Weekly update from the National Housing Conference

Greetings!

Are we heading into a recession, and how would that impact the housing economy, which is just recovering from the worst housing crisis in generations? These questions are increasingly on the mind of housers, economists and policymakers in Washington. While there is no way to say for sure, there are two very important data points worth looking at and several key things to keep in mind.

First, housing prices have been rising steadily. That is not necessarily a bad thing and also not automatically an indication of an economic bubble. The most relevant rule here is that housing is all about location, location and location. In many markets, housing prices have remained relatively flat, and in others they have risen significantly, but in most they have recovered at a sustainable rate. Housing prices rise and fall over time, with flat periods in between. The home price bubble, clearly illustrated in the chart below, shows how some markets have risen and recovered faster than the national index (like Los Angeles, shown in red). But overall, we are at a natural end to a period of recovery that brings us roughly where we would be if the historic trend had not experienced the rapid escalation and fall that took place before and during the crash. Should housing prices level off, we will be experiencing a normal event that is part of a healthy market. And there’s no reason to believe that won’t be the case since the systemically irresponsible factors that extended and amplified the rise in housing prices in 2005-2007 have been largely eliminated from the system. 

The second important factor in predicting the future of housing prices is whether or not a recession is imminent. Recessions bring job loss– and the fear of job loss – which can harm housing values. There is some compelling evidence that a recession is likely, but by no means certain. One of the most accurate leading indicators of recession is a yield curve inversion. This is quite simply when short-term interest rates become higher than long-term rates – or inverted. The chart below shows the difference (or delta if you want to sound like an economist, which I’m not) between the 10-year Treasury bill and the 3-month Treasury bill. Why does this matter? U.S. Treasury bond prices are determined by the market of investors who buy them. Pricing becomes the economic equivalent of a political poll of investors rather than voters. When the delta between the 10-year and the 3-month becomes negative, a recession almost always follows, in part because investors believe it will and act accordingly. The chart below shows this since 1982, but the trend has been quite reliable for nearly 100 years. 

To guard against this cycle, the Federal Reserve Board (the Fed) manages the money supply by adjusting short term interest rates, among other ways . When the economy is slow, it lowers short-term rates and expands the money supply using other tools. When the economy is recovering, it raises rates. Raise rates too high, and the Fed can cause a recession, like it did several times during the Great Depression. Lower rates too much, and inflation can result.

This past year, we have seen several increases in interest rates as the economy has recovered. With the most recent increase, there are signs of slowing. The Fed is like a commercial airline pilot and the economy is the nervous passenger. The Fed wants the economy to have a smooth and steady takeoff and a gentle landing. Like in the mid and late 1990s. Take off too fast, and we can suddenly stall. Come down too fast, and we can crash. So yes, the yield curve is “flattening” but it is not inverted. If the Fed gets it right, we are more likely to have a soft landing followed by a gradual ascent. Hopefully that will be the case; but keep your seat belt buckled!

Sincerely,

David M. Dworkin

President and CEO