Will The Silicon Valley Bank Fallout Collapse The Housing Market?

Key Takeaways

• The past two weeks has seen a raft of bank failures that was kicked off by Silicon Valley Bank
• Some are drawing parallels to the 2008 financial crisis and concerns over whether a housing market collapse is possible
• It’s important to understand the fundamental differences between then and now, with the current bank problems driven by short term liquidity issues, rather than fundamental asset values
• Housing prices are falling, which makes now a good time for potential buyers to work to build as much of a down payment as possible

There’s no hiding from it. The financial sector is having a wobble. Silicon Valley Bank and Signature Bank no longer exist, and over in Europe 166-year-old Credit Suisse has just been sold at a 50% discount to their biggest rival UBS.

Twitter and LinkedIn are alight with loud voices calling the start of an economic apocalypse and the collapse of the housing market.

While you can’t deny that the banking sector is under some pressure right now, most analysts agree that we’re not staring down the barrel of a total collapse of the financial system and housing market.

Even so, there are some key factors that investors need to be aware of. Because one thing is for sure, we’re almost certainly going to see more volatility over the coming months.

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The current banking issues are different to 2008

All this talk of bank collapses and financial uncertainty immediately takes us back to 2008. For many, this is the only other financial crisis in memory, so it makes sense to draw parallels between the two.

But the reality is that the underlying causes of the problems are much different.

Both are issues of risk management, but the current problems are short term liquidity problems, rather than actual fundamental asset problems. Let’s explain.

The 2008 problem

There were obviously many different factors that went into causing the 2008 global financial crisis. It’s too complex to cover all of them here, but one of the central problems was the fact that banks were lending money to people and companies that they shouldn’t have.

The infamous “NINJA” loans meant people were able to get mortgages with ‘no income, no job, no assets.’ This meant that the bank really had no way of ensuring that they got paid, other than the expectation that the property asset itself would go up in value.

Not only that, but banks were often lending more than a property was worth. Forget a down payment, back then banks were lending up to 120% of the property price!

As these loans went into default, it became clear that many of the mortgages that had been written and packaged into mortgage backed securities (long term bond products), were practically worthless.

Almost overnight, banks who had what looked like billions of dollars of assets on their balance sheet, were forced to write down (recalculate) these values. Often down to zero.

That’s an important distinction. The people who were given these mortgages were not paying, and would likely never be able to pay. So those assets were never likely to recover.

Along with all this it became clear that the demand for property had been driven by buyers who should never have been able to buy in the first place. As this realization hit, prices fell and the housing market crashed.

The current problem

In the aftermath of the 2008 crisis, banking standards were tightened up considerably. It’s much harder to get a mortgage and you’re definitely not going to be able to get one without a solid down payment and a source of income.

So as a whole, mortgages and the mortgage backed securities that they’re packaged into aren’t a sinking ship like they were in 2008. Despite the fact that the overall cost of living is high, home owners are continuing to pay their mortgages, and there aren’t currently any concerns about the viability of these assets as a whole.

That fact in itself means that the chance of a housing collapse like we saw in 2008 aren’t looking likely right now. Of course, things can always change.

But mortgage backed securities have still dropped substantially in price. The fundamental reason for this isn’t to do with the assets themselves, but rather the other investment options in the market that have become available.

A 10+ year mortgage backed security paying a 1.5% coupon rate looked attractive a couple of years ago when U.S. Treasury rates were 0.7%. But now that rates have been hiked and investors can buy a new U.S. Treasury at over 3%, those mortgage backed securities look like a bad deal considering they’re higher risk.

So what happens? Demand falls and so does the price.

This is what banks are dealing with. A significant amount of their assets are currently trading at lower prices. But, the assets are sound, and a fundamental component of bond investments like these is that the investors receive their capital back at the end of the term.

So long term risk hasn’t really changed, just short term volatility.

Is the housing market 100% safe?

No, every investment, including real estate, involves some level of risk. And right now the housing sector is also under pressure from rising rates. Mortgages are now a lot more expensive than they were last year and the year before.

That’s significantly reduced demand in the real estate market, with sales numbers in January 2023 down 36.9% from a year prior. Prices have held up reasonably well so far as there hasn’t been a lot of inventory on the market, but they are starting to slowly decline.

While interest rates continue to go up, it’s likely that the housing market will struggle to provide any meaningful gains for investors, and we will probably continue to see a slow slide in prices until that changes.

The bottom line

So the housing market is slowing, but it doesn’t look like a housing collapse is imminent. For potential home buyers, that means now is a great time to be building up the biggest down payment possible.

House prices are coming down for the first time in a long time, and while interest rates are high, they won’t stay that way forever.

A bigger down payment means you have access to better mortgage rates and lower ongoing repayments, so it’s generally a solid financial strategy to build it up as much as possible.

The problem is that bank interest rates are still below inflation, and the stock market looks risky right now.

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