June 22: The economy; California housing market; hedging servicing; learn from Supreme Lending’s ransomware attack

Not worried about computer issues? Your vendor(s) will take care of everything? Guess again. Baltimore was hacked, grinding the recording of documents to a halt. A Florida city will pay $600K ransom to hacker who seized computer systems weeks ago. In Texas, Supreme Lending, known to be “on top of it” when it comes to these matters, was attacked. And knowing the folks at Supreme, it came as no surprise to me that they wanted to help the rest of the industry. I received this note from Jeff Joyce, COO. “We at Supreme Lending saw your blog recently about the ransomware attack on the City of Baltimore. Earlier this month, Supreme Lending discovered that it was a victim of a ransomware attack, which encrypted and disabled our core information technology systems for a few days. We are going to host a call in the near future to share our own recent experience to alert our industry peers to the reality of these attacks.

“If you are an owner or CIO of an independent mortgage bank and would like to join Scott Everett, Founder and President of Supreme Lending, and his team on a call to learn more about the attack and how you may be able to prevent it from happening to your mortgage company, please email Rick Hogle, Supreme Lending’s Chief Strategic Officer, and include your name, company, title, email address, and phone number. We will include you in an invitation to the call once the date and time is set.”

Thoughts on servicing

Recently the commentary suggested asking loan servicers how their Mortgage Servicing Rights values are doing with this down move in rates. (Rates going down leads to early payoffs/increased prepayments, leading to assets running off of books.) In general those producing loans view their increased volume as a hedge against servicing run off, but the comment prompted MountainView Financial’s Matt Maurer to send, “For those that hedge the MSR asset, times are good. MSR hedge gain plus recapture opportunities and healthy pipelines. Probably about a third of overall MSR owners hedge, but more do than don’t that have larger MSR portfolios. If you are a bank and don’t hedge, you’re an outlier. For those that don’t, there are a couple of guys that feel like they have a production hedge and given their recapture capabilities and market share, they can make that argument. We think that there are a couple of larger non-bank MSR owners that should be hedging to manage some of their interest rate risk. It appears that the tail is wagging the dog, and they can’t originate their way out of the MSR loss they get when rates go down. These entities are feeling some pain right now as they have a business model is rate dependent.”

For folks who love demographic stats

The Federal Reserve seems to be in the news a lot. Is there really enough interesting economic news twenty-four hours a day, seven days a week, to support all those financial news stations?

Economists from Zillow have combined U.S. Census Bureau data and their own housing listings to show how much rental prices and home values have skyrocketed in areas across the country that are experiencing a tech boom. Utilizing the Census Bureau’s Longitudinal Employer-Household Dynamics Origin-Destination Employment Statistics that show the relationship between where people work and where they live, the group found that rent around the Seattle metro area had increased 17 percent from 2011 to 2015, triggering a supply and demand challenge. And between March 2012 and 2013, Facebook employees’ home values within four blocks of the company’s headquarters jumped 21 percent compared to 17 percent in other parts of the Bay Area. California housing has become so expensive people have been moving out to adjacent metropolitan areas, such as Dallas, Phoenix and Las Vegas where housing is cheaper. But as people have moved into these more affordable areas, affordability has changed. From 2006 to 2014, Dallas went from 46 percent more affordable than Southern California to 20 percent and Vegas and Phoenix dropped 25 percent to 15 percent over the eight-year period. Lyft and Uber are both public, and Airbnb and Pinterest are also on the verge of going public, meaning home values could move higher still, possibly causing an additional exodus.

Dallas Fed President Robert Kaplan delivered remarks for the Hoover Institution Monetary Policy Conference last month after the Federal Open Market Committee left the federal funds rate unchanged at a range of 2.25 to 2.5 percent. The Fed’s 2 percent inflation target is symmetrical, meaning the Fed doesn’t want inflation to run persistently below or above the 2 percent target, as sustained deviations could increase the likelihood that inflation expectations begin to drift or become unanchored, making it more difficult for the Fed to achieve its dual-mandate objectives of maximum employment and price stability. On a 12-month basis, overall inflation and inflation for items other than food and energy declined and are running below 2 percent, causing the Fed to continue to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes going forward. Headline personal consumption expenditures (PCE) inflation, the Federal Reserve’s preferred inflation measure, has been running below the 2 percent target for most of the last seven years. The unemployment rate has been below the Congressional Budget Office estimate of full employment for two years. GDP growth is expected to be lower than growth in 2018, but sufficient to further tighten the labor market and cause the rate of wage growth to modestly pick up over the course of 2019. Some observers have suggested that this tight of a labor market should cause greater wage pressure, translating into greater price pressure.

Kaplan thought it would make sense to step back and explore some of the potential issues raised by recent weakness in headline and core inflation measures, particularly on labor slack, inflation expectations, and structural forces with regard to how they may be impacting the Fed’s ability to meets its 2 percent inflation objective. Many economists have argued that there may be more slack in the U.S. labor market than standard measurements are capturing, attracting and retaining previously under-represented groups in the workforce. Since 2015, increases in labor force participation have disproportionately come from under-represented groups, such as prime-age female population with less than a high school education, or black males and Hispanic females. Many workers on the sidelines were drawn in as a result of improvements in skills training, childcare availability and transportation availability. Kaplan warned central bankers need to be vigilant to the possibility that there is still the potential for inflation readings to firm substantially, with a time lag, if the degree of full employment overshoot becomes more sizable and persists for an extended period of time.

Another debate relates to the Fed’s ability to manage longer-run inflation expectations, as the Fed has clearly articulated a 2 percent PCE inflation target, helping to anchor inflation expectations. Kaplan argues an extended period of inflation running below the 2 percent target has caused expectations to have drifted lower, as reflected in the University of Michigan survey for inflation expectations, which has dropped over the last six years. Some economists argue that the Fed may need to do more to help keep inflation expectations well-anchored, such as further convincing the public that it is committed to a symmetrical 2 percent inflation target.

An additional area of exploration deals with structural changes in the U.S. and global economies, as the forces of technology, technology-enabled disruption and, to some extent, globalization, limit the pricing power of businesses and mute inflation. The impact of these trends means that companies, depending on the industry, often have much less pricing power than they did historically, causing companies to invest even more in technology that replaces people and, increasingly, taking actions to achieve greater scale in order to effectively manage the investment and margin implications of these trends. The net result is that, in a range of industries, if there is wage pressure, companies are just as likely to see margin erosion versus being able to pass these costs on to the customer. This would suggest that powerful structural changes in the economy may be an important aspect of more muted price pressures, and there may be some evidence in recent productivity statistics that new technology and greater economies of scale could be helping to dampen growth in unit labor costs.

As California goes, so goes the nation?

California’s housing affordability crisis has been eating away at housing demand for some time, but trade and foreign direct investment slowed abruptly in California during the latter part of 2018, potentially signaling trouble for the rest of the nation. Single-family home sales in March were down year-over-year in every major region tracked by the California Association of Realtors, including sales in Southern California down 10.5 percent year-over-year and Northern California down 10.8 percent year-over-year. Most of California’s largest cities and coastal markets were already densely populated when the recovery began and home to some of the most restrictive development laws, making supply more inelastic.

This steep supply curve means small changes in demand result in large changes in price. The influx of new investment from tech, entertainment and overseas investors boosted the demand for housing much more than it did supply. But recently, inventories have climbed across every region of California, and homes are staying on the market longer. California home appreciation in March clocked in year-over-year at a paltry 0.2 percent, compared to 8.9 percent just a year ago.

Tax reform is also weighing on California’s housing market. The new law limits the deductibility of mortgage interest payments to $10,000, thereby reducing tax incentives for ownership of higher priced homes. The most recent measure of housing affordability from the California Association of Realtors indicates that just 28 percent of California households could afford to purchase a median priced single-family home in Q4 2018.

All these factors have exacerbated the flow of residents out of California. Lower sales and slower price appreciation suggest years of price gains and a mismatch between where people want to live and where more affordable housing options can be built have finally reached a tipping point. Years of under-building have rendered the housing stock inadequate for the number of households. And though apartment construction has been very strong since the recession, much of the growth has been limited to luxury or lifestyle units aimed at well-to-do workers in California’s largest urban areas.

California remains the stage on which many of the largest economic, political and regulatory battles first play out, meaning other tech hotspots such as Seattle, Denver and Austin, are increasingly resembling California and it will be interesting to see how home affordability plays out in those cities.

(Thanks to Stephen S. for this one.)

John, who lived in the north of England, decided to go golfing in Scotland with his buddy, Ken.

So they loaded up John’s minivan and headed north. After driving for a few hours, they got caught in a terrible blizzard. So they pulled into a nearby farm and asked the attractive lady who answered the door if they could spend the night.

“I realize it’s terrible weather out there and I have this huge house all to myself, but I’m recently widowed,” she explained, “and I’m afraid the neighbors will talk if I let you stay in my house.”

“Don’t worry,” John said. “We’ll be happy to sleep in the barn. And if the weather breaks, we’ll be gone at first light.”

The lady agreed, and the two men found their way to the barn and settled in for the night.

Come morning, the weather had cleared, and they got on their way. They enjoyed a great weekend of golf.

But about nine months later, John got an unexpected letter from an attorney. It took him a few minutes to figure it out, but he finally determined that it was from the attorney of that attractive widow he had met on the golf weekend.

He dropped in on his friend Ken and asked, “Ken, do you remember that good-looking widow from the farm we stayed at on our golf holiday in Scotland about 9 months ago?”

“Yes, I do,” said Ken.

“Did you, um, er, um, happen to get up in the middle of the night, go up to the house and pay her a visit?”

“Well, uh, yes!” Ken replied, a little embarrassed about being found out, “I have to admit that I did.”

“And did you happen to give her my name instead of telling her your name?”

Ken’s face turned beet red and he said, “Yeah, look, I’m sorry, buddy. I’m afraid I did. Why do you ask?”

“She just died in an untimely accident but left me everything in her will.”

(And you thought the ending would be different, didn’t you?…

you know you smiled…now keep that smile for the rest of the day!)

Visit www.robchrisman.com for more information on our industry partners, access archived commentaries, or to subscribe to the Daily Mortgage News and Commentary. If you’re interested, visit my periodic blog at the STRATMOR Group web site. The current blog is, “Are You Ready for CECL?” If you have both the time and inclination, make a comment on what I have written, or on other comments so that folks can learn what’s going on out there from the other readers.


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Rob Chrisman