The Refi Boomlet Now, But The Long Term For Mortgages?

We are nearing the end of a decades long decline in Mortgage Rates. What happens when refinancing truly dries up?

The following is a reprint of my story in MortgageMedia

In my conversations with lenders, I have been reminded of one truth about this great industry where I made my career; we  tend to be very short-sighted. My caution is that while recession concerns have helped drive bond rates to new lows, and with the understanding they may go lower, there will be an end to this run and once the floor is found, the industry will be significantly oversupplied with lenders and loan originators.

Honestly, there are very few who have not been on the receiving end of this almost uninterrupted run of declining rates that began following the peak in the early 1980’s. While there have been periodic upticks in rates along the way, refinance activity became a key driver to bloating the capacity in mortgage lending. So, here is my caution to our industry about what will likely happen with the only question being, when?

Little Room Left: In order to have a refinance market in the future, there has to be room for lower rates. And if you look at where rates stand today, there is little room left compared to those years looking back. Even if rates level and bump around the current range, loans in the money will burn out. The graph above says it all.

GSE ‘Reform”: The long-awaited Administration GSE paper is expected to be released in the first week or two after Labor Day. Regardless of how it approaches the questions about legislation versus administrative reform, there is an expectation that the FHFA will administratively text steps that will affect the footprint of the GSE’s. Whether increased capital costs which will translate into higher mortgage rates or explicit policy changes that may restrict certain types of transactions that are deemed to be out of scope, it seems likely that a more conservative outlook will, at best, marginally worsen the GSE’s execution form some loans compared to private capital or FHA .

QM: The CFPB has announced that they will end the QM patch. Some have suggested that the GSE’s might just continue what they are doing regardless of the rule changes. Whatever happens, I find it unlikely that investors and lenders will take on the assignee liability of moving some of the loan volume from Safe Harbor to Rebuttable Presumption in co-mingled TBA pools. Whether requiring separate pooling or simply higher pricing to offset the risks, the end of the patch creates uncertainty and real challenges in making up the gap. The MBA has proposed a workable solution, but it  is rare that a regulator adopts a trade groups policy recommendation in full.

Recession: It is highly likely that we are headed to recession. Even if mild the cost burden on servicers with advances and personnel expense combined with other operational costs for any marginal increases in defaults will come on top of these other market and policy conditions that lay before us. 

What To Do?: In watching market corrections over past years I often find lenders in trouble trying to sell at the worst time based on some EBITDA multiple from previous boom years. In the end, these transactions often end up as a purchase for cash on hand and an earn out as smart acquisition experts know not to pay forward for past performance when conditions shift. Frankly, for some, it may be best to look at monetizing at the peak. 

For others with the capital and liquidity commitment and access to a dependable balance sheet, as I wrote in a recent Housing Wire blog, servicing may be one consideration for forward looking plans to weather the final slowdown. There are risks involved and I encourage any lender looking at this option to read my blog on the subject and consult an expert.

Bottom Line: A great friend in the industry who ran an IMB out of Birmingham, Alabama once told me that the key to success was to make hay while the sun shines and save enough to survive the downturns. Sage advice for sure, but this environment is different today. The industry has grown so large in size with more aggressive competition that, given the less likely refinance opportunity after this last gasp, it will be the best business models who focus on purchase transactions that survive long term. Discipline and forward thinking will be critical at a time like this. Let’s not get consumed with this temporary reprieve.

The Insanity Of The Markets

Global debt is at $246 billion dollars, roughly three times global output. There are over $15 trillion in negative yielding bonds globally and even Germany has joined the party with their 30 year bond below zero for the first time.

US Consumers add to the wild ride of this global economy posting over $14 trillion in debt, above the levels seen prior and during the Great Recession.

The Financial Times published a story recently highlighting the steep rise of Baby Boomers, now also seniors, filing bankruptcy in the US at a pace far exceeding their contribution to the total population stating, “The culprits are vanishing pensions, soaring healthcare costs and tens of thousands of dollars in unpaid student loans for themselves, their children and even their grandchildren.”

The Wall Street Journal very recently published a story about the inverted yield curve, a concern being echoed by economists and finance leaders globally stating, “Shorter-term bond yields have climbed above longer-term ones, a phe­nomenon known as an in­verted yield curve. That tends to hap­pen ahead of re­ces­sions.”

Finally there is the burden of debt for the US making it’s ability to intervene in a slowing economy with stimulus even more costly looking forward. As reported by The Balance, “On February 11, 2019, the U.S. debt exceeded $22 trillion. That puts the U.S. debt-to-GDP ratio at 108 percent.”

The issue of debt and political complexity is critical and is best summarized by this, “The problem is in cutting it. Each program has a constituency that lobbies Congress. Eliminating these benefits loses voters and contributors. Congress will agree to cut spending in someone else’s district, but not in their own.”

The article continues with this point;

“Any president must cut into the biggest programs to make an impact on the debt. More than two-thirds of government spending goes to mandatory obligations made by previous Acts of Congress. For FY 2020, Social Security benefits cost $1 trillion a year, Medicare costs $679 billion, and Medicaid costs $418 billion. The interest on the debt is $479 billion. To lower the debt, military spending must also be cut. The most Obama spent was $855 billion in FY 2011. The most Bush spent was $666 billion in FY 2008. Instead of cutting, Trump is breaking all those records. Military spending rose to $989 billion in FY 2020.”

In recent weeks I have heard enthusiasm from those who benefit from what results in a scenario like this. As global investors pursue a flight to quality in US Treasuries and other high rated investments, borrowing costs decline. This can lower rates on everything from Mortgages to Autos. And an inverted yield curve is especially helpful to long term rates leading to cheers from mortgage lenders who now have the opportunity to refinance the mortgages of millions of Americans.

But for retirees with fixed income from investments and deposits as well as any investor needing yield, the implications are concerning. A return to a normalized yield curve is a far more healthy condition for the long term.

But let’s be clear, this is all news that should strike us with concern about this slowing economy. Unlike the last Great Recession, one that brought us closest to a national depression more than any other economic period since the 1930’s, this time the ability to intervene will be limited by the already low interest rate environment and an even more leveraged balance sheet both domestically and abroad. The ability to execute a stimulus plan in recession is better supported when there is a wider spread above zero.

As reported by Fortune Magazine, in a recent survey of economists 60% believe the US will be in recession before the election in 2020. While there is debate between those with the most bearish views and others who look at a more temperate downturn, there should be a heightened awareness about this economic burden for a nation whose wealth gap is only increasing, where housing affordability has become far more urgent to an ever increasing percent of the nation, with concern about health care costs, and where wage disparities for lower and middle class families are widening.”

Piling on with global political extremism, protectionist trade polices, the increasing costs of global weather conditions, and more only increase the concern for leaders, true leaders, to lay aside petty issues and focus on the long term viability of the ever increasing burden being laid upon this citizenship and future generations.

But whatever lies ahead, we should look at this latest rally in the long term bond markets as concerning to the economy versus a positive for its short term benificiaries.

What happens next? My advocacy here is for an active and engaged electorate. The passivity of this nation is something that should be abhorred. Eligible voters need to vote. In 2016 only 61.4% of Americans voted, down from 2014.

Awareness is step one, engagement is step two, activism is step three. We need to demand more as citizens and mute some of the incredible power of special interests in policy setting. Whatever one’s view, it simply won’t matter if we all don’t actively participate.