The last time the housing market suffered a major meltdown in 2006, it took the entire US economy with it. But history never follows exactly the same script twice.
The weakening housing market will undoubtedly hurt the economy. Single-family home construction dropped to an annual rate of 1 million in May from a 15-year high of 1.31 million in December. Permits to build more houses also dropped.
It will probably get worse too.
House prices had already hit a record high when the Federal Reserve in March began rapidly raising interest rates to combat high inflation. Aggressive action by the central bank pushed the 30-year fixed mortgage up more than 6% from just 2.75% last year.
The combination of more expensive mortgages and sky-high prices has made it difficult for most homebuyers to buy a home. Affordability has dropped to its lowest level in 16 years, the National Association of Realtors said.
As housing goes, so goes the US economy, according to an old saying. The resulting slowdown in construction is expected to subtract a large part of gross domestic product growth in the second quarter. And fewer sales means fewer new homeowners spending money to furnish their homes.
However, the housing market is very different now than it was in 2006, and by itself is unlikely to drive the economy into a ditch. The US may well plunge into recession in the next year or two, economists say, but housing will not be the main cause.
“We expect sales to fall further in the coming months, but we don’t expect a repeat of the 2000s crash,” said Alex Pelle, US economist at Mizuho Securities.
Small sign of a bubble
The real estate market today bears very little resemblance to the 2000s.
For one, the typical buyer has a high credit score and is less likely to default. Only about 2% of all new mortgages are granted to so-called subprime buyers, or those with weaker credit scores.
On the other hand, about 15% of borrowers had subprime credit at the height of the housing bubble nearly two decades ago, a survey by Jefferies, a Wall Street firm, shows.
Many of these borrowers lost their homes in the 2007-2009 recession and real estate values plummeted, robbing millions of Americans of paper wealth and making them feel poorer. A massive sale on the stock market added to his troubles.
The negative “wealth effect” helped contribute to a sharp decline in consumer spending that deepened the recession. Consumers account for nearly 70% of everything that happens in the economy.
The current downturn in the housing market, however, is unlikely to lead to lower prices and lower home prices.
For starters, the US has suffered from homelessness for years, even as the number of new families being formed has driven demand to new heights. The pandemic has also dramatically increased the number of people working from home and the clamor for more housing.
Demand for housing is strong in part “because of the rise in remote work and changing lifestyles,” said Comerica Bank chief economist Bill Adams.
Builder have tried to meet most of this demand. Construction of new homes and rental units rose to an annual pace of 1.8 million in April – a 16-year high – before mortgage rates really took off. But that’s still down from the record 2.2 million in early 2006, when the population was 11%. smaller.
It won’t get any better anytime soon either. Construction fell sharply in May and is expected to continue to slow, further reducing the supply of homes for sale and maintaining upward pressure on prices.
High home prices aren’t entirely a bad thing, especially for those who already own their own homes. Stable home values can partially insulate the economy from recession.
Like this? Homeowners are likely to feel better financially than they did in 2006 because their main nest egg is still rising in value.
Additionally, millions of homeowners have taken advantage of record interest rates during the pandemic to refinance and save a bundle. Most of them also opted for fixed mortgages, leaving them immune to rising rates.
That wasn’t the case in the mid-2000s, when half of all mortgages were adjustable. Rising interest rates force millions of homeowners to pay high monthly mortgage expenses, and many who could not afford it have defaulted.
Now, only about 10% of all mortgages are adjustable. Furthermore, the percentage of income that homeowners have to devote to their mortgages is at a record high.
“The links between housing and consumption are likely to be weaker than in the past,” said Aneta Markowska, chief economist at Jefferies.
What could further hurt the housing market is a huge increase in unemployment causing more people to default on paying.
However, with the unemployment rate at just 3.6% and a labor shortage expected to persist for years, some economists question whether companies will resort to mass layoffs if the US slips into recession.
Meanwhile, the housing market is still holding up relatively well despite high interest rates and high prices. Sales and spending on new construction are hovering close to pre-pandemic levels, suggesting the bottom will not fall like it did in 2006.
Of course, some experts said the same thing 15 years ago. “Researchers say the recent housing crisis does not necessarily mean the end of economic growth,” said an article in The Christian Science Monitor at the time.
What followed was the worst recession in decades.