FinLit Newsletter 9-27-2023

Mortgage demand shrinking while mortgage rates hit 23-year high – Let’s talk about housing, stimulus, and consequences

The average interest rate for a new 30-year fixed conforming (under $726,200) mortgage rose to 7.41% last week, the highest level since 2000, while mortgage demand, that is new mortgage applications plus refinance applications, just hit a 27 year low. The below chart from the Mortgage Bankers Association shows 30 yr fixed rates (orange line) vs. a composite mortgage demand index (shaded area). 


For example you can see demand dropped when rates spiked briefly in 2013, and more significantly you can see the extreme spike in demand in 2020 driven by a confluence of factors such as lower interest rates, fiscal stimulus making consumer flush with cash, and the introduction of the “work from anywhere” model brought on by Covid-era remote working. In this one example you can see how complex the economy is and how many different factors may influence one chart.

Focus on that Covid spike in demand with low interest rates for a minute and some of the intended AND unintended consequences. Every action in economics has both intended and unintended consequences, even though often only the intended consequences are the ones that policymakers advertise.

This period:


Consumers and companies had access to more money via:

  • Fiscal stimulus giving money directly to people
  • Low interest rates giving people very easy access to loans such as mortgages
  • Most people don’t think about this, but it is important -> debt creation in the system is an expansion of the money supply, so more mortgages issued is an expansionary action

More money in peoples’ pockets and more access to money creates demand. This is the intended consequence.


Now, ideally you want to seek equilibrium between supply and demand, but in reality, as you can see from the chart above, housing demand was stimulated almost instantly, while the supply of housing usually grows much more slowly. Also, importantly, in high-demand areas like cities, there are some areas where there is simply not much room to build, so your supply will be naturally constrained, while you are stimulating demand. 

So we have artificially created demand that outstripped the supply of housing, meaning bidders have bid up the price of houses to higher levels. Note when we use the word ”artificial” in the economic sense, we are not saying that the desire for housing is artificial. We are saying that demand in the economic sense - economic decisions being made based on market prices – these decisions are being manipulated by some force that would not exist in an equilibrium state. In this case the force is fiscal and monetary policy.


Now we can discuss some of the intended and unintended consequences of what we’ve been seeing over the last several years. On one hand, demand was indeed stimulated and people sought to buy houses, on the other hand, it ushered in many unintended consequences that we have to deal with today.

It's also important to note that, although we’re connecting fiscal/monetary policy to the housing market in this letter, policy had a wide-ranging impact across the broad economy. We are simply analyzing the impact on one sector of the economy, in this case, housing.


Back to that mortgage rate vs. demand chart one last time, in today’s environment. Demand has clearly fallen off as money is less accessible and capital (mortgages, loans, etc) is expensive. So that is why we are seeing this:


The question as it relates to the housing market is, where are we in relation to an equilibrium point. 

The issue is that since rates are centrally set, not set by the market, we are constantly having issues finding this point, because it is impossible for one governing body such as the Fed to “pick the right long term rate”. 

We don’t know yet, are we here in the housing market, where we are closer to an equilibrium?


Or are we heading here, where demand will be suppressed to a point where there is too much supply and prices will be forced downward?


An homebuyer in the market for a house might say quickly that they’d desire housing prices to come down significantly, but housing prices introduce another set of consequences that we’ll explore in future letters.

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