MainStreet Macro: Housing Leads the Way

The title of this blog, Main Street Macro, might be self-explanatory. What you don’t know is that I grew up on Main Street, in a smallish Indiana town. I have a direct and personal connection to what we talk about each week.

Today, let’s talk about my old Main Street house and the millions of houses like it–those profoundly personal and sometimes sentimental investments that have a direct and outsized influence on the economy.

For 50 years, our homes have led the U.S. into recessions (sometimes) and out of them (almost always). Housing’s starring role in economic rebounds has been remarkably consistent, with one major exception: The Great Recession. After the 2008 financial collapse, housing was a heavy weight tied to the ankles of the recovery, dragging it down instead of propelling it forward.

Housing and economic data to be released this holiday-shortened week should reinforce what history has shown us. Here are four signs that the housing market is playing a leading role in the post-COVID rebound.

Sign 1:  People are buying houses

Residential fixed investment–purchases of new single-family homes, apartments and mobile homes, and spending on improvements and broker’s fees – fell 26.7% on average during each quarter of the Great Recession.

This time around is different. The economy suffered its steepest contraction in history in the second quarter of 2020, with GDP falling 32% annualized. But purchases of new homes fell just 2% from a year earlier, then climbed steadily for the remainder of the year.

Source: St. Louis Federal Reserve Economic Research

Sign 2: Borrowing is cheap

Remember the first time you bought a house? I’m sure you do. Does anyone remember the mortgage rate on that first home? In 2002, mine was 6.25% on a 30-year, fixed-rate mortgage.

Some of you might remember signing loan docs with a double-digit rate in the 1980s, when mortgage rates hit 18%! 

Today, a whole generation of millennial homebuyers have never seen a mortgage rate above 5%. And borrowing costs have fallen even further during the pandemic. Fixed-rate, 30-year mortgages are below 3% and have been since August, according to Freddie Mac.

Housing is one of the most interest rate-sensitive sectors of the economy. Cheap borrowing entices would-be buyers and increases profits for homebuilders. All that buying and building increases consumer demand for durables such as refrigerators and furniture, which boosts economic growth.

Housing historically is about 5% of the economy. But when you include rental income, and all the shopping that comes with a new house– rugs, plants, puppies, lawn mowers, fire pits — our homes and their trimmings account for upwards of 15-18% of the entire U.S. economy.

Source: St. Louis Federal Reserve Economic Research

Sign 3: There’s nothing for sale

Since World War II, we’ve built about 1.5 million new homes a year in the U.S., even when the economy was lackluster.  But after the financial collapse, the pace of new home construction dropped to a historic low of about 500,000. 

The market at the time was plagued by a glut of homes for sale after years of overbuilding and reckless lending. A record number of foreclosures scarred Main Street.

A decade later, we’re still licking our wounds. Housing has been chronically undersupplied since the collapse, and only in recent months have we started to see the pace of sales return to historical averages, despite increased demand for more homes.

Supply woes intensified in 2020 as our pandemic-driven yearning to nest met up with rock-bottom interest rates. Home purchases surged in the second half of the year.

The number of homes on the market in December of 2020 sank 23% from the year before, according to the National Association of Realtors. Lopsided supply and demand has favored home sellers over buyers by pushing prices up, and fast. Home prices rose nearly 13 percent from a year earlier, a fourfold of the historical average.

Source: St. Louis Federal Reserve Economic Research

Sign 4: Our nest eggs are growing

With mortgage rates low and home values appreciating, homeowners are flush with record levels of home equity.  This is a sharp contrast to the last recession, when falling prices and rising mortgage debt all but wiped out home equity in the U.S. especially for low- and middle-income Americans.

Equity makes people feel wealthier and makes them just a little more likely to spend instead of save.  And, as those of you who have been paying attention know, consumer spending is a huge driver of any economic rebound.

Source: St. Louis Federal Reserve Economic Research

My Take

The housing market isn’t perfect. The same racial and income inequities that we need to address in the labor market need to be resolved in housing. Double-digit price increases are making homes less affordable for young families.

Still, I’ll take this imperfect housing-led rebound after living through the alternative during the last recession.  A booming housing market can’t solve all the economy’s problems, but the good news for Main Street is that while the economic recovery might start at home, it doesn’t have to end there.

Looking ahead

After the President’s Day weekend, economic releases are back in full swing.  A handful of manufacturing indices are likely to point to continued economic expansion. That would be positive news, but it’s worth noting that the much larger service sector took the brunt of the COVID downturn. Retail sales data released Wednesday will tell us how consumer spending is holding up. We will see how housing is shaping up in 2021 when housing starts (Thursday) and existing home sales (Friday) are reported. If current trends continue, housing is likely to reclaim its traditional pole position to lead the way for the economic rebound.