The 'Sammy Hagar' theory of economics

It’s debatable whether there are many economists who spouse the ‘Sammy Hagar’ theory of economics as suggested by Kirk Tatom (pictured), but as the former full-time member of Deep Blue Something, the band responsible for the huge 90’s hit ‘Breakfast At Tiffany’s’, he believes the rock ‘n’ roll-inspired term accurately describes the Fed’s approach to fighting inflation.

Asked what he meant, the president of Dallas-based Tatom Lending referred to a line in Hagar’s song ‘I Can’t Drive’ that says ‘one foot on the brake and one foot on the gas’.

“They’re shutting down the economy and juicing it up at the same time, and that is the problem. Inflation is pretty simple to understand. You’ve got a lot of money that’s chasing not very many goods, so people are willing to overpay for those goods because money is plentiful. They keep raising rates in response because it’s harder for them to get the stuff to market - until you get to a point where people say ‘OK, I’m not buying anymore’,” he told Mortgage Professional America (MPA).

Applied to the housing sector, it translates into people no longer willing to pay such high prices for homes.

Recent data seems to support his theory. According to real estate analyst Black Knight, house prices were down for the second straight month in August (0.98%). Both represented the largest single-month price drop since January 2009, with the average home price now roughly 2% (or $8,800) off its peak of $438,000 in June.

Read more: Mortgage application activity slows again as rates rise

Meanwhile, mortgage rates have increased across all product types, with the 30-year conforming rate reaching 6.81% - the highest since 2006 - at the start of this month before shooting past 7% late last week.

Tatom insisted that house prices would have to adjust to this new reality.

“The problem with the rate issue is that they’ve gone up too much, too fast,” he said. “When the interest rate jumps way up, you’ve got downward pressure on prices, but prices haven’t come down to meet the speed in which the rate has increased. We have to get to market equilibrium. On a loan product that’s 45% you qualify at 5%, but you don’t qualify at 7%. How do we make that work? Well, if we can’t change the 7% and you can’t buy the rate down, then we’ve got to pull the price down to keep that debt-to-income ratio the same. Right now, we’re sitting around and waiting for the market to equalize itself.”

That may take a little longer, judging by Black Knight’s data, which also revealed that although prices were off their peaks in 97 of the 100 largest US markets, they were still roughly 40% higher than they were in 2019, before the COVID pandemic.

Asked how much further house prices could fall, Tatom said: “I have a feeling that they’ll come down to anywhere from 15% to 20%, probably within the next 10 months.”

Black Knight’s VP, Andy Walden, echoed that view and this week he said the market would be “nearing a bottom” in the next two quarters before flattening out, ominously adding that housing prices “are not built for a 7% environment”.

Tatom’s own experience with realtors is quite revealing.

“I was talking to a real estate agent this weekend who’s got a lot of good listings. She’s got reasonable sellers, but she’s got a lot of traffic - everyone says they’re going to make an offer, but nobody does,” he said.

“You can borrow half a million dollars on a 2.75% rate for a 30-year fixed and it’s a little over $2,000 a month. If it’s 7%, it’s $3,400 a month. That’s a couple of car payments; that’s how much of an increase you’re talking about.”

Read more: Lock volume plummets amid record-low affordability

Tatom believes there will eventually be rich pickings for buyers a year or so from now, even for first-time buyers, whatever mortgage interest rates are doing.

But with refi loan volume all but collapsed (it’s down 86% compared to a year ago) and mortgage demand down 39% year on year, it begs the question of what mortgage professionals should be doing now to right the ship.

Tatom believes there are still many tools and products for brokers to rely on, even if most real estate agents are going through the most challenging period of their careers.

“We can do cash out or renovation loans. There will also be people that want to build, so we can do construction loans. We have other ways to get money moving and non-QM is pretty big right now,” he said.

As for his company, Tatom Lending is actively promoting ‘2-1 buy down’, a financing program that offers the borrower the option to reduce their interest rate payments for the first two years of a mortgage.

This means a buyer pays a reduced 2% interest rate for the first year and 1% the second year. By the third year of the mortgage term, the interest rate goes back to the original interest rate on the loan.

“We just closed one last week, where their rate is 5.99%, but for the first year, it’s 3.99% before bumping up to 4.99% and finally to 5.99%. It’s helping a lot of people to qualify off the higher rate,” Tatom added.

But is there a silver lining in the mid to long term?

“In six to eight months’ time, there’s going to be some bargains out there to jump all over, and it ain’t going to matter what the interest rate is. I see a huge upside for a certain group of people. This is going to be the opportunity of a lifetime for anybody who’s renting or buying their first home.”

Rock on.