Douglas G. Duncan is Senior Vice President and Chief Economist at Fannie Mae where he is responsible for forecasts and analyses of the economy and the housing and mortgage markets. Duncan also oversees strategic research regarding the potential impact of external factors on the housing industry. He leads the House Price Forecast Working Group reporting to the Finance Committee.
Under his leadership, Fannie Mae’s Economic & Strategic Research Group (ESR) won the NABE Outlook Award, presented annually for the most accurate GDP and Treasury note yield forecasts, in both 2015 and 2016 – the first recipient in the award’s history to capture the honor two years in a row. In addition, ESR was awarded by Pulsenomics for best home price forecast.
Named one of Bloomberg/BusinessWeek’s 50 Most Powerful People in Real Estate, Duncan is Fannie Mae’s source for information and analyses on demographics and the external business and economic environment; the implications of changes in economic activity on the company’s strategy and execution; and for forecasting overall housing, economic, and mortgage market activity.
Prior to joining Fannie Mae, Duncan was Senior Vice President and Chief Economist at the Mortgage Bankers Association. His experience also includes work on the Financial Institutions Project at the U.S. Department of Agriculture and service as a LEGIS Fellow and staff member with the Committee on Banking, Finance, and Urban Affairs for Congressman Bill McCollum in the U.S. House of Representatives.
Duncan received his Ph.D. in Agricultural Economics from Texas A&M University and his B.S. and M.S. in Agricultural Economics from North Dakota State University.
Episode Notes:
Narrator This is The Norris Group’s real estate investor radio show, the award-winning show dedicated to thought leaders shaping the real estate industry and local experts revealing their insider tips to succeed in an ever-changing real estate market hosted by author, investor and hard money lender, Bruce Norris.
Bruce Norris Hi, thanks for joining us. My name is Bruce Norris and today our special guest is Doug Duncan. Doug is the Senior Vice President and Chief economist at Fannie Mae where he’s responsible for forecasts and analysis of the economy and the housing and mortgage markets. Duncan also oversees strategic research regarding the potential impact of external factors on the housing industry. He leads the House Price Forecast Working Group reporting to the Finance Committee. Under his leadership, Fannie Mae economic and strategic research group won the NABE outlook award presented annually for the most accurate GDP and Treasury note yield forecast in both 2015 and 2016. The first recipient and awards history to capture on are two years in a row. In addition, ESR was awarded by Pulsenomics for best home price forecast. They won a Bloomberg/BusinessWeek’s 50 most powerful people in Real Estate, Duncan is Fannie Mae’s source of information and analysis on demographics and the external business and economic environment, the implications of change in economic activity on the company’s strategy and execution and for forecasting overall housing, economic and mortgage market activity. Prior to joining Fannie Mae Duncan was Senior Vice President and Chief Economist at the Mortgage Bankers Association. His experience also includes work on the Financial Institutions Project at the US Department of Agriculture and services as a LEGIS Fellow and Staff member with the Committee on Banking, Finance, and Urban Development for Congressman Bill McCollum in the house, US House of Representatives. Duncan also received his PhD in agricultural economics from Texas A&M University, and his B.S and M.S in Agricultural Economics, from North Dakota State University. Duncan, you are a friend of The Norris group and have been for many years. So, thank you for joining us very much.
Doug Duncan It’s a pleasure to join you it’s always we always have a good conversation, it’s always thought provoking and stimulating.
Bruce Norris There’s a big conversation going around and a lot of variations of what, what we’re facing, you know, all the way from hyperinflation to it’s not a big deal, and I’m always, as you know, you put things in writing, and they don’t go away. So, when you say something, it lives for a long time. So, when people say the some outrageous things you go, ‘Okay, were you gonna be stuck with that for a while if you’re not right.’ Okay. So, I guess I wanted to kind of first talk about the tools that are, that are used to, to monitor this type of thing. So, fiscal policy, can you basically explain to our listeners, what fiscal policy is, and it will talk about monetary policy after we go over that stuff.
Doug Duncan Fiscal Policy is the combination of legislation and regulation that takes place by a government. So, it could be the federal government in Washington, DC, the Congress, the Senate and the White House, it could be a state government with the governor and the, the legislature. It does not involve the courts. The courts would be a matter of legal issues as opposed to fiscal issues, nor does it involve our central bank, which is from, which monetary policy emerges. As always taxes, budget expenditures, those kinds of things.
Bruce Norris Okay. Does fiscal policy play a major role in controlling inflation? Or does it usually step up when we were concerned about deflation?
Doug Duncan It can have a have an impact in either direction. If they’re, if in rare instances, there is a cut in government expenditures, that is an absolute cut, not just reallocation from one category to another, that could have temporary deflationary impacts. Certainly the more likely scenario, is that a, an increase in government spending or an increase in fiscal policy initiatives, particularly if it’s not funded with counterbalancing tax revenues, could contribute to inflation.
Bruce Norris Okay, so in the last year and a half, maybe a little less, we’ve tossed in trillions of dollars that were unexpected into the economy. First of all, do you think those actions actually prevented a depression.
Doug Duncan I don’t know if I would say a depression, certainly a recession. In fact, this, this has been the shortest recession in recorded history two months, basically. So, in a sense, it was just a huge exogamous shock, that is a shock that’s outside of the system. And there was a recognition, time period for recognition, time period for understanding of the implications, and then the government actions. I do think that part of the expenditures were certainly merited, particularly in that this was a completely a result of something that really there was no economic history on, although we did see a pandemic in the 1918 time period. And there has been some work done on trying to resurrect the economic history of that. But in terms of anyone that’s living today, there was no precedent. And in terms of the collection of statistics that we collected, there was nothing quite like it during that time period. So, government action seemed to be merited under those circumstances.
Bruce Norris We’ve added trillions of dollars to the, to the national debt. So, what are the ramifications when you’re, when your debt climbs much faster than your GDP?
Doug Duncan Well, depends on, on what those expenditures were targeted toward. And if they were targeted towards things like investments, which have a lifespan like and that’s part of the discussion of infrastructure, that would be actually the classic case.
Bruce Norris Right.
Doug Duncan Then, then it’s actually an investment. So, for example, if it is an infrastructure investment, think here of the example of the interstate highway system.
Bruce Norris Right.
Doug Duncan Funding that on long term debt made sense, because it was a long lived asset, and it improved economic efficiency for the US economy. Some people are characterizing the current discussion in Congress about infrastructure investment, if it were, for example, to create a nationwide broadband network of some sort, that improve the efficiency of our electronic communications, that might be an analog, in which case, you might want to fund that with long term debt, especially given the very low level of interest rates. If, however, as most of these expenditures have been there simply transfers, then it does raise the issue of whether the end they’re not funded through tax receipts does raise the issue of whether or not that will stimulate demand such that it will create an inflationary environment, which would be detrimental to growth over time.
Bruce Norris Okay. What’s interesting about one of the charts that I look at is the velocity of money. So, kind of just tossed a lot of money into the system and the velocity didn’t really go up. So, why the low velocity? And is that a sign that we’re actually doing something smarter with that money that we were given, that spending?
Doug Duncan Yeah, that of course, is the, is the turnovers space, what you’ve seen is a huge pickup in savings at the household level.
Bruce Norris Right.
Doug Duncan Which would, of course, the more share of funds that are saved, the lower the velocity will be. It’s also the case that you have not seen a pickup in credit demand on the, on the real economy side. So, bank lending and other sources of borrowing by the business sector have also been at very low levels. So, it’s perfectly reasonable to ask why is that? Well, I think given the two shocks within a decade, there, there’s a certain conservatism that’s in place, both within the household and the business community. It’s also the case that the growth of our population has slowed both through a slowdown in birth rates of domestic population and a significant curtailment of immigration. When the growth of the population is one of the things that, that is an indicator of the growth of economic activity, since you would expect that the, that growth in population would lead to a growth in income as more people over time are working in generating income which would generate more consumption, slowdown in the demographic profile, it’s reasonable to conclude there might be some slowdown in economic activity, the place that you, you can get a little bit of an indication of what expectations are there is the Congressional Budget Office produces data on potential GDP, that is the potential growth of our national income. Okay, those estimates have come down as the growth of population has come down. And therefore, it looks toward a demographic slowdown in the future needing, meaning less income production, less consumption.
Bruce Norris Okay. All right, let’s let’s shift to monetary policy and basically, what, what is the, how would you describe that monetary policy?
Doug Duncan Monetary Policy is the central bank’s actions governing credit markets and capital markets broadly. In other words, if the, if the central bank perceives that inflation is picking up, they may raise interest rates, and therefore the cost of credit, reduce the, the appetite for household and business sector usage of credit. And to the extent that credit is used to expand economic activity, that would slow the pace of expansion of economic activity. And of course, the reverses that is the case if they’re trying to support growth, an acceleration in economic activity,
Bruce Norris Which is kind of definitely what’s in place now and probably has been since 2009 implemented a lot of aggressive policies, interest rates, record lows, and a lot of asset buying. So, I wanted to land on that square for a little while. Assets Fed Balance Sheet now is a little bit over $8 trillion. And prior to 2008, or nine, do you have any idea what it was? It’s probably less than a trillion?
Doug Duncan I think it was a little bit over a trillion I’d have to check…
Bruce Norris Okay.
Doug Duncan ..exactly. But it’s not far off from trillion.
Bruce Norris Okay.
Doug Duncan Basically, they have to hold outstanding debt, relative to the amount of currency that’s in circulation. So, there’s a relationship between that currency and the Fed’s balance sheet. Also, the Treasury Department holds a trading account with the Fed. So, they have to have a, an allocated component that on their balance sheet. So, there’s two or three reasons, fundamental reasons for the machinery of our system that they have to hold a positive balance sheet.
Bruce Norris Okay. Why, why does the Fed need to buy assets? And, you know, to, to the tune of eight times what’s normal or seven times, what’s normal? What, what was, what caused that? Is that going to change? Is that going to reverse?
Doug Duncan
Well, that’s a great question to which the rationale that is offered by the Fed is that they needed to use their balance sheet to maintain the orderly performance of capital markets. That is, fears rose among participants in the market about whether or not they could access the funding that was required for ongoing operations. In some case, because the counterparties that they would do trades with, they were uncertain about the health of those institutions, and the risks related to doing business with those institutions. So, the Fed offers, offered its balance sheet as a counterparty with zero risk, and therefore could help continue the funding of those entities which might have failed in the event that their counterparties couldn’t settle, the trades that they had with them.
Bruce Norris What would have been, what would have been the ramifications of that?
Doug Duncan That the limit, it could have been the freezing of our payment system. And at the end of the day, the we need a functioning banking system so that you can exchange financial instruments as opposed to real goods and services. If you think about, if you had to trade in real goods and services, I bring you two chickens, and you give me, that’s a fairly inefficient system, if the system says, well, I recognize that the value of two chickens is probably about $12. And you recognize that the value of a ham is about $12. So I’ll just give you $12. You give me the ham, or, or, you know, it’s that we’ve substituted money for goods, because we believe in the value, that we can get the value of exchange through those, through those dollars. That, to me, that’s the payment system. That payment system requires banks and the ability of banks to exchange with one another because they each have different shareholders and they also have different depositors. And so there needs to be liquidity provided to be able to, for the funding, the funding to flow from institution to institution. But if you have an obligation with an institution that you think might fail, then or you’re just uncertain about the risk of that institution, suddenly the transactions start to dry up, and the financial payment system becomes illiquid. And that’s ultimately that, that’s, if the poster child for that was the failure of Lehman, back in the 2007 to nine time period, and the shock that that threat sent through the system about whether or not it was possible, a major counterparty or trader with whom you did business can actually survive. And if you put in a transaction, you might not get your money back. And central banks can use their balance sheet to ease those concerns in the market and keep the payment system operating.
Bruce Norris It, have you just described the repo market?
Doug Duncan That’s a piece of it that’s one…
Bruce Norris Okay.
Doug Duncan That’s one element of that market.
Bruce Norris Okay.
Doug Duncan And so, if you need, if you need liquidity, you can borrow funds from the central bank and pledge certain assets to them as collateral for that borrowing and then repay it the next day in the repo market often is simply an overnight transaction, although it may be a longer timeframe transaction.
Bruce Norris Are other central banks across the world doing the same thing?
Doug Duncan They are indeed, yes.
Bruce Norris Okay. To an extent, to an extent that’s never been done before?
Doug Duncan That is true globally, certainly, in nominal terms, absolutely. At our central bank has sort of is in the middle of that, in that, in many institutions, we actually have lines of credit out to other central banks, who are, who will need dollars to settle settle trades. So, we’re, we’re linked into the international financial system as well.
Bruce Norris Okay. When the Fed buys assets, whatever type it is, is that, is that give a price support?
Doug Duncan It does.
Bruce Norris Okay. Price and…
Doug Duncan Yeah, in fact, one of the one of the controversial things that they did in the most recent iteration is they went into the market to purchase the, the debt of triple A rated institutions there is that that’s constitute that’s controversial, is if, if an investor sees that there are two institutions out there, one of whose debt the Fed is buying, and one of whose is not, it’s a signal to the market of the relative riskiness of those two institutions and changes the cost of credit that each of them will have to pay to access the markets giving an advantage to the one that is perceived to be lower risk.
Bruce Norris Okay. Ah, is it the Fed, Fed participate in altering interest rates by buying long term treasuries?
Doug Duncan Certainly.
Bruce Norris Okay. So that’s, is that kind of the reason we have the interest rates that we do, because if they’re participating?
Doug Duncan It’s part of the reason. One of the things to, to note, is in the $80 billion of treasuries that they’re buying and the $40 billion of mortgage backed securities that they’re buying, they are they’re buying them for policy reasons, not for earnings reasons. So, I say they’re not an economic buyer in the sense that they want to make money. They’re an economic buyer in the sense that they’re trying to affect the performance of the markets in which they’re making the purchases. But that suggests is that they’re altering the prices and the risk return metrics in those markets. And it raises questions about whether the markets have accurate price signals on which to make on which the market participants can make decisions. And I there isn’t a lot of discussion of that. But certainly that’s that’s the fact that they attempt to mimic the market, but they’re very large relative to the market. So, certainly there is some distortion in the price signals that markets offer.
Bruce Norris A few years ago, the Fed had a balance sheet and they decided to lower it. To the consternation of the stock market. It was, it act reacted very negatively. So, how do they successfully unwind? a trillion dollars instead of you know, where they were at, I think, four or 5 trillion, or is this a permanent part of the landscape now, do you think?
Doug Duncan Well, that’s, that’s a great and very important question to which nobody really knows the answer. I think this is just Doug’s opinion, it’s likely that the Fed’s balance sheet will always be larger than it was at the outset simply because there’s more currency in circulation. And they do have to hold a balance sheet that offsets that, that currency in circulation. It’s the taper tantrum in 2014, 13, and 14, which, if you recall a little bit of economic history, the Fed in the, in the aftermath of the 2007 to nine turn, downturn had been building up their balance sheet, Chairman Bernanke in May of 2013, gave a speech in which he said, ‘We are likely at some point in the not too distant future to the, to reduce the purchases into our portfolio.’ The market took that as a signal and mortgage rates, for example, rose about 100 basis points, or one full percentage point over the next six months, which had the impact of slowing the housing market by about 10% in the first half of 2014. They repeated that exercise in 2018, when they started tightening, tightening and raising rates, that again, mortgage rates went up about 100 basis points. And again, the housing market slowed. Those two pieces of information are certainly in the background in current Fed policy, because Chair Powell was on the board for both of those, he was not the chairman for both of those, but that was part of his experience as a member of the of the Federal Reserve Board. And so, certainly, in, in the deciding how to calibrate Fed policy that is a part of his retained memory. So, I think without question, and it’s current, it’s a matter of current debate. When the Fed , when will the Fed and what happens when the Fed not only discusses publicly, the slowdown in its purchases, but actually acts on the slowdown in its purchases? We should certainly expect a market reaction. And that reaction is likely to be an increase in rates.
Bruce Norris Yeah. What’s interesting about what you just said, is the slowdown of purchases. I remember a quote by Paul Volcker talking about the likelihood of the Fed buying assets and it was sort of like, there’s no way, it was sort of like that’s not even a thought. And now, if they just stopped purchasing assets, it would be, it would be a problem. And the reason why it’s it’s pertinent to the industry that we’re in, we have the luxury of being able to get probably a two and a half percent 30-year loan, if I look online, it’s all over the place. When you match that with the California median price, it’s now approaching 825 grand. I might that might be bearable to a certain percentage at two and a half, but not at four and a half.
Doug Duncan That is correct.
Bruce Norris And four and a half historically would be wonderful. Take a look at a 40 year chart and you go, yeah, four and a half. That’s good.
Doug Duncan Well, I don’t think it’s, it’s difficult to draw the line from the current posture of monetary policy to the fact that house prices rose nationally 10% in 2020, and they’re on track to rise 18% in 2021, those things are not uncorrelated. The problem that the Fed has is what you were referring to, which is, how do you back out of the of that policy posture without taking some pain? And my personal view is, you don’t. And so, it raises the question of, should we expect that the Fed’s balance sheet will stay where it is or even grow? That is a realistic possibility. If there’s the unwillingness to take the pain that would be necessary, necessary to restore the full functioning of independent financial markets. Now, you could, you could freeze the balance sheet where it is, and then conduct monetary policy only with interest rates. And after a time, as the economy grew, you would get back to say, a more historical relationship between the Fed’s balance sheet and the asset liability structure of the Federal balance sheet, large or the economy’s balance sheet. But that also has not been at present subject of discussion, although the market is waiting to hear…
Bruce Norris Did, okay, I’ll just make sure I can get it whatever they have on their balance sheet. There are other customers buying similar things. If they wanted to sell what they had on the balance sheet at a market price, would it be? Does it matter? I guess I’m trying to think how do, you I guess you give an example. Let’s say trust deeds, we’ve, we have 10s of millions of dollars of trust deeds, and somebody calls us and said, you know what, I have an emergency, I need to sell one of them, we would be able to pick up the phone and sell the trust deed to somebody it would it would be at par wouldn’t be a problem. So, does does the Fed have the ability to sell what they have? Or did they buy it at a number that’s not replicatable in the market?
Doug Duncan Well, they can sell it. And from the feds perspective, it’s just an intergovernmental transfer. As I said, they’re not, they’re not in the business to make money. But the fact that they bought them means that the price that they paid was above the target price for the risk return characteristic that those assets had for a private party.
Bruce Norris Okay.
Doug Duncan So, so it means that it may well be that the price would be lower when they sold it back into the marketplace, which means the yield would be higher, which is why there’s upward pressure on interest rates when they reduce that portfolio.
Bruce Norris Okay. I just longer bigger picture. I honestly I used to think we’re going to get to balance the budget, we’re going to get back down to zero debt level nationally. I no longer think that. I know I must have been, I must have been drinking kool aid that no one else had. But I really thought that wouldn’t be a common sense thing to do for our kids generation and stuff. At what point, does, is their acknowledgement, ‘Yeah, we’re never paying this off.’ And does that day have a problem? Is there any, and that’s why I’m gonna ask you about hyperinflation. Is there a day where you just go wow, this is completely out of control like monetary, modern monetary policy would have you believe that it you know, you can just go into debt forever and ever and solve everything? Doesn’t there have to be some belief in the value of what you’re creating?
Doug Duncan You know, I was showing a couple of people recently, now that we can talk to each other face to face I pulled out of my pocket, some change. And I asked them to and I was carrying a like a 1950s penny made out of copper. And I asked them to compare the metal content by weight of that copper penny with a penny produced in this past year and the mint. There are two different weights.
Bruce Norris Wow.
Doug Duncan It’s because the decline in the value of our currency makes it uneconomic to make pennies out of copper. It’s more valuable used in production in, in the industrial world than it is in our clients. I made that point because the feds target is to reduce the value of our purchasing power by 2% annually. That’s their target is 2% inflation on an annual basis, so you can continue to borrow, and not completely pay off the dad, so long as the markets believe that the growth that you have in the income that you produce will repay that. And it and one of the, one of the risks that we’re coming up to the renewal of the federal debt ceiling, and there, there’s some question about whether there’s some folks that would, would support, whether they would support the increase in the federal debt ceiling, which will be necessary given the expected growth of our outstanding debt. And if that were not increased, then that would in some sense, be a loss of confidence by a global investors about whether or not the US was going to meet its outstanding obligations. So, it is to your point, that if once the markets no longer believe that we will be able to meet our obligations, then the game changes quite substantially because interest rates on all of that outstanding debt will will get repriced at a higher level and that of course only aggravates the imbalance between revenues and debt, and expenses.
Narrator For more information on hard money, loans and upcoming events with The Norris Group, check out thenorrisgroup.com. For information on passive investing with trust deeds, visit tngtrustdeeds.com.
Aaron Norris The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669. For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.