Plain English with Derek Thompson - Why Everybody Is Wrong About a Recession and Housing’s Great Comeback

Episode Date: February 14, 2023

Last fall, three-quarters of voters told CNN that the U.S. was in a recession. A Bloomberg economic model said that the odds of a recession by the fall of 2023 were 100 percent. But we’re not in a recession. The unemployment rate is lower than any month since the 1960s. Real disposable income is growing. The economy is expanding. Consumer spending is strong. Even housing seems to be rebounding. In today's episode, Derek explains the origins of the great American recession myth, and Bloomberg writer Conor Sen breaks down the housing turnaround that could define the 2023 economy. Host: Derek Thompson Guest: Conor Sen Producer: Devon Manze Learn more about your ad choices. Visit podcastchoices.com/adchoices

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Watch out for mouth tendrils and follow along on Spotify or wherever you get your podcast. Today, the recession versus reality. As most people know, the U.S. economy is in a recession. Last fall, three quarters of voters told CNN that the U.S. was in a recession. A Bloomberg economic model said the odds of a recession by the fall of 2023 was 100%. These numbers are a little bit strange because we are not in a lot. recession. We're actually not even close. The unemployment rate today is lower than any month since

the 1960s. Real disposable income is growing. The economy is expanding. Consumer spending is strong. Even housing seems to be rebounding. So why is everybody, not just normal people, but professional economists too, so convinced by, so obsessed with this idea that we are either in or at the precipice of a recession. I have two theories. The first theory is what I've called the everything is terrible but I'm fine philosophy. If you ask Americans about how the broader economy is going or whether American schools have gotten to political or whether America is on the right track or whether they trust the media, capital T, capital M, the media, when you ask about the states of things broadly, people tend to give really depressed answers. Everything is terrible. The

economy, oh, it's in a recession. Media can't trust a thing they say. Schools, they're a mess. America, dumpster fire. But if you ask the specifics, the answers tend to change. How are your finances? Oh, they're okay. How's your favorite podcast or news outlet? Oh, it's great. It tells me the media is terrible, by the way, but it's great. In September, Gallup released an education survey that asked two questions. How's U.S. education broadly? Only 45% said they were satisfied. A calamity. Schools in disarray. But then they asked, how's your oldest child's education? And 82% of Americans said they were satisfied. Everything is terrible, but I'm fine. The second theory is what I've called the yo-yo economy.

The news media tends to judge the economy, I would say, based on a rolling average of everything that's happened in the last six months. It is perfectly backward-looking. And as a result, they missed the fact that the economy just keeps doing these yo-yo's. Furniture inflation goes up, but then it crashes. Used car inflation surges, but then it crashes. Saving rates, tech stocks, Bitcoin, crypto, everything is a yo-yo these days, up and down. And when the world is on a string like this, you cannot evaluate the economy by memorizing the

conditions of the last six months and just repeating them adenosium. You're going to get stuff wrong. So, for example, look at housing. Two years ago, 2021, the U.S. housing market was flaming, scorching, red hot. Last year, the market collapsed. Construction down, home purchases down, home prices down, mortgage applications, everything went down and fast. And if you do what most media analysts do, you memorize that number.

narrative, and you just parrot it for a few months. And that works really, really well until things change. And things are changing. The rest of this episode is about the fact that things are changing fast. The housing flash freeze is over. The comeback might be right here, right now. Today's guest is Bloomberg writer Connorsen. We talk about five signs the housing market is set for a major comeback in 2023, and how a housing turnaround will change the narrative about inflation, the recession, and so much more. I'm Derek Thompson. This is plain English.

Connor Sen, welcome back to the podcast. Derek, thanks for having me. So last year, you came on the show during what felt like peak recession fears in 2022. We had had consecutive quarters of negative GDP growth. people were losing their minds about the imminence of the inevitability of a recession. And I wanted to zag. And I brought you on to help me zag to predict that actually it was not inevitable. And it was not imminent that we were going to have a recession.

You explained all the reasons why you thought a recession was not forthcoming. And at least for the year of 2022 up till now, you were right. So now I want to do another pod because the housing market seems to be rebounding. The housing market, which was crashing, crashing, crashing, crashing throughout 2022, seems like it may have hit the bottom, and the bottom just might be a trampoline because some of these numbers are going up much faster than I anticipated. So I texted you, I said,

do you think you could summarize our potential housing rebound in like five numbers? 30 minutes later, I had five numbers in my inbox. So we're going to go through these five numbers. Absolutely ideal situation of the guests doing the hosts work for him, by the way. Before we get to the numbers, catch us up, right? The pandemic housing market in 2020 and 2021, I think most people remember, it was absolutely insane. It was so hot.

And suddenly, it all hit a wall in 2022. What happened? So we saw mortgage rates go from 3% at the beginning of 2022 to 5% by April to 6% by August to 7% by October. And that process really just took buyers out of the market. They pulled back in April, May, and they really, really pulled back in September, October. And 2022 was in large respects the market trying to figure out what to do with that because you had lots of home buyers who, or sorry, homeowners who had gotten these pandemic 3% mortgages. And they said, fine, we'll just stay. No problem.

And a lot of maybe would be sellers said we would rather rent out or just not sell than transact in this market. At the same time that a lot of buyers either couldn't or wouldn't transact in the market. So it became kind of a standoff for the rest of the year. And the question heading into January was, okay, Q4 is slow, mortgage rates are high. high, what are things going to look like after the holidays when people come back and assess market conditions? And what we've seen is a really explosion in demand over the past five or six weeks. It's so crazy to think, like, how insane the housing market was in 2020 and 2021 and then just how quickly it totally froze up. It's like, you know, there's viral videos where they're in, like,

Antarctica or like Northern Minnesota during a polar vortex, and they take a pot of boiling water and they throw the boiling water into the air and it crystallizes suddenly into ice and snow. Maybe you've seen those viral videos. This was basically the housing market for the last three years. It went from uncomfortably scalding to the point where I'm writing takes like month after month saying, I think housing can't get any hotter. Now I think housing can't get any hotter. And the Fed starts raising rates. Mortgage rates go up fast than they've gone up in decades. And it just instantly, instantly becomes ice cold. Building confidence declines every month. New home sales fall practically every month between January 22 and October 22.

And that leads us to this rebound, where we might go from ice cold to hot again. So the first number that I want to bring up that explains the U.S. housing market today is 6%. The average 30-year mortgage rate has now fallen to 6% from 7%, which is where it was in the last quarter of 2022. What's going on with rates right now? And why is this maybe the most important story to begin with when explaining the housing market? Yeah, so the question really in 2022, heading into 23, was what level of mortgage rates will get the market back into balance? And we can argue about what balance looks like, whether it's flat home prices or a pickup end transactions. But when rates at seven, it was just like, okay, this is clearly a level that has frozen the market. And some people said 5% was the level that would sort of unfreeze the market because that's what it was in spring before things sort of slowed down. Toll Brothers, a luxury home builder, actually said that they thought 6% was. was the level that would be workable for people. And that's sort of what I thought it would be,

because you've seen home prices have come down a little bit, a little more in markets like Boise and Phoenix that were overheated. But nationally, they're down about two, three percent from the highs. And then incomes that kept growing because jobs were really strong. And I think to some extent the sticker shock of going from seven to six, all of a sudden made it seem like this isn't so bad. And there's also been some changes in terms of this notion of mortgage rate buy downs that both home builders and home sellers of employed, where it's not quite what we saw during the peak of the home buying frenzy in the mid-2000s, but they might give you 2% off your mortgage rate for the first year, 1% off for the second year. You still have to qualify for the eventual higher rate,

but it's a way for home buyers to sort of swallow the sort of affordability challenges for at least for a couple years. Can you help me understand this divergence between the federal funds rate that the Federal Reserve controls and mortgages, because last year we saw mortgage interest rates go up pretty much in tandem with the Fed raising its interest rate. But the Fed is still raising rates, even if it's by less, 25 basis points in the last announcement. But the mortgage rate is actually falling. Why are we seeing that divergence? So two reasons for that. One is that mortgage rates tend to be benchmarked more to 10-year treasury rates rather than the over-reasing. night Fed funds rate that the Fed raises and lowers every month. And that's just because a mortgage

pays down over time. The average amount of time people spend in a home tends to be about seven years. So that's just sort of the part of the curve where mortgage rates sit. And because markets anticipate that the Fed will be done raising interest rates sometime this spring, they immediately went from, okay, if we know where we think the Fed will top out rates, we can start to project when they might cut rates. And it's debatable whether or not too many cuts have been priced, but a fair number of cuts have been priced in 2024, which then lowers this 10-year rate, which then lowers mortgage rates. And the other part that goes into mortgage rates is a risk spread between mortgage rates and treasury rates, and that's a function of volatility and sort of complex financial stuff.

But as sort of financial markets have settled down over the past few months, that spread has started compressing as well, which has led to lower mortgage rates. So you're saying it's conceivable that in the next few months, even as the Federal Reserve continues to raise rates by, say, 25 basis points every few months, we might still see 30-year mortgage rates hold steady at 6% or maybe even decline a bit? It's possible they could decline maybe up to another half percent just because the mortgage spread, again, the difference between mortgage rates and treasury rates is about 50 to 75 basis points higher than it historically has been. And so it's possible that spread could compress as people

get more comfortable with the conditions on the ground. The second number is 500,000. And here we're talking about national housing, Inventory. If you've heard me talk about housing and any other podcast on this show, you know that inventory is one of the numbers that I'm always looking at. So last year in 2022, National Housing Inventory, the number of houses sitting on the market fell to a record low of 250,000. It doubled in about six months from the beginning of the year to the end of the year, peaking just shy of 600,000. And now it's falling again. Houses are getting scarcer on the market, which could put pressure. on prices. So this is all, these are all figures from Alta's research. Connor, why is inventory such a critical stat for us to focus on, and what is this number telling us? Right. So inventory is really how many homes are for sale, and it sort of gets you to the point of what would make a home price go down, and it's typically more people trying to sell than people ready to buy. And if there just aren't that many homes for sale, it's hard for prices to go down,

especially at a time when demand might be coming back. And what's really interesting about this decline in inventory in 2022. Again, we're already in the mid-February and we're still making lows that we haven't seen since last June is that if there aren't enough existing homes to buy, that makes homebuilders potentially more interested in building new homes to sort of fill that gap. And that home building sort of impulse leads to construction and jobs and sort of pushes a lot of the GDP-type measures of economic activity. Yeah, I think for people who are listening and sort of getting confused about sort of the the relationship between inventory and home prices, just basically think of it as pressure,

right? That lower inventory puts pressure on housing prices to go up because if there's fewer houses on the market, plus more buyers, that means that, you know, that there's naturally that less up, that smaller supply is going to force prices up. And that's what we seem to be seeing right now. One of my favorite housing analysts, Bill McBride, says that we tend to see two bottoms in the real estate market. We see a bottom in housing activity, and then we see a bottom in housing prices. So, you know, if you look at the inventory,

start to change direction, right? It was rising, rising, rising throughout 22, and now it seems to be falling again. That might just predict that prices are going to do the opposite inflection point, that they have been falling for a while, but they might come back up. The third number that I want to,

throw at you or that you initially threw at me is 2014, the year 2014. So last October, new home sales were lower than almost any month in the last 10 years. It was one of the worst months for new home sales that we've seen basically this century, if you exclude the global financial crisis. So that's a situation where the boiled water was well and truly frozen. In January, for this year, we do not have official numbers yet, but according to some projections from private sector companies, new home sales in January are supposed to be higher than any non-COVID month since at least 2014.

So new home sales could really trampoline from these decade lows. What are you seeing in terms of the prospects for new home sales? So it's difficult because right now, so much of the volatility month-to-month in housing activity has been due to changes in mortgage rates. So if mortgage rates surge back to 8%, that would freeze the market again. But if they fell back to 5.5%,

we might have a booming market. And so when we're trying to project where are things going to go, it's really a function of mortgage rates. And since mortgage rates have hit 6% in recent weeks, and sort of people who wanted to buy a home last year, but maybe were scared or had affordability issues, have decided to come back to the market in January.

We're seeing this huge rebound in sales. So it almost makes you have to think about, does the data tell you enough about where things are going, or do you have to think about the fact that there are buyers out there who want to buy homes, who maybe are just responding to mortgage rates and predictions about where home prices will go over for the next few months and enter the market or exit it based on shifts in those in that thinking? So the sum of everything that we've said so far, we've seen that mortgage interest rates have started to come down a little bit.

That seems to be spurring more new home buys. More new home buys means that inventory is going down, and as inventory goes down, should expect housing prices to go back up. You put all that together, and it's starting to sound like the housing market, which really entered a dead zone in 2022, is getting hotter. This is all looking at the demand side, though. And so now I think we should bring in the supply side. And the third number that I, should be the fourth number that I have for you is 40%. Since October of last year, and October really seems to have been kind of the bottom of this housing market.

But since October of last year, D.R. Horton and Linar, the two largest publicly traded homebuilders, are up 40 percent, 40 percent stock appreciation in the last five months for these two large home builders. What are you looking at when you look at D.R. Horton and Linnar? So the question for homebuilding stocks in 2022 wasn't just what are sales likely going to be in the future. It was, well, home prices fall so much that these large inventories of land and houses under construction that they have will turn into losses. Because they were marked on their balance sheet at a certain price level, certain valuation. But if home prices were to fall 30%, that could be off significantly. And then the stocks could crash. And what's happened is that we're now in February. And so we got through those really tough months.

They continue to sell homes. They continue to report earnings. And now they've cleared that backlog to some extent. And now they have lower mortgage rates and higher demand seemingly this year to work with. So they sort of benefit from the concern of lower home prices isn't what it was. And now there's also the prospect of much better demand this year. And maybe in 2024 as well, which has really shifted to thinking of what the prospects for the home building industry look like over the next 12 or 18 months. What about the cost of inputs?

That was a huge problem in 2022, especially early 2022. There were all these fears that the input cost for all of these houses was going to skyrocket, which is going to make it really unappealing for these builders to build homes because the cost is going to rise commensurately. Have we seen those costs come down a little bit for things like lumber and plastics? We have, and they've talked about the fact that lumber prices have, because of that cost, I saw one estimate that for a certain-sized townhome. the decline in the cost of lumber would mean a $70,000 savings for a builder on the cost side. That's how much the drop in lumber had an impact of.

And then to the extent that sort of trades and construction and labor, that loosens up and is no longer as pandemic crazy as it has been, there's the prospect of cost cuts there as well. So you could see stabilizing home prices while their costs come down, which all of that would flow through into higher profit margins down the road. Yeah, this gets into what I've called the yo-yo economy. I feel like there's a lot of economic analysts, not you and hopefully not me, but definitely a lot of economic analysts who for whatever reason tend to anchor their analysis of the economy to whatever was happening six months ago. And if that's your mode of economic analysis, you are well and truly effed in terms of trying to understand this economy because everything keeps changing over six months intervals. So, for example, you saw in just the category of something like, you know, durable goods,

used car inflation went absolutely berserk and then it came down and it was negative. Durable goods inflation went absolutely berserk. Stuff like furniture, I think people remember maybe like a year ago, it was so unbelievably expensive to buy new furniture. The overseas shipping costs from Shanghai were skyrocketing, but those came all the way back down. Computer costs, semiconductors had this boom and bust cycle. We saw it in terms of savings rates. We saw it in terms of tech employment, you know, with the hiring going on in Silicon Valley.

And we might be seeing it in housing. And it just goes to show that, like, you can't hold onto or embrace an economic narrative and just stick with it for six months without continuing to check that narrative against emerging numbers because we really are just in an unbelievably bizarre economic period where things just keep going up and down, back and forth, penduluming all the time. And I think to your point on housing, we look at gross domestic project, product, GDP, and how in the past, in the last two quarters of 2022, it grew about 3%, which to some extent was an offset of what happened in the first half the year, which was very weak.

But housing detracted over 1% each quarter from GDP because we saw housing starts fall, fewer home sales, all of that flowed through into lower GDP. And if we start to see that housing is now inflecting higher and it's going to start adding to GDP, going from like a minus one on GDP to say plus half percent is like increasing trend GDP by a percent and a half. And at a time when forecasters are looking for only a half percent of GDP growth in 2023, you can see clear quickly how sort of much, much higher growth might be this year than people thought coming into the year. It's such a good point. And you're getting a little bit ahead of where I wanted you to go because I'm going to ask about recession implications of all this analysis

in just a second. But it's such a good point that I think not enough people are staring closely at just how significant this housing rebound is, not just for sellers, not just for buyers, but also for anyone looking at whether the U.S. is going to enter a recession. Before we get to a full analysis of the implications of the housing market on the possibility of a recession, let's hit the last number that you threw at me. Number number five is 45. 45. This is a prediction number rather than a factual figure. And I'm going to let you set this one up. Tell us about the monthly sentiment survey of home builders put out by the NAHB and why 45 is an important number for us to look at. So this is a monthly survey of home builders where you can respond anywhere between zero and 100, where zero is, the housing market is completely dead, 100 is, things are on fire and it's never been hotter.

and 50 represents neither growth nor contraction. And this index had fallen significantly from the pandemic highs in 2022, where by December it hit 35, which is sort of pretty deep contraction and close to where it was at the pandemic lows in March and April of 2020. And then in January, we saw a very small rebound to 37. But that was really when people just started to see, because the surveys probably people are responding to it in the early part of the month. And so we really hadn't seen the full impact of how strong housing

demand was at that point. And we get this number Wednesday this week and sort of to set up how quickly this could shift during this yo-yo pandemic economy between May 2020 and June 2020. So right when the housing market started taking off, that index went from 37, which is pretty strong contraction to 58, which is sort of modest expansion in a single month. And I think we could be seeing a sort of more modest version of that this month where we go from 35 or 37 in January to a much, much higher number. I think maybe more like 45, but if it went into expansion territory, it wouldn't totally shock me just because we have seen that big of a swing so far in 2020. What would it mean for, now let's move into the possibilities of recession. I'm interested

in you explaining to me what this really would mean for the general economy, because as we talked about last year, once again, you have a ton of economists and banks that are predicting a recession in 2023. I think at one point, I saw the Wall Street Journal report that nearly 100% of major bank analysts projected a recession in the next year and a half. That number, I think, has fallen a little bit. But if everything that we're talking about really comes to play out, if the buyers come back into the market as mortgage rate stabilized around six or even five-ish percent, as home building picks up, and only among places like NAR, but also among all sorts of private home construction companies around the country. And we start to see residential investment

pick up. That's a huge part of the economy. It seems like the odds of a recession have to come down if we start to see that home builder number go from the 30s to the 40s to the 50s. Yeah, I mean, the fact that the housing market turned on a dime and slowed as much as it did in the latter part of 2022, and we didn't even see trend economic. growth, let alone below trend or recession, for that to go from sort of a pretty deep contraction to growth in a very short period of time would suggest that not only will we avoid recession, but we could be talking about reacceleration and overheating by the middle of this year, which unfortunately would say maybe 6% mortgage rates are too low and the Fed would need to

somehow engineer them higher to prevent the kind of inflation that people are worried about right now. All right. So this is really where I wanted to get to because, and I want to try to set this up in a way that doesn't utterly confuse listeners. But the Federal Reserve is walking on a wire. And on the one hand, obviously, it doesn't want to raise rates so quickly and so dramatically that it plunges the U.S. economy into an unwarranted recession.

But that's not happening right now. Unemployment is at the lowest rate that it's been, I think, since 1969. The labor market is pretty hot. And if housing comes back, the combination of a relatively tight labor market and a growing housing sector could mean that even as the Federal Reserve is trying to bring inflation down from seven to six to five to four to in the threes or twos, it might sort of hit a floor around, say, four percent, which I think most people, the Federal Reserve are going to consider too high to not continue to raise rates. So let me put the question to you this way. Do you think there's a possibility that the housing market bounces back so convincingly that by the second half of this year, like, even some people that consider themselves somewhat dovish will be saying, I think the Federal Reserve needs to keep

raising rates by 0.25 or even 0.5%. That is my concern. And as much as we're talking about a rebound in the housing market right now. Since the jobs report, that was so strong about a week and a half ago, mortgage rates have shot up quickly. And it could reverse. We'll see what happens with the data this week, but they've shot up from six to six and a half percent. So we could already be seeing the market start to respond to this and saying, well, if the housing market is responding this well to six percent mortgage rates, this thing needs to cool off more to accomplish the Fed's inflation goal. And we could be saying maybe seven percent mortgage rates are what we need to prevent this sort of economic overheating, which is really tough for people like.

you and me where we want to see our friends be able to buy homes and nobody wants to see a housing market like last year, but it's this weird situation where maybe to fix the inflation goal in the short term, you have to just keep crushing the housing market. What do we even call this? How would we situate this outcome in terms of the vocabulary that people use about hard landings versus soft landings? So to refresh people who aren't familiar with this arcane economic glossary, hard landing is the idea that the Federal Reserve in trying to land the inflation rate from 7% to 2%, crash lands the economy because we get a recession on our way down to 2, and as a result, it's hard on the American people.

On the other hand, people have talked about hoping for a soft landing. That is, we glide the plane down from 7, 6, 5, 4, we glide it down to say 2.5 or 3%. And everyone basically says, all right, Jerome Powell has done his job. What would it mean for the Federal Reserve to essentially bring inflation down to, you to like, let's say 4%, we're talking about like, let's say it's core inflation down to like four or that or high 3%. But the housing market takes off and as result pushes up residential prices enough that inflation starts to creep up again.

The Federal Reserve has to keep raising rates. I mean, what kind of, what would we refer to this outcome as? So I've heard people refer to it as a no landing scenario. And that's sort of probably a temporary state of affairs because to the extent the Fed believes that that's where we are, they are going to respond more forcefully, I believe, anyway. And we'll have to shift, maybe sort of repeat a more mild version of what we saw last year, where we have this overheating economy and they realize maybe 5% interest rates wasn't high enough. And they're sort of now trying to calibrate things a little bit higher,

not the sort of massive rate hike cycle we saw last year, but it turns out that maybe six or six and a half percent rates gets them to where they want to be. And we're just going through the next level of this yo-yo economy. as we figure out what actually gets us to the kind of balance that the Fed is looking for. Right. It's almost like, you know, in flipping it from hard landing versus soft landing, speaking about housing, it's like we want to avoid a hard takeoff, right? We want a soft takeoff. We want housing to try to find some way to stabilize at a slightly higher equilibrium, right? Maybe NHB around like, you know, 48 to 52. Maybe we have, you know, an increase in

new home prices, but things don't go berserk. But we want this kind of soft takeoff in housing that will allow that housing component of inflation to stay low, even as all these other elements of inflation, whether it's services or durable goods, also stay low so they can be brought down into the threes, right? Yeah, the way I'm thinking about is, I think stable growth is okay to the Fed because you could say as supply chains and things work out, things will just sort of work themselves out. Declining growth is certainly good from an inflation standpoint. accelerating growth is probably the thing that can't tolerate. If we really do have the unemployment rate at its lowest level since the 60s,

and then growth is surging higher, it's hard to see how we're going to have 2% inflation in that world. So we really just need to get from, you know, maybe it's just that the housing market goes ice cold, now we're warming up, and then we'll stabilize at some point this spring, and we can all leave a side relief. But right now, the acceleration that I think we've been getting this year

is probably not the kind of thing that we can sustain or that the Fed would tolerate. It really is the weirdest. economy. I mean, every number that goes up goes down six months later. Every number that goes down goes up six months later. So I guess what we should probably do is just wait to see the direction of housing for the next six months, then bring you on some time in the fall to follow up on your predictions. Conor Sen from Bloomberg, thank you very, very much. Thank you for listening. Plain English is produced by Devin Manzi. If you like the show, please go to Apple Podcast or Spotify.

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