In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi share their new housing recession model that provides a data-driven definition of a housing recession, look back at the history of housing recessions, and discuss whether or not we’re in a housing recession today.
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“Housing recessions come in all shapes and sizes. At least from the perspective of sales and affordability, it does look like the worst is behind us. Of course, it's very much dependent on the path of inflation and Fed action.” – Odeta Kushi, deputy chief economist at First American
Odeta Kushi: Hello and welcome to episode 69 of The REconomy podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark. In today's episode, we are staying true to a promise that we made some episodes back.
Mark Fleming: Hi, Odeta. Umm, what did we promise?
Odeta Kushi: You don't even remember?
Mark Fleming: Well, I do say a lot of things, but not sure if I promise a lot of things.
Odeta Kushi: Okay, good point, I guess I can be a little bit more specific. Exactly, 10 episodes ago in Episode 59, we brought up the topic of a housing recession. And, in that discussion, we promised that we would follow up with an episode where we better define a housing recession.
Mark Fleming: Oh, I do remember promising that and am pleased to say we are staying true to our word. Maybe first, though, it's worth recapping that episode to really highlight why a housing recession definition is even necessary. And keep in mind that a housing recession can be independent of an overall economic recession, which may or may not come to pass if the Fed achieves an economic soft landing.
Odeta Kushi: That's a great idea. Well, let me start with a question then. Mark, are we in a housing recession right now?
Mark Fleming: Ah, you know, the classic two-handed economist here. I can make arguments for and against, but I think I would lean towards yes, because the overall number of transactions in the housing market is way down right now.
Odeta Kushi: Sure, but builder confidence has been on an upswing as have been home sales, new-home sales, that is, and even prices, are going up again.
Mark Fleming: Ah, and there in lies the difficulty in defining a housing recession. Much like regular economic recessions, you can have indicators that are saying different things. Recessions are complicated. Not all recessions are created equally. And recessions are not single-indicator events.
Odeta Kushi: Well, you mentioned regular recessions. In episode 59, we briefly discuss how those recessions are determined. It's worth summarizing, again, because it serves as the basis for the measure that we've created to capture housing recessions.
Mark Fleming: That's a good idea. The National Bureau of Economic Research Business Cycle Dating Committee, the NBER BCDC, is the official authority on recession start and end dates and they have a, shall we say flexible, definition of a recession.
Odeta Kushi: The BC DC. Does that make us the HCDC?
Mark Fleming: Odeta. Indeed it does. And you just walked yourself into the 80s musical reference from Episode 59.
Odeta Kushi: I do see where you're going with this. And I just want to highlight that AC DC was actually formed in the 70s.
Mark Fleming: True, but they really made it big in the 80s. But we digress. The BC DC says a recession "involves a significant decline in economic activity that is spread across the economy and lasts more than a few" -- very specific there -- "months." And they use three criteria, depth, diffusion and duration. They look at measures ranging from real personal income less transfers -- that's Social Security payments, welfare payments etc. -- nonfarm payroll employment, employment as measured by the household survey, and more.
Odeta Kushi: And that's where the HCDC, aka we got our idea to try and measure housing recessions.
Mark Fleming: You're really committing to this HCDC thing.
Odeta Kushi: I think if I say it enough, it'll just stick.
Mark Fleming: I like that plan. Founding members of the HCDC.
Odeta Kushi: Yes. So, to determine if the housing market is in a recession, we created a comprehensive rule-based measure modeled after the NBER BCDC's method of calling recessions, which relies on the economic indicators that you just mentioned, or the housing equivalent of those economic indicators.
Mark Fleming: We have to get into the methodology just a little bit here. The housing-specific indicators that we're measuring are average hourly earnings of non-supervisory construction workers; the total number of employees in residential building construction; the total number of employees in real estate rental and leasing; the number of single-family housing starts; private residential fixed investment; and personal consumption expenditures on housing and utilities -- what we pay for shelter -- existing home sales; and the Real House Price Index, which is a measure of affordability and incorporates incomes, interest rates and house prices. If the growth rate of four of the eight indicators is negative for at least three consecutive months, then a housing recession has begun.
Odeta Kushi: And one caveat here, that's the rule after 1990. Due to data limitations prior to 1990, only three indicators must be negative to indicate recession, whereas after 1990, it must be four. It's also worth highlighting that we're looking at these indicators on a monthly basis for the measures that we only get quarterly or annually, so we're doing a linear interpolation to get to a monthly series. Also, we're taking a three-month moving average of the month-over-month growth for each series. That's because monthly growth rates can be quite noisy. So the moving average smooths out some of that noise. All right, whew, we are past the technical details.
Mark Fleming: So HCDC drumroll please. What's our rule-based measure telling us?
Odeta Kushi: Wait, wait, wait, before we get to what it's telling us about today's market, I think it's worth discussing all of the recessions that this measure captures and perhaps highlighting a few.
Mark Fleming: Well, that's a good point, we'll sort of qualitatively back test how well this measure does at capturing housing recessions.
Odeta Kushi: That's right. So our measure captures 10 housing recessions since 1970. That would be the recessions of 1973, 1979 to 1980, 1981, 1987, 1988 to 1990, 1994 to 1995, 2000, the Great Recession and the housing recession of 2022.
Mark Fleming: Wow, I didn't realize we had so many recessions.
Odeta Kushi: Yeah, I didn't either.
Mark Fleming: There are a few obviously that stand out. For example, in 1979, and again, in 1981, the housing market was considered in recession. Because in the late 1970s and early 1980s, interest rates were soaring, as the Federal Reserve was combating the Great Inflation. Sounds a little familiar. As a result of tighter monetary policy and higher inflation, mortgage rates increased to a peak of 18% in 1981. As mortgage rates were going up to numbers unseen before or actually even since, homes were becoming significantly less affordable and home sales and new construction was falling.
Odeta Kushi: Now, fast forward to another housing recession period 2006 through 2010. I think there's probably general agreement that the housing market was in a recession during this period, the housing crisis in the Great Recession was fueled heavily by the fact that job loss was paired with a significant share of homeowners who didn't have much equity in their homes. Six of the eight indicators mostly agreed that housing was in recession during this period. The only indicator that didn't experience significant decline over this period was average hourly earnings of construction workers because, as we know, wages tend to be downside sticky, meaning that they can move up easily but move down only with difficulty.
Mark Fleming: And last, but certainly not least, 2022. According to this measure, the housing recession of 2022 began in May and ended in November.
Odeta Kushi: Well, that makes sense. The average 30-year, fixed mortgage rate increased by 1.6 percentage points during those months, which resulted in a 14% decline in affordability. As a result of the rapid decline in affordability, builders pulled back on breaking ground on more homes. Additionally, higher rates, as we know, have a dual impact on sales. They price out buyers who lose purchasing power and then keep potential sellers rate locked in, resulting in fewer transactions. The housing market recession paused in December of 2022, as rates came down from recent highs, and in the first couple of months of 2023, the housing market began a very slow recovery as rates stabilized and the new-home market began to take market share from the existing-home market.
Mark Fleming: And, on that point, we mentioned at the top of the episode that the total number of widgets or transactions in the housing market is down, but new construction is on the rise. There's a reason for that -- existing homeowners aren't moving.
Odeta Kushi: Well, the latest first quarter 2023 data shows that just over 90% of mortgaged homes are locked into rates below 6%. Rates today are higher than that, so homeowners are staying put and existing-home inventory has traditionally made up about 90% of total inventory. Today, that's more like 70%.
Mark Fleming: And, while existing homeowners are staying put, builders have inventory to sell. They can also offer incentives, which come in the form of mortgage rate buydowns, paying points for buyers and offering price reductions. They can also offer upgrades on appliances and other interior quality features.
Odeta Kushi: So, if there are no existing homes to buy, a new home is a pretty good alternative. So, while the existing home market is clearly in a recession, it sure looks like the new-home market is in recovery.
Mark Fleming: But, in aggregate, the housing market still looks very recessionary. That's likely because the new-home market is still a smaller share of the overall housing market.
Odeta Kushi: Well, since you mentioned today's market, what is our measure saying about today's housing market?
Mark Fleming: Well, unfortunately, our measure is sounding the alarm bells or should I say, Hells Bells? Get it?
Odeta Kushi: Clearly, anything goes.
Mark Fleming: Oh, impressive 2000s ACDC reference, Odeta.
Odeta Kushi: Thank you, thank you. Don't look so thunderstruck.
Mark Fleming: Oh my gosh, that is pretty good.
Odeta Kushi: Alright, I will stop there though. But back to our housing recession indicator. June data is still trickling in, but early signs point to a possible double-dip recession that began to take form in March of this year. It's not surprising that the housing market continues to struggle, even if a small segment of the housing market -- new construction -- seems to be bucking the trend, potential home buyers are still contending with higher mortgage rates and a limited inventory of homes for sale.
Mark Fleming: And that shouldn't be too surprising, as the Federal Reserve's fight against inflation persists, and a lot of uncertainty still exists in the economy. Real estate is very interest-rate sensitive, which is why when the Fed first hit the proverbial brakes on the economy by hiking rates, the housing sector was the first to respond "recessionarily."
Odeta Kushi: As long as the Fed's fight against inflation persists, it will continue to put downward pressure on the housing market because, as we know, mortgage rates typically follow the same path of long-term bond yields, which move with inflation expectations and the Fed's actions.
Mark Fleming: So our measure is saying the housing market was in recession in 2022, but it took a bit of a breather and is possibly slipping back into recession again, as rates push closer to 7% and homeowners stay put.
Odeta Kushi: Yes, but remember what we said, housing recessions come in all shapes and sizes. At least from the perspective of sales and affordability, it does look like the worst is behind us. Of course, it's very much dependent on the path of inflation and Fed action. All right, well, that's it for today's episode. If you are interested in finding out more about our housing recession measure and seeing the history of what it has indicated about past and current housing recessions, you can check out our blog at firstam.com/economics.
Thank you, as always, for joining us on this episode of The REconomy podcast. If you have an economics-related question you'd like us to feature on a future episode, you can email us at economics@firstam.com. We love to hear from our listeners. And, as always, if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.
Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2023 by First American Financial Corporation. All rights reserved.
This transcript has been edited for clarity.