The Blubber

The housing market is headed back to a 1980s-style recession, Wells Fargo, $WFC, has said.

In spite of the persistent warnings and predictions of a recession from various economists and experts in the past year and the current one, the U.S. economy as a whole has demonstrated remarkable resilience. However, the housing market tells a different tale.

The convergence of mortgage rates around 8% and soaring home prices, which markedly increased during the pandemic, has adversely impacted housing affordability in the United States, resulting in a slowdown in activity in certain cases. Wells Fargo warns that as long as mortgage rates remain at elevated levels, borrowing costs will continue to rise, potentially pushing the housing market into a recession.

In a recently released commentary, titled "Rising Borrowing Costs Stand to Tip the Housing Sector Back Into Recession," Wells Fargo economists observed that, despite a generally positive trend in the first half of 2023, the residential sector now appears to be contracting in response to the recent surge in mortgage rates.

Early in October, for the first time in over two decades, the 30-year fixed mortgage rate reached 8%. While rates may decrease as the Federal Reserve eases its battle against inflation, the bank predicts that financing costs will remain elevated in comparison to the lows seen during the pandemic for the foreseeable future. Consequently, the bank reports that prospects for a "housing rebound" are fading as mortgage rates continue to rise.

Although Wells Fargo didn't explicitly reference the last housing downturn, their senior economist, Charlie Dougherty, and economic analyst, Patrick Barley, highlighted the parallels between the current housing environment and the 1980s. This perspective aligns with recent research from Bank of America Research and First American. Bank of America issued a warning of impending "turbulence" reminiscent of the 1980s, marked by high mortgage rates, as Paul Volcker's Federal Reserve battled double-digit inflation. First American suggested that housing was experiencing a case of déjà vu from the 1980s, characterized by high inflation, elevated interest rates, and a new generation of homebuyers—essentially, millennials adopting the habits of their boomer parents.

Dougherty and Barley wrote, "A 'higher for longer' interest rate environment would likely not only weigh on demand, but could also constrain supply by reducing new construction and discouraging prospective sellers carrying low mortgage rates from listing their homes for sale."

The economists went on to explain that rising borrowing costs will further diminish affordability. They cited the National Association of Realtors (NAR), which calculated that the average principal and interest payment for borrowers using a 30-year fixed rate mortgage had increased by 26% in August compared to the previous year.

Wells Fargo emphasized, "The increase in monthly payments has far exceeded growth in median family income, which was up 5% over the same period." Additionally, mortgage rates have risen since August, leading to even higher monthly payments.

The erosion of affordability isn't solely due to elevated borrowing costs; it is also attributed to home prices, which have surged by over 40% since the onset of the pandemic. CoreLogic, a provider of information, analytics, and data-enabled services, calculated this increase, and it includes monthly increments throughout this year. Furthermore, constrained supply is partly a result of homeowners holding onto their properties out of fear of losing their low mortgage rates in an already under-supplied market.

Nevertheless, if Wells Fargo's forecast that the Federal Reserve has completed its interest rate hikes and will lower rates next year proves accurate, mortgage rates should follow suit. According to Wells Fargo's national housing outlook, the average 30-year fixed mortgage rate will conclude this year at 6.94%. Next year, the bank anticipates that the average 30-year fixed mortgage rate will decrease to 6.39%, and in 2025, it will dip even further to 5.70%.