Opinion: The Fed broke the banks. What’s next for mortgage?

It is often said that the Fed raises interest rates until something breaks. Many have already pointed to the failures of Silicon Valley Bank, Silvergate Bank, and Signature Bank as evidence that the Fed “finally broke something.”

While the failure of these institutions appears to have occurred without warning, the truth is that warning signs were there all along. The collapses were inevitable given their unconventional funding makeup against the Fed’s misguided policy of overly aggressive interest rate hikes over the last 12 months. 

The Fed’s past actions in the name of checking inflation also threaten to break — or may already have broken — other critical economic sectors, including the housing market. Much as the Fed was blind to the liquidity crises created by its rapid pace of rate increases, we believe the Fed has also failed to appreciate how severely its actions have imperiled the housing market. 

Historic housing shortage

The unprecedented rate hikes over the past 12 months have exacerbated a historic housing shortage while destabilizing the residential mortgage market. Continued increases would complete the demolition job, creating economy-wide impacts far worse and longer-lasting than the inflation they purport to address. 

The Fed’s failure to appreciate the current impact of past increases is due, in large part, to its apparent reliance on stale housing data to guide policy decisions. Although economic data since the Fed’s February 0.25% hike has been mixed, more forward-looking numbers like February’s Producer Price Index have shown prices declining.

And although the overall CPI rose 6% in February, 70% of that increase was attributable to increases in the shelter index, a measure of housing costs that is well-documented to lag private sector data.

More current spot market rent data, such as Zillow’s observed rent index, showed a month-over-month increase of 0.3%, significantly below the government figure of 0.8%. Additionally, the Case-Schiller National Home Price Index has shown declines every month since June 2022.       

Rate hikes have rocked the housing and mortgage markets

What the data does clearly show is that rate hikes over the last 12 months have already rocked the housing and mortgage markets. In 2021, mortgage originations hit a record high of $4.4 trillion. With interest rates on 30-year fixed-rate mortgages hovering around 7%, the Mortgage Bankers Association estimates that the total value of originations plummeted by roughly half in 2022, down to $2.24 trillion, and will fall to $1.87 trillion in 2023.

Refinancing activity has also evaporated, falling from $2.6 trillion in 2021 to $667 billion in 2022, with a projected $449 billion this year. Today, refinances (including cash-out home equity loans) have slowed to a 22-year low of approximately 10% of current loans originated. 

Aggressive action to curb inflation

The Fed, of course, has taken this unusually aggressive action to curb inflation. Before this most recent tightening cycle, the last time the Fed raised rates by 0.75 percentage points was in 1994.

In 2022 alone, the Fed hiked rates by 0.75 four separate times. Ironically, the dramatically slower sales pace will actually increase inflation in the housing sector, as many builders have already reduced their plans for future home construction, which will exacerbate a housing deficit that has been building for over a decade.

Although February single-family housing starts ticked up 1.1% from January, they are still down over 30% from last year. Future rate increases would make the shortage even more severe as both builders and individual homeowners retreat further from the market. 

Housing supply at all-time lows

Even more pronounced than the Fed’s impact on housing supply is its potentially irreparable damage to the mortgage industry, which has evolved in ways that make a severe and artificially engineered slowdown more perilous than in previous economic cycles.

Today, three of four mortgage loans are issued by independent mortgage companies. In the past, depository banks that dominated the industry could withstand a significant decline in mortgage lending, since it represented just one of several lines of their businesses. Independent mortgage companies have no such luxury.

They have already significantly reduced in size, shedding thousands of jobs in response to the unprecedented shrinkage of the market for mortgage loans. Without a pause in rate hikes to allow the mortgage market to stabilize, many of those lenders will cease to exist — as some have already. 

Once independent lenders are gone, it will not be possible to bring them back like a remodeled house. Instead, we will undergo a traumatic reshaping of the industry not seen since the savings and loan crisis of the 1980s.

Additional negative impacts

The shrinking supply of mortgage market participants will have additional negative impacts, including, ironically, inflationary pressure. Fewer lenders mean reduced competition, resulting in higher interest rates for borrowers and a smaller pool of American homeowners. Reduced homeownership will increase demand for rental housing, the price of which is reset at the end of every lease.

Those fortunate enough to enjoy low interest rates on current mortgages; meanwhile, are unlikely to move until the rate environment returns to earth. The effects of a frozen housing market will be felt far beyond the construction and mortgage industries. The housing market is known for its multiplier effect across the economy, and as purchases that accompany a move into a new home — furnishings, paint, art — slow, disparate industries are affected.  

Indeed, starting with the loss of independent mortgage issuers and the jobs that come with them, all the negative effects above have a cascading impact across the economy. After taking historic action in response to inflation, it is time to pause the rate hikes driving these negative impacts and give those already enacted a chance to work without further damaging the housing sector. 

In a stroke of fortunate (or unfortunate) timing, the Fed entered its blackout period the day after the government seized Silicon Valley and Signature banks and before it announced its Bank Term Funding Program. So, we don’t have any hints as to how these recent events have impacted the FOMC participants’ thinking going into its March meeting. But we sincerely hope board members consider that additional rate hikes will not be the tough medicine they believe the economy needs. 

After all, even the right medicine must be taken in the proper doses and at the proper time to be effective. Otherwise, it can become poison with devastating effects on the American dream of homeownership. 

Allan Polunsky and Marty Green are principals at Polunsky Beitel Green, a Texas-based law firm.

This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.

To contact the authors of this story:

Allan Polunsky at allan.polunsky@mortgagelaw.com

Marty Green at marty.green@mortgagelaw.com

To contact the editor responsible for this story:
Sarah Wheeler at sarah@hwmedia.com