Assuming the US economy is either in a recession, or on the precipice, it will be the first time in history that housing pulled the economy into a recession. Typically a recession drags housing down kicking and screaming with it.

Who cares? (I find it easier to talk to myself)

It help explains why the federal government has been so tardy in reacting to the impact of housing on the economy. Once the Fed began to raise the federal funds rate in 2004 after keeping rates unusually low for 3 years, actions (and acknowledgements) were taken only after last summer’s credit market implosion. It makes me even more wary of comfort messages like this.

What happened?

The unusually low rates and unprecedented liquidity in the credit markets fueled the housing boom of 2003-2006 across the US (and much of the world). This created a high level of speculation resulting in unusually high sales levels. The differential between normal sales levels and those of this period were represented by investment properties.

The music stopped in July 2007.

Investor demand, flippers, etc. fueled artificial housing demand layering over an above a brisk housing market caused by low rates and non-existent underwriting standards left a high level of unsold inventory and foreclosures behind.

The combination of rental and sales market trends we see now are unusual.

  • Sales activity slowing

  • Sales inventory levels rising

  • Sales prices sliding

  • Foreclosure activity rising

  • Rental inventory levels rising

  • Rental prices slipping

We now have a situation where both sales and rentals are in sync: characterized by price erosion and inventory expansion.

Perhaps we needed a jackass pulling the cart, rather than a horse?

13 Responses to “[Up Side Down] The Cart Before The Horse (The Mortgage Before The House)”

  1. Gabe says:

    I have a little graphic that I created a couple of years ago that fits the bill:

    • gabe
  2. dapple says:

    It is not correct to say this is the first time that housing has caused a recession. The housing sector almost always leads in a recession. See

    The 2001 recession was the only post-WWII exception. And the fact that housing did not experience a downturn then is part of the reason the bubble became so large.

  3. dapple – that’s only housing starts. and besides – that’s one of the most useless metrics generated by DOC.

  4. maurice says:

    I love this article because it is so right on point. When Bernanke assumed the post of “New Sheriff in town” the rates started to climb rather aggressively. I thought government was supposed to act responsibly and play the role of moderator using fiscal and monetary policies together. Well the funny thing is that I predicted the “bust” once I saw this happening and I watched in disbelief as the air was sucked out of our credit system. You see; we were in overdrive but you must gradually pump the brakes and not slam on it because what happends is that the cart then ended up in front of the horse. Our economy has been in poor shape for a few years and unemployment has been high for just as long but our folks were able to make mucho monopoly money from real estate which kept them out of the Department of Labour unemployment head count. Let us not forget that our retail business was hot because of the number of undocumented immigrants who were shoping as they earned money from the construction trade. Man, we are really upside down, and instead of thinking things out the government is now placing huge band aids on the wounds that it could have avoided.

    God Bless America

  5. dapple says:

    It is not just starts. The 90-91 recession and S&L crisis were a direct consequence of falling home price in the Northeast and California.

    Housing is one of the most interest rate sensitive sectors. Except for the 2001 recession, all post-WWII recessions were the result of the Federal Reserve raising interest rates to cut off inflation. In periods of Fed tightening, the housing sector is always one of the first sectors to slow.

    I agree, on a month-to-month basis, the starts statistics are very noisy. But look at Norris’ blog entry, he is using a 3-month moving average. I will try to find a chart of housing starts vs. recession periods. Housing starts is one of the most accurate leading recession indicators.

    It is only the last two recession (2001 and now) that fall outside of the usual pattern of Fed tightening, housing slowing, followed by consumers cutting back.

  6. dapple says:

    Here is a chart.

    Except for 2001, a drop in housing starts always leads a recession:

  7. Interesting perspective. I still don’t agree that the 1990-91 recession was brought on by housing. Housing prices fell as rates climbed and job losses increased. Housing didn’t lead the economy into a recession during that period, it was along for the ride. I agree it’s highly interest rate sensitive. Housing follows unemployment which drives recessions. This go around, its the reverse. Housing is driving unemployment and was the last straw in driving us into a recession.

  8. Laura says:

    Lucky for buyers prices that have been inflated in traditionally low markets are coming back down to “affordable prices” for the working joe.

    Now we have other problems to worry about in allowing the Working Joe to actually purchase the property. Lending guidelines are more astringent requiring a bigger down payment and Univeral Default is driving up his all of his revolving credit account percentage rates along with repayment amounts, Debt To Income Ratio and lowering his Credit Score. So to once again disqualify him.

    Just when Working Joe thought he could buy the house he always wanted revolving credit companies nix him with digging into his wallet deeper.

    Universal Default is used by all Credit Card Companies, and Auto Insurance. Universal Default clause allows all of the creditors to monitor the consumer’s credit report for opportunity to raise their rate and change their terms. If the consumer has one account on their credit report with a late pay within 7 years prior, any creditor can decide at any time to charge more to this customer even if the derogatory remark is not against their own company.

    Anyone who begins paying on accounts with say $150 per month payments on all Credit Card accounts can suddenly end up paying $800 per month for the same debts with higher interest rates. One person reported that the usual payment was $250 and received his new monthly bill the following month with the new rate of 30% plus higher repayment at $2000 per month for the same charged items.

    58 Million American Citizens have complained about the issues above and reported that this practice is deceptive. It is a downward spiral to consumers not being able to afford the monthly payments, on-going derogatory credit reporting which lasts 7 years each occurrence, Consumers not being able to get back on track or obtain reasonable credit due to extremely low credit scores, and BANKRUPTCY.

    This program is a win for Credit Card companies who can destroy the average American Citizens life by wrecking their ability to repay debts, cause emotional stress and health issues due to extremely high bills and flooding of collection calls up to 20 times a day, destroying the consumers credit for 7 years after the last occurrence, and controlling the consumers ability to have an enjoyable life.

  9. CSC says:

    Actually I think things began to fall in mid 2005. Certainly predictions that it would were out there long before that. Industry insiders were aware, though not admitting it. People knew the music would stop, they just didn’t think they’d be the ones without a chair.

    In Aug 2005 I saw prices fall where I lived almost overnight. Suddenly, builders’ model homes that were being snapped up at inflated prices, probably with risky loans, had signs that said “price reduced.” A few weeks later the same unsold houses had a sign that said “for rent.” I’m still seeing houses sit for a long time or have prices reduced.

    Prices need to come back to earth and loans needed to be less risky. It’s sad for those who lost money who were duped into believeing the values of these houses was real, but we can’t keep it artificially inflated.

    I live in an area where incomes are far too low for so many overpriced (and shoddily built sometimes) new houses to sell for a half million or more. Creative, i.e. toxic, financing was probably how people got into some of them. I knew a woman who worked at the courthouse. She said foreclosure filings had more than doubled. And still, the real estate ads are running, telling people who only have TV for their news, that it’s a great time to buy. I know of two realtors who’ve been called on the carpet for daring to tell the truth. If the industry wants to maintain a shining reputation, first it has to shine, not just blow sunshine.

  10. As always, Jonathan, I like the way you pull no punches and stimulate ideas. Unschooled as I am in law and economics, I wonder whether the following idea is worth consideration:

    Perhaps there is another way than the ones being discussed in Washington to alleviate the mortage/credit/housing crisis. In return for giving homeowners the funds they need to avoid foreclosure, the Federal government will obtain a portion of the equity. The money would be returned to the government when the property is sold.

    Although such an arrangement raises a number of questions—for example, whether it would be possible for the government to be first in line for repayment and what would be the consequence of a property falling into disrepair or being destroyed by a fire or other calamity—it could balance nicely the need to avoid “bailout” with the desire to act compassionately while costing taxpayers a pittance in the end.

  11. Interesting and clever Malcolm. One of the biggest issues in foreclosure today is who actually is in line at the feed trough. With a broad array of tranches for individual loans, one of the biggest challenges facing the issue of foreclosures is what position each investor or lender is in. Now add another layer in first position, it would seem to be a nightmare. In addition, that “federal” layer places the first mortgage in 2nd position, increasing the risk and the rate to the homeowner.

    In other words, it’ll be a cold day in Miami before I think that is possible. 😉

  12. CS says:

    New York City, a superstar metropolis, is weathering an econmic slowdown–not a deep recession. As a real estate executive for one of New York City’s prominent firms, I can attest that a year ago our vacancy rate was less than 1% for our rental properties. Now it is 1.5%, still below a national average typically 5%. Last time I looked, there were no stockbrokers jumping from windows or society matrons selling apples on Park Avenue.

  13. CS – I respect your perspective given your background and I agree with your points but this post is more applicable to the US rather than specific to Manhattan. One of the things unique to the NYC market in recent years has been a robust local economy, wall street, significant benefit from the weak dollar, a city govt running a surplus. No one is saying depression, but we are definitely in a transition. Purchase activity is already challenged by credit availability yet this market is not immune as you seem to be alluding to. The credit crunch is hitting wall street 2 fold since it will likely impact compensation and employment levels over the next 2 years as well as tripping the us into a recession or near recession.

    I may be wrong, but I seem to recall robust rental markets in NYC when the economy is in recession or performing poorly, no? If you are in the rental business, you are in a very good place.