Speaker 1: I don’t know if you guys remember what happened around 2007, 2008 when it came to the housing market, but put simply, banks became loose with their lending policy. People borrowed a lot to buy a house. House prices shot up into a bubble and eventually their bubble popped. Now, the interesting slash, slightly scary thing is that something similar is happening today.
There is a comparable mix of ingredients right now and the housing market, as there was almost 12 years ago. And it’s about time someone talks about it. So 2008, if you don’t understand what happened, then you’ll need to go watch a movie called The Big Short. It’ll give you a good snapshot of how things played out. But basically, as the story of how everything crumbles, people wanted to get rich. So the brokers were getting rich by finding as many people mortgages as they possibly could. The banks were getting rich by selling these mortgages to institutional investors as something called collateralized debt obligations for short CDOs. Now, the thing you got to know is that a lot of these CDOs were actually sound investments. They were mortgages that were paid by people with stable jobs and in stable financial situations. But a lot of these CDOs were terrible. The people paying these mortgages simply couldn’t afford them. So the inevitable happened. CDOs caved in on themselves. Investors lost money, the housing market fell apart, and, of course, the CDOs got outlawed. But there is until fairly recently when they invented something called the Betio, the bespoke tranche opportunity. It’s basically just a CDO, but with a new name and a better reputation to it’s very sort of sneaky. Now, just like CDOs, some of these betas are good, but a lot of them are risky. And if mixed with the wrong market conditions, things can end badly. The problem is that the market conditions that we are in today aren’t exactly great. There are a couple of factors that make the housing market risky, which I’m going to go over now. The first is interest rates. I want to take you back 60 or so years so that we can get a good overall picture of how things look. Now, what I want you to do with this graph is look for the anomaly. The section that sticks out not any time in the 65 year period has interest rates had zero. And so 2009, just after the great financial crisis and again in 2020. But why has the Fed done this?
Why have they pushed interest rates as low as they possibly can push them before it gets into the negatives? They did this because they have to they need it low to stimulate the economy. They need people to be able to borrow as much as they possibly can so that they can buy, they can spend, they can invest and keep the financial system ticking over or else a collapse might have already happened. But there is a range of problems that come with having low interest rates. Well, you need to realize is low interest rates have a direct correlation to what mortgage rates are set at. If interest rates are low, it becomes cheaper for banks to borrow money. Therefore, they are able to give lower mortgage rates. Currently, the interest rates is very low. Consequently, mortgage rates are very low. Now, this is important because if mortgage rates are low, it becomes easy to borrow money. You say the long term historical average mortgage rates is around eight percent. So let’s say you earn seventy K a year and you got a nice down payment ready. If the rate is eight percent, you can afford a house for 250000 dollars. But if the rate is around three percent, which you can get today with a good credit score on you, you can now buy a house worth three hundred and fifty thousand dollars, a.k.a. 100000 dollars more. Essentially, with mortgage rates so low, you are able to borrow a lot more money. And do you think consumers are going to be cautious and not borrow this? Of course not. Generally speaking, they borrow as much as they can. This leads onto the second factor that I want to talk about, which as people in a lot of debt, just as I said, the funny thing is when you keep interest rates so low, people borrow more money. What a surprise. If we take a look at household debt, it’s now climbed to all time peaks even larger than what it was in the previous financial crisis. OK, so you’ve got low interest rates. This leads on to high amounts of debt, especially high amounts of debt used to buy houses. Now let’s. Continue down the trail. What do you think happens next? Of course, house prices start to climb up, more people are able to borrow, which causes increased demand for houses.
More demand means more people bidding for houses, which means they sell for higher prices. If we take a look at the US national home prices, we can see that even when adjusted for inflation, house prices are higher than what they were in the 2008 housing bubble crash because, OK, at the end of the day, people have a choice. You can keep your hard earned save money and leave it in the bank. What would then happen is inflation will eat away at it and your money will slowly or not so slowly become worth less, not worthless, but worth less. OK, so why does this happen? Well, because the more you print money, the less the original money in the system becomes worth. For example, let’s say there were ten pieces of gold in the entire world. It would be worth a lot, those individual pieces of gold. But if there were 10000 pieces of gold added to the system, the current gold in the system would be worth a lot less. It’s the same idea. So what’s happening now? The Fed is not afraid to print a lot of money for stimulus checks and other needs, which causes inflation so people can leave their money in the bank and watch it get eroded into or they can get a mortgage and buy a house this way instead of inflation, eating away at your savings eats away at your mortgage, which means the value of your mortgage becomes worth less, which is a good thing if you want me to put it plain and simple. And people are not stupid, they know this. And so more people decide to get mortgages and buy houses again, contributing to the rise in house prices. But the problem about having high house prices is it gives plenty of room to fall. You see, this is how the fall often takes place. And a few people at the bottom, they default on their mortgages because they realize they can’t afford at the bank and takes over their capital, a.k.a. the house, and they try to sell it. What this does is it puts more houses on the market, a.k.a. more supply.
Now, anyone who has done economics or understands common sense will know what this does to house prices. Increase supply equals a decrease in price. OK. Why? Because now more buyers have more options to choose from and more leverage power to bargain with, a.k.a. they can buy houses for cheaper. So house prices decrease and more people default on their loan because what they recognized as they owed more on the house than what the house was actually worth, then house prices continue to decrease. More people default on their loans, and that’s how the downward spiral goes. Basically, what I’m trying to say is it often doesn’t take much for things to crash. And the higher the house prices are, the riskier things become just one block taken out of the tower and things can collapse. And this collapse was potentially close to happening earlier on in 2020 because of the crisis that we all saw.
A lot of people could not afford to pay the loans. They just had a good chance of collapsing the housing market. So the loan companies did what they had to do and they allowed a ton of forbearances. As you can see, beginning of March 2020, the forbearance rate was just over two percent. Just a couple of months later, that rate increased by almost four times the amounts to over eight percent. This allowed people to deal with their mortgages, at least in the short term. But at the end of the day, that doesn’t help the underlying problem, and that is the economy decline and the unemployment increase in 2019. The US’s GDP, the way of measuring the economy, was twenty one thousand four hundred twenty seven billion dollars, according to the official data of the World Bank. In 2020, that number has been forecasted to decrease by seven percent, according to the Conference Board. This would leave a GDP around 20000 billion. Now, unemployment’s has, of course, increased as well because of the world crisis illness.
As you can see, earlier on in 2020, unemployment was around three point five percent. The crisis hits and that number went up to around 10 percent. Now, there are plenty of problems that unemployment brings. One of the big ones is people not being able to afford their mortgage payments with high house prices, high amounts of debt and interest rates not being able to go any lower. It’s not exactly. A recipe for success, does this guarantee that a market crash will definitely happen in 2021? Of course not, but it’s certainly one of the weirdest markets that I’ve seen for a long while.