Written by: Samira Fatehyar
Synopsis
You can listen to the podcast here.
Lots of data continues to develop. One minute we see the stock market racing up at an amazing momentum and the next minute it’s headed downward and fast. One data set tells us everything is going to be okay and the next says quite the opposite. When we are in the midst of unprecedented times, this will be the case. There is lots and lots of noise. Don’t let it drown out the important factors.
This week I decided to take a deep dive into housing. I wanted to examine rent debt, mortgage rates, and homeownership by generations, especially as it relates to Millennials and Generation Z. But first, we’ll have our economic update and later we’ll dive into mortgage schemes in Europe as well. I hope you enjoy this post!
Economic Update
Manufacturing and Services
Last week, the ISM came out with two key pieces of economic data regarding the manufacturing and services sectors. Now, for those of you that may have forgotten:
The ISM is the Institute for Supply Management, which is the largest association for supply management in the world. They aim to provide education to professionals in the industry. So how is their manufacturing index calculated? The ISM sends a survey to purchasing managers in 300 manufacturing firms. How is their service index calculated? The ISM sends a survey to purchasing and supply executives in 400 (non-manufacturing) service firms. It monitors any changes to production month over month.
I found it quite interesting that the manufacturing sector is expanding and at quite a fast pace where the service sector is starting to contract. But, let’s get into the data of it all. Let’s first start with the good news in the manufacturing data.
Table 1
ISM Manufacturing Data, February 2021
https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/pmi/february/
Looking at the data we see that almost every single factor that the ISM takes into account for manufacturing is increasing. New Orders, Production, Employment, Backlog of Orders, New Exports, and Imports are all growing. But I want to emphasize that prices are also increasing and this should be something we need to keep in mind as we move forward as I see this being a trend for some time. Why are prices rising? Well, we are experiencing a shortage of a lot of key products like semiconductor chips and lumber, which may start causing a strain on production. This can also lead to higher inflation, which is a topic we will be discussing again, but later.
Graph 1
ISM manufacturing index, 2016 to present
https://www.marketwatch.com/story/u-s-manufacturers-growing-at-fastest-pace-since-start-of-pandemic-ism-finds-11614611841
Though many businesses remain optimistic about the future as the economy starts to reopen with more vaccines being distributed. The manufacturing sector’s sentiment is right about where it was in 2018, one of our highest points in recent years. Overall this is great news for manufacturers and I do hope we continue to see this rise in manufacturing sentiment.
As for the service sector, it’s not as optimistic as manufacturing is. The service sector’s sentiment has now hit a 9-month all time low.
Table 2
ISM Service Data, February 2021
https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/services/february/
Now, it should be noted that all factors contributing to the overall sentiment is still growing it’s just at a slower pace. So what’s causing a lack of confidence in purchase managers? The service sector is experiencing supply chain bottlenecks due to shortages of key materials as well as prices rising due to the shortage. Again, like in the manufacturing sector, prices are turning out to be a major concern for both sectors.
Graph 2
ISM Services Index, 2018 to present
https://www.marketwatch.com/story/the-huge-service-side-of-the-economy-suffers-a-hiccup-in-february-ism-finds-11614785129
Though looking at the graph above, the decrease in sentiment is not as bad as it was during the start of the pandemic last year. Many believe that this is just a temporary lag and by next month things will continue to buzz along within the economy. I am a bit more cautious of this sentiment as we are betting on vaccine distribution and hopes that supply shortages will loosen up and prices will neutralize. The hope is that inflation doesn’t cause a major occurrence, but unfortunately I see no way around it at present. Let’s continue to remain hopeful, but just make sure you are not making financial decisions based on what may turn out to be false hope.
Fed Chairman Powell
On Thursday, March 4, many investors were expecting to hear from Fed Chairman Powell about some tactic to curb higher Treasury yields and when that didn’t happen, the market took a nose dive. So what is causing higher Treasury yields right now and why is it all so scary to investors? Well this means that mortgage rates are going up, but we’ll get into that in a little bit.
Right now, there is an expectation in the market for higher inflation, which means the dollar has less purchasing power and will take more dollars to purchase the same good. Now what’s causing inflation fears, well we went into that a month ago, but it has to do with a couple of things. Currently, markets are worried that the stimulus package will end up overheating the market and cause inflation to rise. Others, like myself, are concerned with the Fed’s balance sheet that seems like it keeps growing, without any sign of eventually letting the air out of the enormous bubble they are creating. And yes, many will argue that we need the recovery to happen before they can let the air out, but we have markets already jumping to the conclusion that we are in a recovery. A sentiment that both I and Chairman Powell disagree with. He mentioned in his meeting that we have a long recovery ahead of us.
We have too many in the market jumping to big conclusions about what will happen next in terms of inflation. Currently, many equity bulls believe that the increase is a sign of a strong economic recovery. But it’s leading to concern that consumer good prices will go up. Many see Chairman Powell as being dovish right now, which means that he supports low interest rates and an expansionary monetary policy to increase employment. But many are worried that if the Fed continues on this path, that market expectations of inflation will increase to a point where the Fed will have to become hawkish, or increase interest rates and contract the money supply to combat high inflation. This can lead to high unemployment. This is essentially what the Fed is battling between, high inflation or high unemployment.
Inflation expectations in the market are not far-fetched, but many want the Fed to act now and well they can’t because our unemployment situation has not improved. So in the meantime, I foresee Treasury yields continuing to stay at elevated levels until more economic data comes out. Once we get more data, it’ll give a sense to the Fed as to which direction they should go in, but get ready for a continuous rollercoaster in the meantime.
The State of the US Housing Market
Rent Debt
The very first part of this topic I wanted to dive into is that of rent debt, or the amount that is owed in back rent. This is extremely important since it will essentially determine whether we will face a homeless crisis or not. Now, there isn’t much data out there regarding rent debt and how much is owed. Much of the data is conducted through surveys and so it makes it a bit more complicated when trying to assess the damage.
Now, before I get into the estimates, I should note that in the December coronavirus relief package, $25 billion was set aside for rental assistance. In the newest $1.9 trillion stimulus package, another $25 billion will be set aside for the same thing, so essentially there is $50 billion that should help with rental assistance. Though it’s quite a lot of money, it may not be enough to combat the growing problem.
The Urban Institute, a think tank that conducts social and economic policy research, came out with a table summarizing the three organizations that conducted surveys to assess how much is due in back rent.
Table 1
Back Rent Estimates in January 2021
https://www.urban.org/urban-wire/many-people-are-behind-rent-how-much-do-they-owe
The three organizations are the Federal Reserve Bank of Philadelphia, the National Council of State Housing Agencies with the help of Stout, and Parrott and Zandi, who work for the Urban Institute. The estimate in rent debt in the US from the three organizations ranges from $8.4 billion to $52.6 billion. Yes, it’s quite a range but it’s essentially the only direct data we have when it comes to evaluating rent debt.
Now, I will note that the three different estimates differ in three ways. The first is that not all took into account if the renters had Covid-19 related job losses or if they were just in financial stress. The second was an assumption on how much back rent delinquent renters owed. The third way was the timing of each estimate. The Philadelphia Fed used data available through August 2020, Stout used data through November 2020, and Parrot and Zandi used data available through mid-January 2021. I’ll also note that none of the estimates include the impact of the initial $25 billion available through the stimulus package passed in December.
So knowing this it makes a lot of sense as to why the Philadelphia Fed estimates rent debt to be $8.4 billion, Stout estimates $13.2 to $24.4 billion, and Parrott and Zandi estimates it to be $52.6 billion. Though the methodologies are a bit different the timing of each may indicate that the problem is indeed ballooning over time.
Each organization also estimated different numbers for how many people currently have rent debt. The Philadelphia Fed estimated it to be 1.4 million households, Stout estimated it to be 7 to 14.2 million households, and Parrott and Zandi estimated it to be 9.4 million households. This is also quite a range. The range tells us that it could be anywhere from 1% to 12% of the population affected with rent debt. You might be thinking, wow well that isn’t so bad, but it’s a problem that’s been exacerbated by the pandemic and if real relief can’t come, I can almost guarantee that these numbers will increase.
Now, you may be wondering how much in back rent is owed on average? Well the Philadelphia Fed and Parrott and Zandi come to similar conclusions of $5,600 to $6,000, while Stout estimated $1,740. I think the more realistic number is the $5,600 to $6,000 as housing costs are rising and becoming more unaffordable to the average employed person. Parrott and Zandi further estimate that the average person is behind in almost 4 months of rent, using the Bureau of Labor Statistics’ Consumer Expenditure Survey.
Unfortunately, the $1,400 stimulus checks that is expected to be mailed to people in need will not cover the total amount owed in back rent. But you may be wondering, well that’s what the $50 billion set aside for rental assistance will be used for. Well, I wanted to take a look and see who was eligible and how they could go about getting assistance.
According to the US Department of the Treasury, in order to be eligible for the emergency rental assistance program, you need to meet at least one or more of these criteria:
1. Qualifies for unemployment or has experienced a reduction in household income, incurred significant costs, or experienced a financial hardship due to COVID-19;
2. Demonstrates a risk of experiencing homelessness or housing instability; and
3. Has a household income at or below 80 percent of the area median.
Now, these are extremely important criteria and they’ve noted that those that are below 50% of the area median household income will be prioritized. According to the National Low Income Housing Coalition (NLIHC), 78% of the emergency rental assistance programs require the landlords not to evict, with 10% requiring landlords not to evict for a period of 7 months or longer. The rental assistance programs have established that landlords may be able to get up to 80% of back rent owed. There are many landlords that may not be able to wait that long and though many have a chance to receive 80% of the back rent, not many may receive that much. It should also be noted that each county has reimbursement caps, so there’s a chance that these landlords may not receive anywhere near the 80% depending on how much in back rent is due. On top of this, with all the fraud and misappropriation of funds seen with the PPP program, many are skeptical that the government can do a good job and distributing funds to those who need it the most.
The NLIHC recently released a paper where they look at the effects of the previous rental assistance programs that went into effect last year and how effective they have been in helping those in need. They found that with the help of nonprofit organizations and community outreach, these programs were more effective and efficient. To me, that makes a lot of sense since those people on the ground will know exactly who is struggling and having a hard time to pay rent instead of someone in an office somewhere else looking at just the strict eligibility requirements. The paper went on to note that there is a need to be more flexible in tenant eligibility requirements as well as more flexibility with landlord requirements in order to get more people to participate in the assistance program.
If you’ve been reading my previous blog posts, I’m sure you’re aware of how much I disagree with current real estate prices and housing costs as I don’t see them sustainable in the long run. I will once again emphasize this point. The problem I’m seeing that will soon create more and more pressure on people is that the economy is set to reopen again and people will hopefully get back to work, but we’re still seeing rising housing costs as it relates to wage growth. We are still seeing inflation fears in the market, which is putting a lot of pressure on mortgage rates to increase. (More on that in a little bit). The dream of attaining a stable housing situation is becoming harder and harder.
According to the Census Bureau’s January survey, they noted that greater than 1/3 of the US adults are struggling to pay basic household expenses and that 11% of surveyors noted that their households didn’t get enough to eat the week prior. This is an issue that isn’t going away any time soon.
For those of you who know me, know that I own my own real estate consultancy firm, Rockwell Consultants. I am a big proponent of small landlords and educating small landlords so they can compete in the market efficiently. With this issue of tenants unable to pay their rents and landlords having to eat up the costs in order to pay their mortgage payments, it could lead to a wave of small landlords coming out of the market and having more institutional type money come in and own a large part of the market. According to the National Association of Realtors, more than 70% of four-plexes or less are owned by mom-and-pop type landlords and almost half of the 49 million housing rentals in the US are owed by individuals. We cannot afford to lose smaller landlords. Why? Well as more of these billion dollar companies come in and buy these rental units the higher the prices will go as the number of market participants on the supply side will be much less. This makes it less affordable for everyone.
I know many smaller landlords that are trying their best to work with their tenants and are begging their banks to work with them. I applaud those landlords because what they are currently tasked with is not easy. It makes me wonder why those with so much to lose are always the ones asked to do the heavy problem solving and make the greatest sacrifices. But in any case, I hope the government sees what they are asking of landlords. This problem has many sides and there is no easy solution, but I hope me shedding the light on it all helps everyone understand the problem a little better.
Mortgage Rates Rising
Mortgage rates have recently been on the rise and has started causing a panic with many buyers in the market. I wanted to dive in and explain this as I’ve seen many trying to jump in to buy right now without truly understanding what they might be getting into. So let’s break down mortgage rates and understand what factors influence them.
Mortgage rates are loosely tied to the 10-Year Treasury yields, which as we know from our previous discussion is rising at a fast rate since inflation expectations are rising and hope for higher growth in the economy is taking over. Now, it may seem a bit confusing here that yields are driving up mortgage rates as well.
Currently, bond buyers are expecting higher inflation, so in order to protect their bonds, they are demanding for higher yields in order to curb a loss in their bond yield. See, when bond buyers pressure the market for higher yields, mortgage lenders have to charge borrowers more to protect their profits. To clarify, mortgage lenders sell into the bond market.
On top of this, we also have market participants starting to get into a frenzy. What do I mean by this? Well right now with all this talk about how mortgage rates are going up, many potential homebuyers are rushing into buying a house right now to lock in a good rate. Well this is creating a supply and demand imbalance. Why is there an imbalance? This has to do with convexity hedging. I’m going to do my best to explain this phenomenon.
So let’s first understand convexity as it relates to the world of finance. When interest rates decrease, bond prices increase and the opposite is also true. When the time to maturity is longer the magnitude of the change is larger. So if interest rates decrease, for 30 year treasury notes the bond prices will increase higher than it would for 2 year treasury notes, as an example. So on a graph, you’d see the relationship is not linear, it has a convex shape to it.
Now, let’s take a look at positive vs negative convexity. Positive convexity occurs when prices move inversely (or opposite) to interest rates. Mortgage-backed securities have a negative convexity. Prices won’t increase as rapidly and has the ability to drop when interest rates go down. This happens because mortgage backed securities have an underlying asset, a mortgage. When interest rates increase it lengthens the duration of the bond, since prepayments and refinancing slows down, while a decrease in interest rates cuts the life of the bond since homeowners tend to refinance or prepay into a lower rate. So it would make sense that mortgage backed securities have a negative convexity.
Now, you may be wondering what is the convexity hedging phenomenon I alluded to earlier? So in the environment we are seeing right now, we are seeing interest rates rising. From what we learned earlier, this means that mortgage bond are lengthened. So in order to reduce risk to portfolios, these large investors find ways to hedge or to invest in something that will go in the opposite way of this mortgage-backed securities. In this case they could sell more US Treasuries which would increase yields even further, since the supply outpaces demand, the government has to find a way to entice more people to buy bonds, which then adds to the vicious cycle of ever increasing Treasury yields. So right now, we are experiencing a bit as that, but compared to history, the impact this time around is not as large.
Another factor that is contributing to rising mortgage rates is that of lenders’ profit margins. An estimation of lenders’ profit margins that people use is called the primary-secondary spread. This is essentially the difference of what the rate they are lending at (the primary rate) and the yields on newly-issued mortgage backed securities (the secondary rate). This has been decreasing since the peak of the pandemic. See, since rates dipped to new lows, everyone rushed into refinance at the lower rates, well mortgage lenders profited off of this big, since they could keep their loan prices high and thus earn higher margins. According to an analyst at Nomura, up until 2 weeks ago:
Originators could cut their margins and keep rates stable, but the current level of the primary/secondary spread, at about 1.25%, is approaching a “fair” level of about 1.1%
Graph 4
Mortgage Lenders’ Profit Margins
https://www.ft.com/content/ae8e09ce-de94-48ec-98cb-cd222713a20f
Knowing this should give you a better picture as to why mortgage rates are rising as well. Now, if we look at mortgage rates since 2007, we can see that, we are still in pretty low mortgage rate territory. Are mortgage rates going to increase? Eventually, but that doesn’t mean you should run out and buy a house at the overvalued prices sellers are currently asking for.
Graph 5
30 Year Fixed Rate Mortgages Average, 2007-present
https://fred.stlouisfed.org/graph/?g=NUh
Just because everyone else is running out the door to get a house, doesn’t mean you should too. If there’s anything we’ve learned from the housing bubble in 2008, it’s that.
The Impact on Millennials and zoomers (Generation Z)
Though there seems to be a consensus that millennials are a financially cursed generation, Zoomer’s (or Generation Z) financial future seems uncertain. Many believe that the mistakes Millennials went through will be corrected with Zoomers and thus Zoomers will not suffer as much as Millennials. It’s been interesting researching this topic as there is a lot of brushing over the issue at hand. I’ve seen people saying things like, “Sure, millennials won’t be homeowners, but don’t worry about the economy and the real estate market because we have Generation Z coming in soon and they’'ll rescue it.” Now, as a Millennial, I might be a little biased on this topic, but it is one that needs to be talked about. Now, do I want Zoomers to suffer? Gosh no! I want a future where young people never experience what Millennials had to experience. First the global financial crisis and now the Covid financial crisis, it’s been tough for us Millennials.
Let’s first take a look at a bigger picture graph to see where Millennials stack up against other generations in terms of homeownership. Since the oldest Zoomers are 24 years old, there’s not much data yet to see how many of them own homes. Apartment Lists put all this data into a research paper and I thought it had some really great insight.
Graph 3
Homeownership Rates by Generation, 1985-2020
https://www.apartmentlist.com/research/millennial-homeownership-2021
Looking at the graph above, it’s quite obvious to see that Millennials are way behind every other generation. The Millennial homeownership rate is 47.9%, while Generation X is at 69.1%, Baby Boomers are at 77.8%, and the Silent generation is at 78.8%. Less than half of Millennials own homes and I don’t expect this trend to change anytime soon.
Apartment Lists found that 18% of millennials expect to rent forever. To put this into easier terms, that means almost 1 in 5 millennials expect to rent forever. This is an increase from 2018 when only 10.7% of Millennials felt this way and in 2019 when 12.3% shared this sentiment.
Chart 3
Percentage of Millennial Renters who expect to always rent
https://www.apartmentlist.com/research/millennial-homeownership-2021
The majority of the current 18% aren’t wanting to do it by choice but because they simply cannot afford to buy a home. Affordability is a big factor when it comes to buying a home and as I’ve said time and time again, right now we are still experiencing overvalued home prices. This will not help Millennials in any way, shape, form. Unfortunately with the pandemic, home prices have increased but so has unemployment, so it’s a double whammy for those who were hoping to purchase a home soon.
Graph 6
Survey Question: Why Do You Expect To Always Rent?
https://www.apartmentlist.com/research/millennial-homeownership-2021
In another survey question Apartment Lists found that of the more than 80% of Millennials that do want to purchase a home, 63% of them do not have a dedicated down payment savings put aside. They have $0. 14% has somewhere between $1 and $4,999 saved. 8% has somewhere between $5,000 and $9,999 saved. And lastly, 15% has more than $10,000 saved. Just doing the math and how the average home mortgage requires at least a 15-20% downpayment those with just $10,000 can at the very least get a home priced at $66,000. 20% of those surveyed are hoping to get financial assistance from family for their downpayment while the remaining 80% are hoping they can save enough themselves. This can become an easier challenge to overcome if housing prices become more affordable.
Now if we take a look at Zoomers, Apartment List stated the following:
Beyond millennials, the COVID-19 recession is a watershed economic moment for the following generation, Z. Currently ages 23 and younger, many are coming of age at a time of great economic uncertainty. And despite their youth, the share of Gen Z renters who expect to rent forever is already 18 percent, similar to older millennials renters who have lived through the affordability crisis first-hand. Whether the Gen Z homeownership rate continues the existing trend and falls short of the millennial rate remains to be seen. But the economic inequalities that contribute to low millennial homeownership are strengthening, not weakening. One thing that remains to be seen is the extent to which remote, decentralized working arrangements prevail in a post-COVID economy. This may provide Gen Z a unique opportunity to access good jobs and affordable homes at the same time, even if the two exist physically in different places.
It looks like Zoomers are already on the same path as millennials but there is a glimmer of hope for them if remote work takes off and homes become more affordable. But a lot needs to happen before we can be sure of that becoming reality.
A Bank of America Research report, states that:
Like the financial crisis in 2008-2009 for millennials, Covid will change and impede Gen Z’s career and earning potential.
It’s also interesting to note that Zoomers were set to become the most educated generation:
But progress has stalled and even reversed due to the pandemic. The share of children receiving primary, secondary, and tertiary education had already plateaued pre-Covid. Further, the share of high school graduates going into higher education in the US is declining, as high student loans make the benefits of university increasingly unclear.
It looks to me like Zoomers are actually learning from the mistakes of Millennials in that a higher education doesn’t necessarily equate to income security. I hope this will lead to more of a focus on trade schools and evolve into more of a diversified workforce and thus a population with diversified skill sets. There or so many news stories purporting the reality they want. Like I said at the beginning of this segment, many news articles saying that Zoomers will come to the rescue for the housing market and homeownership rates will be normalized again. It doesn’t seem like this will happen and that makes the future more interesting.
See, if we could predict future changes, that would just be…boring. Having a completely different world where the majority of people remote work, would just be very cool, at least to me! The future doesn’t have to seem bleak, especially with more changes coming about. But I don’t see these changes being truly positive until housing can become affordable again.
European View
Keeping our attention on housing markets and mortgages, I thought it would be good to see what else is happening in the mortgage market in Europe. We’ll be looking at specifically Poland and the UK this time.
Poland
There has been a mortgage crisis in Poland for the past several years. See, it all started when Polish banks decided to start issuing mortgages denominated in Swiss francs instead of the Polish zloty. So, as always, I’d like to step back and give you a historical background to this before we dive in deeper. For those of you who weren’t aware, Poland is part of the European Union, but is not part of the Eurozone, so this means that they use their own currency called the zloty. Switzerland, on the other hand, is not part of the European Union or the Eurozone.
This makes things interesting, since as an American, to think of obtaining a mortgage or loan denominated in anything other than dollars is a foreign idea. Regardless, it shouldn’t be a problem as long as the currencies remain relatively stable in relation to one another. Unfortunately, this was not the case in Poland and thus lead to the crisis they are in now. To help us understand this, I thought it would be helpful to compare the Polish zloty and Swiss franc with the Euro.
Graph 5
Euro to Zloty 2005-present
https://www.ecb.europa.eu/stats/policy_and_exchange_rates/euro_reference_exchange_rates/html/eurofxref-graph-pln.en.html
Looking at the graph above, it’s clear that there has been a bit of a wild ride for the zloty especially from mid 2008, when 1 euro skyrocketed from 3.21 zlotys to 4.88 zlotys in mid 2009. Ever since then, it’s been worth 4 zlotys or more. This means that it devaluated or you needed more zlotys in exchange for 1 euro.
Graph 6
Euro to Swiss Franc, 2005-present
https://www.ecb.europa.eu/stats/policy_and_exchange_rates/euro_reference_exchange_rates/html/eurofxref-graph-chf.en.html
Looking at the graph above, we can see that the Swiss franc has appreciated against the euro since 2008. Where 1 euro used to be 1.70 francs, it’s now right around 1.1 francs. This means that Swiss franc is strengthening against the euro, which means that it takes less francs to exchange for 1 euro.
So here we see that the Polish zloty is depreciating against the euro and the Swiss franc is appreciating against this euro. This all just means that the zloty is worth less and less and the Swiss franc is worth more and more.
Now, let’s get back to the Polish mortgage crisis. So back during the Global Financial crisis (2008-2009), many Poles got the opportunity to obtain mortgages denominated in Swiss Francs. Now, you may ask, why did that happen? Well, in many smaller European countries, like Poland, local banking rates aren’t very competitive when it comes to lending and the majority of banks in these countries are foreign banks. These foreign banks mostly borrow in terms of euros because of the risk of local currencies depreciating. With interest rates in Switzerland almost always being one of the lowest in the world, many mortgages became denominated in Swiss francs. Now during the Global Real Estate bubble preceding the Global Financial crisis, mortgage rates in these smaller European countries were in the double digits while Swiss franc mortgages were somewhere around 3-5% depending upon the terms, according to the graph below.
Graph 7
Swiss Interest rates for new mortgages, 2007-present
https://www.credit-suisse.com/media/assets/private-banking/docs/ch/unternehmen/unternehmen-unternehmer/hypothekarzinsprognosen-04-2021-en.pdf
A paper, written by the Swiss central bank, explains that Swiss-franc mortgages
“rarely involve cash flows in Swiss francs. All loans are disbursed and all installments are paid in [local currency]. It is merely the value of the installments due and the value of the outstanding loan which are indexed to the [Swiss franc].”
So, at the time it didn’t really matter if it was denominated in Swiss francs because many Poles paid in zlotys anyway. Now what exacerbated the problem at the time was that many local currencies, like the zloty, were appreciating at the time of the real-estate bubble since many were expecting Poland and Hungary to join the eurozone. This never happened. So, I keep referring to many other smaller countries; these loans were not only exclusive to Poland but to Romania, Croatia, and Hungary.
Anyway, when the currencies started going in opposite directions this spelt bad news. Essentially, this meant that the value of the mortgages went up because the Swiss franc appreciated and the homes were worth less because the Polish zloty depreciated, putting many homeowners underwater on their mortgages. It’s unfortunate, but we all should have learned from the Global Financial crisis that speculation never ends well.
According to Bloomberg,
In Poland, more than 430,000 households still have loans in francs or indexed to them, for a total obligation of $24.7 billion.
This is a large amount. So, what have people done? There have been many lawsuits filed on behalf of these mortgage holders as the risks weren’t conveyed properly to them. On October 3rd, 2019, the EU’s top tribunal court ruled “that if Polish courts determine the mortgage contracts contain unfair terms, EU law would not block annulment of the loan agreements.” Though the Polish courts ruling was announced in December, many banks are now trying to solve the issue through out of court settlements. This basically entails converting the loans to zloty at the exchange rate at the time the mortgage was taken out, thus making loan payments recalculated.
Now, that would be great but now many banks are not sure they want to make these offers as they would end up losing quite a lot of money. They have instead decided to wait until the Polish Supreme Court rules and issues guidelines on March 25, 2021. We will see what comes out of it. But as of right now, looking at how exposed these banks are because of these Swiss franc mortgages it looks like it will be a losing battle either way.
Chart 2
Size of foreign exchange mortgage portfolios by Bank, reported in billions of Zloty
https://www.bloomberg.com/news/articles/2021-02-22/poland-s-mortgage-plan-shows-cracks-after-raiffeisen-pulls-out?sref=jbVt2saA
The UK
With all this talk of mortgages, it’s interesting to note that the UK is set to launch a mortgage guarantee scheme within the next month. The scheme is aimed to help younger generation Britons buy a home, but is also available to existing homeowners as well. So what does it entail? Well, in order to get this type of mortgage, you will need to have only 5% of the properties value as a deposit for homes worth up to 600,000 pounds. The Treasury of England will be guaranteeing a portion of the loans which will end up making banks provide higher LTV (loan to value) mortgages, which tend to be riskier.
There are many people that have expressed criticism towards this new mortgage scheme as it will end up driving up housing prices and with mortgage rates increasing, will lead to riskier deals. Though I believe this scheme to be very well intentioned, with mortgage rates increasing, I see this becoming a bigger problem down the road as the interest portion of the loan will be higher and in the end make monthly payments higher than they otherwise should have been. This also doesn’t take into account the risk of housing prices appreciating.
It should also be noted that the British government wants to extend their stamp duty holiday which essentially means buyers are not taxed on the first 500,000 pounds used for a home purchase. This was introduced last March and has been used by many. Doing this though, may also continue to increase housing prices. Just in 2020 alone, average home prices in the UK has increased by 8.5% to 269,000 pounds, the highest average on record, according to the Office of National Statistics.
We all know that real estate markets are cyclical, no matter if you’re in the UK or the US, this is the case. So if housing prices are artificially inflated because you have suddenly opened the doors to younger buyers, you actually end up hurting the younger buyers you were trying to help. Why? Because if they buy at the peak say the house is worth 500,000 pounds when they buy it but in two years it’s worth anything less, they’re left paying more on a mortgage than the home is worth. On top of this, they will be paying higher mortgage rates. This doesn't seem fair, does it?
Though I do agree, that this is very well intentioned as it addresses the fact that younger generations are having a harder time getting to the first rung on the ladder, but the timing of this mortgage scheme seems very dangerous. I will say that the UK is definitely having a hard time economically not just because of the effects from the pandemic but also because of the Brexit effect occurring. I certainly hope this turns out for the best and home prices don’t skyrocket only to come back down and hurt all these younger buyers.
Concluding Remarks
The current trajectory for the youth population around the world seems pretty bleak. But I don’t think that just because the trajectory is one way that means that’s what will happen. Let’s learn from the data. Let’s learn from the mistakes. Let’s do better for future generations. It’s not too late.
One thing I want to stress is to not be reactionary to market data right now. And this is a very hard thing to say, especially when everyone is doing one thing and you don’t want to have a fear of missing out. Do the research. Ask questions! Here’s to hoping for brighter days ahead! Till next time!