Goldman Believes Housing Will Live To Fight Another Day

Luke Suddards

3 months ago6:06 mins

Goldman Believes Housing Will Live To Fight Another Day

With global central banks trying to shove the inflation genie back in the bottle with aggressive interest rate hikes, housing markets have been feeling the pressure. And that’s led to increasing worries that a rising wave of defaults might collapse housing markets around the world, and create a crisis. Goldman Sachs has just published an in-depth report on housing sectors around the world, with a country-by-country look at the risks.

What did Goldman find?

It broke down a series of risk factors, but before we dive deep into those, let’s take a look at where we are now in terms of delinquency rates. They aren’t trending upward: in the US, they’ve fallen off sharply since the pandemic crisis, and now stand below 1.5%. And, they’re below 1% for the UK, Australia, New Zealand, and especially Canada.

Delinquency rates as a percentage of mortgages. Gray bars are US recessions. Sources: Haver, Goldman Sachs Global Investment Research.
Delinquency rates as a percentage of mortgages. Gray bars are US recessions. Sources: Haver, Goldman Sachs Global Investment Research.

What are the big risk factors?

1. Mortgage rates and their duration.

When central banks raise their key interest rates, borrowing costs rise across the board. And that means mortgage rates go up. This year we’ve seen some punchy moves in mortgage rates, with increases of nearly four percentage points and three percentage points in the US and UK respectively. And it’s not just the magnitude of these moves that’s caught many by surprise, but also the speed.

Those higher rates have a more palpable impact depending on the structure of the mortgage market. Examining the data on some of the biggest developed economies indicates that the standouts are the Antipodeans, in New Zealand less than and equal to 1-year fixed-rate loans make up almost 80% of their total loans market. That is really something – your mortgage rate would reset to the latest borrowing costs at least every year, and in this hiking cycle that means a lot less cash in your pocket. Australia doesn’t fare much better, with more than 60% of home loans resetting every year. On the other end of the spectrum is the US: with no loan terms under one year with very few borrowers locked in for a short, one-to-five-year period. Americans tend to lock in for much longer. France, Germany, and Italy are also more skewed to longer-term fixed-rate mortgages.

Higher interest rates and shorter mortgage periods can be a toxic combination – with consumers forced to adjust to often steep increases in their monthly housing costs. That’s why Goldman estimates that much larger potential “payment shocks” will hit the Australian, New Zealand, Canadian, and UK economies. The below chart shows a significant proportion of mortgages will reset to higher rates (blue bars, left axis). And it shows that around 20% of households in Australia and New Zealand will face higher interest payments in 2023, compared to about 10% of households in the UK and Canada (red bars, right axis).

Percentage of mortgages and households estimated to see their mortgages adjusted to a higher rate in 2023. Sources: RBA, RBNZ, BoE, BoC, Goldman Sachs Global Investment Research
Percentage of mortgages and households estimated to see their mortgages adjusted to a higher rate in 2023. Sources: RBA, RBNZ, BoE, BoC, Goldman Sachs Global Investment Research

2. Employment and home prices.

When there’s an economic downturn or a recession, unemployment typically rises. And losing a job makes it tougher to make mortgage payments, particularly in less affluent households where the savings might not stretch very far. Using a sophisticated statistical technique, Goldman estimated the effect of unemployment on mortgage delinquency rates. It found that a one-percentage-point increase in the unemployment rate would push up UK delinquency rates by 0.2 percentage points after a year. In the US, the delinquency rate would rise by only half as much – 0.1 percentage point. And in Canada and Australia, the results would be far more muted.

The impact of a one-percentage-point increase in unemployment on default rates. Note: there are 100 basis points in a percentage point. Source: Haver, Goldman Sachs Global Investment Research.
The impact of a one-percentage-point increase in unemployment on default rates. Note: there are 100 basis points in a percentage point. Source: Haver, Goldman Sachs Global Investment Research.

The chart also shows how much time it would take for default rates to fall and normalize, indicating longer-term “scarring effects”.

Given these estimates, the UK stands out as being at higher risk of rising defaults due to its ominous economic outlook. The Bank of England is forecasting a two-year recession and a doubling of the unemployment rate. This is before any of the effects of fiscal tightening (lower spending or higher taxes) are baked into their models.

Falling home prices compound the issue for homeowners and the housing market. And prices have dipped by roughly the same amount – about 15% annualized from their respective peaks – in the US, Canada, Australia, New Zealand, and Sweden. Goldman expects prices to fall further, which would shrink the amount of equity that people have in their homes and could discourage people from paying off their mortgages. Home equity is the difference between the current market value of the house and what's owed on the loan.

Goldman’s model estimates that falling house prices wouldn’t create a severe impact on default rates. For example, a 10% decrease in home prices usually leads to an increase in delinquency rates of about 0.14 percentage points in the US, and just less than 0.1 percentage points in the UK, Canada, Australia, and New Zealand. The speed at which default rates drop back down again is faster with a home-price shock than with unemployment, however. In other words, home prices are less important than unemployment when it comes to defaults. Goldman believes this is down to the fact that these mortgages are “full recourse”, meaning people are incentivized to repay them because they know their lenders can seize assets or income beyond the housing collateral if they default. Academic research shows that just 6% of US defaults on mortgages involved a borrower who wasn’t incentivized to repay the loan because the amount they owed exceeded the home’s value.

Mind you, US homeowners are in better shape than one might think – with more home equity to their names – because house prices have increased, particularly for those who bought before the pandemic peak.

3. Mortgage credit quality.

One positive to emerge from the ashes of the global financial crisis (GFC) was more sensible and stricter regulations surrounding home loans around the world. Leverage requirements are more stringent, borrowers have to put more money down (i.e. have a lower loan-to-value ratio). Borrowers are subject to stress tests of their ability to repay under higher rate scenarios. Plus, they have to have higher minimum credit scores, a lower amount of debt compared to their income, and, for higher-risk borrowers, they may have to pay for mortgage insurance on top of it all.

And it’s led to a significant improvement in the credit quality of loans. According to Goldman, it’s the main reason why we won’t likely see a wave of defaults within the housing sector now.

Table showing various credit quality metrics. Source: Goldman Sachs Global Investment Research.
Table showing various credit quality metrics. Source: Goldman Sachs Global Investment Research.

What’s the bottom line then?

Piecing it all together, the analysis suggests a surge in default rates like what we saw during the global financial crisis is unlikely over the next year. But that doesn’t mean everything will be as smooth as silk. Homeowners in countries such as Australia are going to be most exposed to a mortgage-rate shock. And, in the UK, a darkening economic cloud and rising unemployment pose a particular threat to the housing sector, because of the connection with delinquency rates.

Indeed, the UK is the weakest chink in the armor, with its big pool of short-term mortgages, the most negative economic outlook, and the highest sensitivity to rising unemployment. Despite this, Goldman’s European economists believe the payments shock will fall mostly on the wealthier households, which are more likely to have built up a war chest of savings during the pandemic. This should help prevent the worst economic scenario from playing out.