A new insight blog post by First American Economist Ksenia Potapov examines the balance between foreclosure and employment and questions whether or not the impact of a near-term recession on the labor market will cause a rise in foreclosures.
According to Potapov, early, proactive policies early in the pandemic both prevented early mass foreclosures due to lockdowns and caused concerns of a wave of foreclosures after those protections end. That wave of foreclosures never came to fruition, and in fact still remains near historic lows.
Monetary policy tightening and interest rate hikes by the Federal Reserve to lower inflation back to a target 2%, it is causing the housing market to “rapidly cool” and will more than likely will be followed by a cooling labor market.
“Mentions of foreclosures invariably bring up memories of the Great Financial Crisis, but the housing market today is very different from a decade ago,” Potapov said. “Nationally, household equity reached 70% in the second quarter of 2022, the highest level in over 35 years.”
“At the same time, the labor market continues to show strength. The unemployment rate is near pre-pandemic lows, and the supply and demand imbalance persists, pushing up wage growth,” Potapov continued. “However, the housing market has cooled considerably amid the affordability shock driven by rapidly rising mortgage rates, and signs of a labor market slowdown are emerging. Both trends threaten to increase the risk of foreclosures over the near term.”
By all metrics, house price appreciation is slowing from peaks in all major metropolitan areas, while many have experienced nominal price declines overall.
Prices are poised to fall further as the hot sellers’ market of 2021 and early 2022 turns in favor of buyers, which could chip away at some of the equity that homeowners have built up. Annual house price growth in August, according to the S&P Case Shiller House Price Index, was 13%, down from a peak of 20.8% in March 2022. Price growth will inevitably continue to decelerate to reflect the reality of higher mortgage rates.
It is obvious that the double-digit gains houses have appreciated over the past two years were not sustainable, especially because average home price appreciation is 3.6%. But even if home prices go south, it would take a considerable amount of time for these losses to eat away at all the equity that many homeowners have accumulated over the last few years. For example, for the average national homeowner who bought a home in July 2020, house prices would need to decline 27% to wipe out all of their equity gains from appreciation.
“As for the labor market, the Federal Reserve is tightening monetary policy to cool demand and tame inflation, which is likely to lead to an increase in unemployment,” Potapov said. “That increase, however, could be modest. Federal Reserve projections as of September 2022 expect the unemployment rate to peak at 4.4% in the fourth quarter of 2024, a rate like that of 2017. It would take a significant decline in equity and a strong spike in unemployment to trigger a wave of foreclosures, and that doesn’t look likely in the near term.”
But according to Potapov, strong underlying market fundamentals are continuing to support the housing market due to high equity levels, which in turn protects borrowers in distress from entering foreclosure.
“Foreclosures in the third quarter of 2022 increased, but remained below pre-pandemic levels. While we can expect the number to drift higher as the labor market slows and house prices fall from their peak, the result will likely be more of a foreclosure ‘trickle’ than a ‘tsunami.’”
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