Mortgage Reset Alarmism Is Off the Mark

Some investors think the US is already in a recession. As we wrote two weeks ago and as recent data have confirmed, we don’t think that’s the case.

Industrial production is up at a rapid pace so far this year, while payrolls have expanded at a monthly pace of 457,000 and the unemployment rate has dropped to 3.6% from 3.9%. Real gross domestic income (Real GDI), a companion to real GDP that is just as accurate, but which arrives a month later, rose at a 1.8% annualized rate in Q1.

Nonetheless, the recession story is out there and some claim adjustable rate mortgage resets are going to knock the economic legs out from under consumers. The idea is that with the Fed raising rates rapidly, as the rate on adjustable mortgages reset, homeowners are going to have to make higher payments, which means less money to spend on other goods and services.

Let’s start off by noting the most basic problem with this theory, which is that even if mortgage resets increase some families’ payments, the holders of those mortgages will get the extra payments and their purchasing power will increase. On net, purchasing power should remain unchanged.

But, to be cautious, let’s indulge the reset theory by pretending the extra payments are money that just disappears, with no one on the other side of the transaction. Even then, our calculations show the theory doesn’t add up.

Households have about $12 trillion in mortgage debt, according to the Federal Reserve, so, yes, the top-line number sounds scary. But, according to the Federal Housing Finance Agency, only 3.7% of these loans are adjustable, or about $450 billion. Now let’s say that one-third of these mortgages reset every year. That’s $150 billion worth of mortgages resetting. Still a big number, still potentially scary.