Ask any economist if you can shut down the country during a pandemic and still manage to avoid an economic contraction.
The answer is no. The American economy depends on consumer spending, which accounts for about 70% of GDP. While panicked consumers have been stocking up on toilet paper and counter wipes, spending has plummeted at other places like retail malls, restaurants and anything related to travel.
GDP growth likely will be zero in the current quarter and contract 5% in the second quarter, Goldman Sachs economists said on Sunday. That probably will be followed by a jump of 3% in the third quarter and 4% in the final three months of the year as pent-up demand drives business activity, the forecast said.
“The uncertainty around all of these numbers is much greater than normal,” said the group, led by Goldman’s Chief Economist Jan Hatzius.
But that doesn’t mean the housing and mortgage industries will suffer the same fate as the travel industry.
The most important thing to keep in mind when evaluating how those sectors might fare in a recession is: Don’t go by what happened last time.
In recessions, housing typically outperforms the rest of the economy. Homebuilding – economists use the fancy term “residential fixed investment” – usually leads the way into the expansion that follows.
But, something different happened in 2008: Housing couldn’t carry out its traditional economic rescue role because it was on life support. The first national real estate crash since the Great Depression was the cause of the worst economic contraction since the 1930s.
Subprime lenders gave out risky mortgages, including NINA loans, meaning “no income, no assets,” to just about anyone who asked, and Wall Street packaged those into bonds that were widely sold at massive profits. When defaults made them near-worthless, it crashed the financial system, including some of the nation’s largest banks.
This time, the banks are in a stronger position. The Dodd-Frank Act passed in the wake of the financial crisis required regulators to enforce stricter capital and liquidity standards. And for the last decade, mortgage lenders have operated under a tougher set of rules.
While there have been recent attempts to roll back the 2010 financial reform law, Bank of America CEO Brian Moynihan has been a longtime supporter of the stricter rules. Two years ago, he told the Economic Club of Washington D.C. the changes made the system safer.
On Sunday, during an appearance on Face the Nation, he pointed to the strength of banks as a reason for optimism.
The banking industry today has “capital and liquidity – that is so different than the last crisis,” Moynihan said. “This is a health care crisis and if we cure that, the economic issues will go away quickly,” he said.
The current crisis has all the makings, so far, of a short recession that will rebound when the epidemic subsides, Treasury Secretary Steven Mnuchin said at a White House press conference on Saturday.
“This is not like the financial crisis,” Mnuchin said. “This is about providing proper tools and liquidity to get through the next few months.”
The Federal Reserve showed it’s ready to use the tools it has. At 5 p.m. on Sunday, before the opening of stock markets in Asia, it slashed its benchmark rate to near zero for the first time since the financial crisis. It was the second emergency rate cut in two weeks.
The Fed also announced it was restarting the bond-buying program it used during the financial crisis to bolster demand for Treasury bills and mortgage-backed securities.
On Monday, the Federal Reserve Bank of New York, which carries out market operations on behalf of the central bank, began buying $500 billion in Treasuries and $200 billion of agency-backed mortgage securities.
While the U.S. stock markets tumbled anyways on Monday, posting the biggest losses since the crash of 1987, that isn’t necessarily a measure of whether the Fed’s action was successful. The aim of the Fed’s bold action on Sunday, coupled with the ramping up its overnight funding operations with $1.5 trillion of “repos,” or repurchase agreements, announced on Thursday, is to keep credit markets functioning.
In other words, the Fed is trying to avoid the same type of credit crunch that came close to toppling the U.S. economy into a depression – with a “d” – in 2008.
“The primary purpose of these securities purchases is to restore smooth market functioning so that credit can continue to flow,” Fed Chairman Jerome Powell said on a conference call with reporters on Sunday night.
The Fed rate cut will make business borrowing cheaper, and that will make it easier for homebuilders to gear up in the midst of a housing shortage, said Mark Vitner, a senior economist at Wells Fargo.
“Even in a recession, homebuilding is likely to hold up relatively well,” Vitner said. “We’re going into this period having vastly underbuilt single-family housing in most of the country, so there’s not an overhang of inventory. We need to build more housing.”
While some industries will suffer from workers not showing up because of virus fears, that won’t impact the construction industries as severely, he said.
“Construction workers usually have gloves on, and I don’t think they’re big on shaking hands,” Vitner said. “When you have people working on a house, they tend to be small teams and they’re not that close together, so homebuilding isn’t an activity the virus will impact all that much.”
The U.S. real estate market is undersupplied by 3.3 million homes, and the shortage is getting worse every year, Freddie Mac said in a report last month.
“New housing supply is not keeping up with rising demand,” said Sam Khater, Freddie Mac’s chief economist. The shortage has been increasing by about 300,000 units a year, he said.
For an example of how the housing and mortgage markets can fare during a recession – with the all-important exception of last time when it was the cause of the crisis – look at the economic contraction in 2001, after the Sept. 11 terrorist attacks.
Alan Greenspan, then the Fed chairman, initiated a series of cuts in 2001 that pushed the central bank’s rate down to 1% in 2004, the lowest in more than 40 years.
While everything ground to a halt in the weeks after the terrorist attacks, the cheap borrowing costs helped the housing and mortgage markets do well in subsequent quarters. Lending for home purchases grew to $960 billion in 2001 from $905 billion in 2000, according to data from the Mortgage Bankers Association. In 2002, the level exceeded $1 trillion for the first time, coming in at $1.1 trillion.
But the refinancing market did even better. As mortgage rates dipped below 7% – at the time, considered an incredibly low rate – refinancings surged. In 2000, the year before the recession, refinancings totaled $234 billion. The level jumped to $1.3 trillion in 2001, $1.8 trillion in 2002, and $2.5 trillion in 2003.
When homeowners refinance at a cheaper rate, it lowers their monthly mortgage bill and puts extra money in their pockets that they tend to spend. That can provide important support to the economy.
The 30-year fixed mortgage during those years averaged: 8.05% in 2000, 6.97% in 2001, 6.54% in 2002, and 5.83% in 2003, according to Freddie Mac data.
As an example of what a short recession followed by a robust recovery looks like, after a 1.7% contraction in 2001’s third quarter, when the terrorist attacks occurred, the U.S. economy grew 1.1% in the fourth quarter and surged 3.5% in 2002’s first quarter.
That’s the type of V-shaped recovery Treasury’s Mnuchin is hoping for.
“If the medical professionals are correct, I expect we will have a big rebound later in the year,” Treasury’s Mnuchin said on Fox News Sunday. “This isn’t like the financial crisis. This will have an end to it as we confront the virus.”
