, $1.56 trillion in outstanding, I'd say about half of that $800-$900 billion of that goes into CLOs. That's pretty transparent, because that debt is rated. There's a lot of transparency around the financials of the companies with that debt.
But the other half of that, the other $800-$900 billion that – we know nothing about. It's very, very opaque. We have no sense of the terms, the underwriting, the ownership, the structure. And that makes it much scarier, nerve wracking, because you just don't know what you don't know.
And again, how would the Fed step in and support that market if it went south in a big way? So, I think that's a reasonable concern and issue. Now, it's not like anything I'm saying is new to the Fed or FSOC, that's the folks that look at the system and scour for these kinds of vulnerabilities. They know all this. So that's the good news. The bad news is I'm sure they are scratching their heads trying to figure out how to get their mind around it, measure it, and ultimately what to do about it if things do go off the rails. So, I do think this is a significant vulnerability that, again, could manifest if the system remains under a lot of pressure. And it will, if the Fed has to continue to keep its foot on the brakes and the curve remains as inverted as it is for any length of time.
Willy Walker: You mentioned that we've got a jobs report coming out on Friday Mark, you've been very straightforward of focusing that the consumer is still very strong, and we can talk about the consumer in a moment. But as it relates to employment, in listening to some of your previous statements and reading some of your stuff, I think it's really interesting your take on the jobs market and why you think that 3.5-3.6% unemployment rate is here to stay for quite some time.
Mark Zandi: Yeah it may rise a little bit, Willy. I mean if it went from 3.5% too little over 4% no big deal. There's a lot of debate as to what this unemployment rate is consistent with full employment and wage growth, consistent with a 2% inflation target. So, if you told me four I don't know that I would argue? But I think it's fair to say that, that I think we're close to full employment. I don't think we're too far beyond full employment. I mean, the 3.56% unemployment rate that's been around for more than a year now is the same unemployment rate we had back before the pandemic for a year or two. Back then, we were worried about inflation being too low, well below the 2% inflation target. So why do we think 3.5% or 3.6% unemployment today is an economy that's too tight or operating beyond full employment. It feels like we're kind of roughly where we need to be.
If it eases up a little bit from here, that's fine, no big deal. And again, that might help on the inflation front, but I don't know that we need to. Again, going back to my point, why raise interest rates if inflation is coming in, wage growth is moderating, all the trend lines look good and in an economy that isn't beyond full employment is, you know, consistent with an economy that's operating where it should be operating right around the mid threes.
I will say, I do think job growth will continue to moderate here. Businesses are responding to the higher interest rates and the softening in demand. They're not doing it by laying off workers; the layoff rates are low. They picked up a little bit late last year, early, in the tech sector, but that’s already settled down. And if you look at layoffs, probably they remain very low. But the way businesses are adjusting is by reducing their hiring. They’re hiring rates are starting to come in. And I think if that’s the case, that’s another reason to believe we’ll be able to make through all of this without a recession, because I do think layoffs are critical to spooking investors, going back to consumer confidence, and causing investors to go into the bunker. You know that that only will happen if there's a significant increase in layoffs. And so far, that's not happening.
Willy Walker: You say that there is labor hoarding, I think is the term that you use going on by corporations a) due to a lack of immigration, b) boomer retirement and c) just the need for labor given that we're not going to go into a recession. And so, I think one of the interesting things to me is you picked these two things out and identified them a while ago.
In other words, while everyone else is saying we're going to go into a recession and there's increased joblessness is going to put downward pressure and that's going to hurt the economy and what have you, You said, no, we're not going into a recession. And in the process of that, companies are going to continue to hoard labor because it's so hard to go out and hire new labor.
How significant an issue is immigration reform to the US? We talked a moment ago, Mark, about the debt and this is clearly something you're putting out there. You know, you got kind of a ten-year trajectory to get your act together or this actually does become a very significant issue. But on the immigration side of things, isn't it fair to say that given the current birth rates in the United States, if we don't do something to get real immigration reform in place, to get legal immigrants coming into the United States at significant numbers, that the ability for this economy to continue to grow is under great, great pressure?
Mark Zandi: Yeah, totally. I think you nailed it. I do think businesses are what I call ‘hoarding’ because they know their number one problem. And this was the number one problem, the real problem before the pandemic, during the pandemic and now and in the future will be finding workers and retaining workers. And this goes to just simple demographics, the aging out of the workforce by boomers. Me, I'm aging out. People are retiring very quickly. By the way, interestingly, since the pandemic hit, we're seeing a lot fewer retirees come back into the labor market. Historically, people retire, then they come back. This time they're not coming back to nearly the same degree for lots of different potential reasons.
As you point out, the other key demographic fact here is that immigration has been under pressure, certainly in part because of policy going back to the Trump administration, in part due to global demographics, countries that have seen their incomes rise and their economies do better, their birth rates decline. Once birth rates fall below replacement rates, immigration stops. So, for example, Mexico, we're not seeing many people from Mexico come into our country because the birthrates have declined in those countries.
And then, of course, the pandemic itself had an impact on immigration. So, immigration has been impaired, and that's also significantly affecting growth in the labor force and our ability to grow more quickly. The other thing about immigration that's really lost in a lot of the debate is that immigrants are not only important in terms of people working, but it's also very important to productivity growth that immigrants tend to be more entrepreneurial, more risk taking. It's almost self-selection. You don't pick up and leave one country and come to another country, even if it's the United States of America without being a risk taker. And so, you do see a higher rate of business formation and innovation among companies that are founded by and driven by immigrants.
Of course, the other point I’d make quickly about immigration is it's really vexing our politics. You know, one of the reasons why we seem to be kind of fracturing politically is around this issue of immigration and for good reason. Immigration creates a lot of tensions, reasonably so in border parts of the country. And then you can see it's now spreading to different parts of the country. So, this is an issue we need to address. If there's no better policy that we could implement to improve our underlying growth rate more quickly and more significantly, then improving reforming our immigration policy to allow for more immigrants, more skilled immigrants. But we need skilled and unskilled workers. But, you know, making it a more rational policy, I think nothing would go further to helping our long-term growth prospects than doing that.
Willy Walker: So. at the beginning of this year, when lots of people were calling for a recession and now it seems easy for people to say, okay, we're going to maybe have a soft landing here. I mean, we all have to keep in mind that there were plenty, plenty, plenty of people who a year ago were clearly saying we're headed for a massive recession. And then even as recently as a month ago, people were still saying, you know, we're still headed towards a recession now. So, the tune has changed.
But well over six months ago, you were out there saying, I think we avoided a recession in the US for five reasons. One of them was the labor issue about labor hoarding. The second is excess savings within the consumer, light household debt load, anchored inflation expectations and low oil. The consumer is still very healthy as it relates to two things: savings and overall debt load. Take that and if you would, tie it into fixed rate mortgages and how important the refi wave that just happened on the single-family side is to the overall balance sheet of the US consumer.
Mark Zandi: Yeah, that's been very important. Obviously, people refi down into the previously record low interest rates. I mean, hard to believe, but the 30-year fixed I think got down to 2.6, 2.7, something like that in kind of late 2021, right before the Fed started jacking up interest rates. And of course, that set off a refinancing wave that was particularly massive. And so, I think the average coupon on existing single-family mortgages is about three and a half percent. And they're locked in.
In fact, if you look across all household debt, mortgages, auto, student loans, cards, consumer finance, the whole shooting match. Only about 10% of the debt has interest rates that adjust within one year of a change in market rates. So, the American household is very well insulated from this run up in interest rates. So, their so-called debt service burden, that's the proportion of their after-tax income that they must pay to remain current on that debt is about at a 50 year very low and not rising again because people have locked in those low rates. So that's really been very helpful.
It's also one of the biggest distinctions between our economy and everywhere else in the world. It varies a lot, but if you look in other developed economies like in Europe, Canada or Australia, New Zealand, certainly in emerging markets, their debt is much more short-term debt and adjusts more quickly. So those economies are much more at risk or more sensitive to the run up in interest rates because it translates through in terms of those debt payments a lot more quickly.
Willy Walker: So, let me just jump in with a quick question for you on that one. Is it fair to say that the holding on to the line that the United States of America is built on the 30-year fixed rate mortgage for the reason why Fannie and Freddie should have been taken into conservatorship and remain in conservatorship today is actually, if you look at it in hindsight, exceedingly important to the fundamentals of this economy today. And one of the reasons why it's performing the way it is?
Mark Zandi: It is. It is, though, it is interesting. I mean, what we're doing as a nation is we're transferring the interest rate risk from the household to the financial system, right? So, the risks are just in a different place. Overseas it's in the household sector, here it's in the financial sector. That's worked out great for us in the current context, in large part because Fannie and Freddie are in conservatorship and we've managed, the interest rate in obviously in the post-GFC world been a lot of changes to Fannie and Freddie. So, they're much less risky. And also, given all of the regulatory changes since the GFC (The Great Financial Crisis) to liquidity and capital, banks have done a much better job managing that interest rates. They haven't managed it perfectly - SVB blew up, but it's certainly a lot better than it was. So, what we've done is we said, okay, the financial system is in a better spot to digest the interest rate risk than the household sector. And again, in the current context, in the current business cycle, that's worked out marvelously for us for a lot of the idiosyncratic reasons that I mentioned before. But we have had our scrapes with interest rate risk doing a lot of damage. I mean, there was the GFC, there was the S&L crisis. There's no free lunch. You can't get rid of the risk; you have to decided where it is going to go in how you manage it and how you mitigate it if it blows up.
Willy Walker: So, let's touch on energy for a moment and then I want to go to housing. This was a great segway for us to go to housing. But I want to tick off on the one other reason that you put out there on why we wouldn't go into recession, which is oil. And oil last July was at $110 a barrel. I've said a couple of times I read a Truist analyst report in July of last year that said that oil was headed to 160 bucks a barrel. And it was a pretty convincing piece, fortunately dead wrong. And today we sit at 79 bucks a barrel.
And I guess there are two questions I have there, Mark: How important to the overall inflationary outlook is energy cost, oil imports? And second of all, do you have confidence that oil stays in a sort of band of where it is today, or do you think that we could find ourselves in a much higher energy cost environment going forward for whatever reasons, whether it is the Ukraine war and supply shortages coming out of Russia or anything else that plays into that picture?
Mark Zandi: Well, oil prices are one of those things I've forecast where my confidence is not so much, it's a tough one because there's so many moving parts that are not driven by economics or driven by geopolitical dynamics. Russia is kind of at the top of the list, but OPEC, particularly what Saudi decides to do. What's going on with China and COVID policy. So, there's a lot of moving parts here. I will say that I am expecting oil prices to settle in between $80 and $90 a barrel, WTI on the low side, Brent on the high side. So, we're kind of sort of there and I've been expecting it for a while. I mean, China, the economy has been softer, and we haven't seen as much demand and that's kept prices down for longer than I anticipated. But, now feels like we're migrating up. So, $80 to $90. If we stay there over the next 12, 18 months, certainly not go over that to any significant degree for any length of time. We’re golden, I'm confident about inflation. I'm confident that the Fed will end its rate hikes that we will get through without a recession.
If prices jump though, back closer to $100 or certainly if they go over $100, that means that the cost of a gallon of regular unleaded is going to go from $3.75, which is where we are today to $4.50. If we get back to $125 barrel oil, that's five bucks. If that happens, then we're done. I think it's going to suck the wind out of consumer, confidence will fall. The Fed will likely continue to raise rates to try to keep inflation expectations down. And we're going into recession.
So, if there's one thing that makes me the most nervous, most immediately. And I worry about lots of things, financial system, potential government shutdown, student loans. There's a long list. The one thing I worry about the most, because it can happen so fast and it's so unpredictable is the price of oil.
Well, here's the other thing. It's not only the price of oil, it's about refineries, right? I mean, one thing we're seeing now, one reason why we're paying $3.75 and $80 oil is because the heat is causing all kinds of problems for the refining sector. And it's just crack spreads are gapping out. And, you know, this nightmare, Willy, that we're going to have a Category 5 hurricane. First of all, it goes over my home in Florida. That's the first thing. And then it goes into the Gulf and hits the coast of Texas and wipes out a refinery, that would be a problem. That would be very problematic. Then you could see prices that are up or at a point where we might go into a recession. So that's the one thing where I'm not as confident in where I think the risks are most significant. The oil price.
Willy Walker: You mentioned really quickly the student debt repayment number of $1.5 trillion of student debt outstanding. The Biden administration has put forth a forgiveness program that was going to add a huge amount to the federal government's indebtedness, if you will, to the tune of about a half trillion dollars that was obviously voted down by the Supreme Court. We're coming back online where at the end of August, consumers need to start repaying their student loans after the forbearance program that was put in place around COVID. You don't think that's that big an issue, do you?
Mark Zandi: I don't. We do the arithmetic and all the student loan borrowers started repaying and didn't have resources and had to cut back the same amount on everything else they were spending their money on. It's about $70-75 billion. Not inconsequential, certainly not for them. But it's not a dagger in the heart, I don't think. But the Biden administration also just recently, through executive order, said to servicers of those loans not to report a delinquent student loan borrower to the bureaus. So, there is no penalty to a borrower if they don't pay. So, I suspect many will not until they have to, which at this point is a year from now, which may be extended again, who knows?
Willy Walker: How can they do that? In other words, isn't credit rating, isn't your FICO score, it's calculated in the private sector. The concept that the Biden administration would say you can't report that data. Isn't there a lawsuit coming along to say, no, we want fair and accurate data on our consumers and that needs to be reported?
Mark Zandi: Yeah, I'm sure there'll be lawsuits. There always is. I will say this was the same, we did this with the CARES Act and the American Rescue Plan. Anyone who was delinquent on any kind of credit, they could not be reported to the bureaus, in fact, that did create a lot of problems around score inflation, which is a whole nother issue or story. I think in this case, they have more significant legal standing. And I'm not a lawyer, but listening to the lawyers, because these are government loans, and they can service them any way they want. And part of the program allows them to adjust these terms to their servicers, and they're just exercising that right in terms of their agreements with the servicers. But I'm sure there'll be lawsuits, but by the time they're adjudicated, you know. My point is, I don't think we're going to see $75 billion in payments come October.
Willy Walker: I got it. Let's shift to housing for a moment, because as you have talked about us not hitting a recession as it relates to the overall economy, you've also said we're in a full-bore housing recession right now and that the only thing that is going to end that recession is that housing becomes more affordable. I've got a quick slide that I want my team to throw up on the screen, if I can.
Source: Census Bureau, Zelman & Associates analysis.
That is from Zelman that they sent across to me this morning. This slide I find to be fascinating, Mark, because as you can see here, the purple at the bottom is the number of homes. This is new home sales under $300,000. And you can see that, you only need to go back to 2010-2011 when over 70% of new homes were being sold for a price point under $300,000.
And as you can see, over the last decade, new homes being supplied to the market have just gone up and up and up as it relates to that price point where they're coming in. We can pull this slide back down. It's made the point I wanted to make.
With your point about mortgages in a three and a half percent mortgage, the existing inventory isn't going to come on the market because anyone who would sell their home today loses a three and a half percent mortgage and has to flip into a six, two, six and a half percent mortgage. So, you're not getting a supply of old inventory. I just showed very clearly where the homebuilders are building, which is at a very unattainable price point for the average American. So, what's the net-net here? Because you're very clear in saying until we get this affordability issue taken care of in housing, which is a supply issue and supplies are being constrained for lots of different reasons, until that happens, we're going to stay in a housing crisis in America.
Mark Zandi: Existing home sales are very low. They're kind of pandemic low, GFC low. And I don't see them coming back in any meaningful way unless affordability is restored. And that requires mortgage rates to come down, incomes to rise and/or house prices to decline. And I suspect we'll see some combination of all three things.
New home sales have held up better because builders have effectively cut prices. I mean, their effective prices have actually come down 10 to 15% because of all the incentives that are providing. Interest rate buy down being the most notable. They just are subsidizing a much lower initial interest rate for a year or two or three. So, they've effectively cut prices. And that's why the new home market is held up a lot better than the existing market, at least so far.
But I do think we do need to see, and I do expect mortgage rates to come in a little bit. I mean, right now, the 30-year fixed last I looked was close to seven. If I'm right, about ten-year yields, long run being around four. That suggests the 30-year fixed on average should be five and a half, five and three quarters. So, I expect some of that. I don't expect a recession. So, I do expect some improvement in incomes. But even with that, I do expect house prices to come in a bit. And I think that the way this works is it's a slow grind. It's not a cliff event because people don't want to sell their home with a three and a half percent mortgage. But at some point they will have to sell. Life happens. Divorce, death, children, job change. And they can hold off selling for a while, but they can't hold off selling forever. And over time, those life events will build up. We'll see more people putting homes on the market and transactions will occur and those transactions will occur at a lower price.
Now, I don't expect big price declines, but if you told me peak to trough prices are down 5-8% over the next two, three years nationwide, I'd say, okay, that sounds about right to me. You know, something like that. And if you get incomes, household incomes rising four or 5% and you get mortgage rates down to five and a half by three quarters, then we get affordability back to something that's more workable and we'll start to see those existing home sales start to come back up again, origination volume starting to come back up again. But I do think we need some price declines.
Willy Walker: But given that slow grind, what does that mean for the multifamily industry? As I hear you walk through that supply of new single-family homes at a price point that is thoroughly unaffordable for most renters, existing inventory not being put out on the market, therefore that lower price point inventory isn't up for sale, therefore not available to renters. I sit there and hear that, and I say renters aren't going to be able to, if you will, move from rental housing into for sale housing. Therefore, occupancy levels stay high in multifamily and therefore we do get rent moving again from where they are right now, which is basically flat across the country. And that in 2024, in 2025, multifamily rents are going to start to move again.
Mark Zandi: Yeah, I think that's right on the demand side. I think for affordability the single-family market is nonexistent. So, renters can't afford single family homes. Of course, rents are high given the surge in rents previously. So, they can't say they're having a hard time saving as well to put that down payment they need. So, I do think that means the homeownership rate, the percent of the population that rents their own home, that's peak. I don't know, we got a data point today. It will be 65.9%. So, I think that the high watermark is around two thirds. I think on the demand side, you're right.
I think though, there's supply coming. I think there's more supply. I mean, if you look at the amount of multifamily units in the pipeline going to completion, it's close to a million units. That's a record by orders of magnitude. Got all bottled up because of the pandemic. Going back to my earlier point about why we have high inflation, pandemic messed with supply chains and labor markets, couldn't get multiple units cross the finish line. I'm saying stuff you know better than I, but that will happen. And as we get more supply, most of it I think is probably more in the high end of the market as opposed to affordable workforce housing. But at the high end, so in big downtown areas, big cities like Philly, there's a lot of multifamily units that are in train coming to completion. And I think that that's where you're going to see the continued rent weakness, you know, going forward.
But in terms of workforce, affordable rental. Yeah, you're right. I think if you make the distinction between lifestyle rental versus rent by necessity, I think lifestyle rental is under pressure compared to rent by necessity.
Willy Walker: Marc, we've talked about a lot here. We talked about housing, we talked about the consumer, we talked about energy. We've talked about mortgage rates. We've talked about Fed policy and where rates are going. As you look across the landscape right now, given that you have been very prescient over the last year about some things that a lot of people are concerned about that haven't materialized. As you look out and say, okay, August 2nd of 2024, if we had this conversation, then what's the outlier, if you will, in the analysis?
I thought your comment about energy and about a hurricane that comes through and knocks out a rig in the Gulf of Mexico is a really interesting one as it relates to the sensitivity that we have there as it relates to energy input and energy costs. But beyond that, anything else that you're focused on that says, there's a weakness here, it sounds like the banking sector isn't something that you're terribly concerned about unless we stay higher for significantly longer or they keep tightening to a degree that you're not projecting right now. What else? What's the outlier? You don't think student debt is something that we really have to worry about right now? What's the curveball that you are focused on, trying to get your arms around that people ought to be focusing on at this point?
Mark Zandi: Well, I think the next thing that may nail us here is the government shutdown, high probability there will be a shutdown come October 1st, which is the start of the federal fiscal year. You need of the House to agree to a budget and the incentives at this point are not to do that. There are a lot of House Republicans. They're pretty angry at the debt limit deal. They don't feel like they got the spending cuts that they wanted and they're going to try to get those cuts via the budget process and use a government shutdown as leverage.
There is a Treasury debt limit deal, there was an agreement that if lawmakers can't come to terms, there will be a 1% across the board cut to all discretionary spending January 1, 2024. One percent's pretty significant, and it's both non-defense and defense. And the thought was that would be kind of a forcing mechanism to get people to agree because Democrats don't want cuts to nondefense. Republicans don't want cuts to defense. So, there would be an agreement come January 1, but that means there's a fourth quarter we could have a government that's not operating and that by itself, you do the arithmetic, that could be over a percent of GDP in a time when GDP is already going to be pretty weak because of the Fed tightening and everything that's going on. I think we can get through without a recession, but I don't know that it's going to be easy. I don't know if a soft landing is a good description of what we're going to experience. But you throw in a government shutdown, that could be a problem, particularly if you get to January 1 and they can't come to terms. You get a 1% cut, that's going to be really an issue. Student loan debt is not an issue by itself, but you now have a government shutdown, student loan issue, you have banks tightening credit, you've got oil prices moving north. I can construct a recession scenario pretty quickly if I have a government shutdown lasting more than a few weeks. And I think that I'm here in D.C. today. I'm sitting in an office in D.C. today listening to the conversation that's a real possibility.
Willy Walker: It's interesting, though. I think the last time the federal government shutdown was when Speaker Boehner was speaker of the House. And I think we were shut down for 13 days. The calculation was that tens of billions of dollars it cost our economy to be shut down for those 13 days. I certainly hope that those that are focused on the continued growth of the economy and avoiding any type of recession understand how much of a negative impact a government shutdown could have on us.
Mark Zandi: I think you should run for office.
Willy Walker: Yeah, right, exactly.
Mark Zandi: We need you. I’d contribute. Please put up a website. I'd contribute.
Willy Walker: Yeah, exactly. It's always great to see you. You're so insightful on the markets. I very much look forward to getting together in person sometime soon. And thank you very much for giving us an hour of your time and talking through these markets that we're working our way through. Better, I think, than many people expected other than you. And it's great to have gone back and looked at some of the things you've said over the last year and how many of those things came to fruition. I hope we avoid a government shutdown and I hope all your other thoughts as it relates to what's material and not material come to pass.
Mark Zandi: Well, you're very kind. And I really, again, appreciate your friendship and your support and look forward to the conversation a year or two down the road. So hopefully I'm at least half right.
Willy Walker: Mark, it's great to see you. Thanks, everyone, for joining us today. We'll see you again next week. Thanks, Mark.
Mark Zandi: Bye bye.