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January 2024 » thefivestar.com 37 January 2024 F E A T U R E S T O R Y We tend to think of this inventory issue in the context of what's happened since the pandemic. But the reality is, even leading up to the pandemic, we had more than a decade of underbuilding in the aftermath of the financial crisis, so inventory was low even before the pan- demic. Even amidst the longest economic expansion in history, inventory was low in 2018 and 2019, and it just managed to get worse as prices went up and as so many people refinanced with that ultra-low mortgage rate. That accentu- ated what was already a problem. It's a problem 15 years in the making. Q: What are the factors preventing us from building sufficiently to keep up with demand, and how are they changing? McBride: Right now, one of the impediments is that the cost of capital is very high. That's by design. Interest rates have gone up dramatically to cool inflation. Rates aren't going to stay at these levels unless inflation flatlines and doesn't come down closer to the target. The cost of labor is going to stay high. I don't have a good read on the zoning thing, but I know people in real estate or the mortgage business who repeatedly point to examples in their locale about how zoning restrictions have had an impact. So again, I don't know how that gets fixed overnight. Q: Are you seeing significant changes related to migration? McBride: Certain markets were red- hot during the pandemic—Austin, Boise, and Phoenix—and those markets have certainly come off the boil. But you are continuing to see migration, particularly among upper-income taxpayers, toward lower-tax locales. Again, I don't know that that's necessarily a flash in the pan. Q: Where do you fall on the prospect of us experiencing or avoiding a recession? McBride: I do see a soft landing ma- terializing. My forecast is with that as the backdrop. It's a rare instance. Arguably, the Fed only pulled this off once before, back in 1995, so history has not been on their side when it comes to this. The odds of that soft landing have certainly improved in recent months. We at Bankrate survey top economists every quarter. They are now putting the odds of a recession in the next 12 months at 45%. That's down from 65% a year ago, so we're seeing meaningful change there. So yes, I see the soft landing materializ- ing, and I'm certainly not alone in that feeling, but there are plenty of X factors that could derail that. Inflation could remain stubbornly high or, even worse, you could see a pickup in inflation again. That would certainly derail the expecta- tions economically and for rates. There are still a lot of unknowns about just how deep the problems are with commercial real estate and what, if any, systemic impact that might have. That is a big wild card and could be sys- temically disruptive. We've seen interest rates go up at the fastest pace in 40 years, and there are still plenty of X factors out there. So, another shoe could drop, and we could, despite expectations, find ourselves in a recession. And then there's also the stuff we just never see coming. There's no shortage of X factors. There never is. Q: You mentioned that the Fed has historically struggled to secure these soft landings. What made this situation different? McBride: Studies will be done and books will be written for the next decade theorizing about that. One thing that has come to the forefront is that perhaps the economy is less sensitive to short-term interest rates than it has been in previous decades. I mentioned the tendency for homeowners to have refinanced in large numbers at very low mortgage rates. That insulated millions of homeowners from seeing an escalation in their pay- ments. So, when interest rates went up, it didn't hit large swaths of homeowners. So, maybe there's less impact on the consumer and the overall economy because of the increased preponderance of fixed-rate mortgage debt. The other part of it is the Fed, although they were late to acknowledge inflation and late to do anything about it, they did have the benefit of hindsight and looking at the mistakes previous Fed committees had made regarding interest rates and infla- tion. They have been deliberate about trying not to repeat those missteps. It's too early for a victory lap, but if the soft landing materializes, I think that there's certainly an element of that that would be a factor. A year ago, I was in the camp that ex- pected a recession before the end of the year. In accordance with that, I expected mortgage rates were going to fall very sharply in the second half of 2023, even much more than what we had seen in the fourth quarter. As a result, my prediction on rates for 2023 wildly missed the mark. I'm happy to be wrong. The economy held up much better. We didn't have a recession. The economy continued to grow at a robust pace. The labor market remained very strong. We still have some of the lowest unemployment rates in more than 50 years, and there are 1.4 jobs open for every unemployed worker. The economy held up very, very well, and as a result, we didn't see a sharp decline in mortgage rates. I didn't see mortgage rates going as high as they did, and I had them coming down a lot more because of the expectation of a recession. When that didn't materialize and infla- tion remained in the crosshairs through- out the year, that meant mortgage rates ended up being a lot higher in 2023 than I initially forecasted.