Update 375: Amid Volatility and Shades of ‘08
Whither the Housing Market, Where Headed?
The next recession is not a matter of it but when. As for how, we look for early warning signs where we wish we had last time. The U.S. housing market was at the epicenter of the financial crisis of 2008, both as a cause and a consequence — history won’t forget the long period from 2009 to 2013 when roughly a quarter of all homeowners were under water. Although it accounts for a small amount of economic output, the housing market can experience outsized volatility during downturns.
This week, the 10-year Treasury yield dropped below the 2-year for the first time since June 2007. This inversion of the Treasury yield-curve rattled major stock market indices, as an inversion is regarded by economists as a fairly reliable predictor of a recession ahead — but when, how deep, and where, so we can head it off? We start by surveying ground zero of the last recession: the US housing market.
Mortgage rates are at their lowest level since 2016, with average rates for a 30-year fixed rate hitting 3.6 percent last week. Mortgage rates have declined precipitously since November of last year, when the 30-year mortgage hit almost 5 percent. Despite the fall in rates, home sales are sluggish, with home prices remaining stubbornly high.
There is also some confusion about the effect of Fed interest rate decisions on the housing market. Many Americans view the Fed’s decision to lower interest rates as a sign that mortgages will get even cheaper. But do the Federal funds rate and mortgage rates correlate? What do indicators in the housing market tell us about the prospects for the macroeconomy?
A Common Correlative Misconception
When financing a home purchase, buyers can choose either an adjustable-rate mortgage (ARM) or a fixed-rate mortgage (FRM). In 2017, 90 percent of homebuyers used a 30-year FRM to finance their purchase. For FRMs, longer dated treasury yields have a correlative and symbiotic relationship, as opposed to the Federal funds interest rate.
ARMs are more susceptible to changes in the federal funds rate, but only around 6 percent of mortgage applications are for ARMs. For the vast amount of mortgages, a change in the federal funds rate has little-to-no effect on the interest rate buyers pay.
Mortgage rates only tell us part of the story. Nationally, the housing market is showing signs of weakness, raising questions about the progressivity of the recent 25 basis point cut in interest rates by the Fed. If it does not help or solve inequality, does not improve wages, has a remote impact on consumer behavior, and has little to no effect on housing — who does it help?
Market Conditions: Fine or Flipping Out?
Here is a rundown of the factors influencing the US housing market today.
- Debt: The amount of mortgage debt in the economy has now surpassed the peak in the third quarter of 2008. Mortgage debt is the largest sector of household debt and has been on the rise since 2013, in part due to ever-growing home prices. Today’s debt pile does not resemble that of the boom times leading up to the recession. With stricter lending requirements and less debt in delinquency, the debt burden is more sustainable than a decade or more ago.
- Sales: Low mortgage rates and an ostensibly strong economy suggest conditions are ripe to buy a house. Despite this, sales are down in 2019, following an abysmal year in 2018. Existing home sales in June, historically the most active month in the home buying calendar year, were down 2.2 percent compared to June last year. Overall existing home sales are projected to be down to 5.25 million in 2019, a 1 percent decrease from 2018, and the lowest figure since 2015.
- Prices: The National Association of Realtors Housing Affordability Index (HAI) indicates that housing has been less affordable in 2018 and 2019 than it has been at any time since the financial crisis. Wages have not kept up with increasing housing costs and tight credit standards continue to make homeownership hard to reach for many. According to the St. Louis Federal Reserve, the median sales price of homes purchased in 2Q of 2018 was $315,600, where as in 2Q of 2019, the median sales price of homes purchased was $320,300.
- Volume: Over the first six months of 2019, the total number of single-family permits issued for the first half of the year was down 6.1 percent over the same period last year. Among other reasons, high construction costs continue to have a negative impact on housing production. The market has seen some recovery in housing starts since the beginning of this year, but the stock is still lower than it was leading up to the Great Recession. Housing starts should be rebounding more than they are with Baby Boomers looking to downsize and Millennials beginning to start families. However, housing starts are running at a third of the 1972 high point when many Boomers were beginning to start their families.
What Lies Ahead
The softness in the housing market is cause for concern. More interest rate cuts by the Fed will likely do little to change affordability, which is the fundamental problem with US housing stock. From 2016 to 2019, the median price of a single family home went from $235,500 to $279,600 — a nearly 19 percent increase over just three years. Inflation over this same period increased by around 7 percent. No wonder so many young people are struggling to afford to buy their own homes when they are trapped by student loan debt and their wages are stagnant.
More than a decade ago, problems in the US housing market precipitated a global financial crisis. While many of the causes of that crisis have been remedied and a national housing bubble no longer exists in the same way that it did in 2007, homeownership remains inaccessible for many Americans. Policy solutions aimed at improving housing affordability are therefore not limited to housing policy alone, but are closely related to other policy areas. Proposals to reduce the burden of student debt, raise the minimum wage, and others, are all part of a broader solution to ensure that the American dream of home ownership continues for generations to come.