During economic recessions, house prices tend to go down. The reason is quite simple; personal income is one of the most significant factors driving home prices. The more money people make, the higher price they can afford to pay for a house.
During a recession, jobs and income levels decline, which means people have less money and can’t afford to pay as much money for a house.
In 2020 we are experiencing the most severe recession since the great depression (yes, it’s worse than the financial crisis,) but housing prices are at an all-time high.
At first glance, you might be thinking that a 3.5% decline in real GDP is no big deal. Which highlights how useless economic data is without the proper context.
Consider that the peak to trough decline in real U.S GDP during the financial crisis was 3.97%.
So, we can summarize the severity of this recession as follows.
Even after a 30% annualized Q2 growth in GDP, and trillions of dollars in monetary and fiscal stimulus, the U.S economy is roughly in the same position it was during the darkest days of the financial crisis.
The 2008–2009 recession was the most severe since the great depression, and that is roughly where we are at today.
Yet, Housing prices are at an all-time high
According to data from the St.Louis Federal Reserve, from August 2019 to August 2020, U.S home prices rose by approximately 5.6%.
That is represented in the following graph, where the official start of the recession is measured in the yellow shaded area.
So, why are home prices rising to all-time highs in 2020 when they fell sharply during the financial crisis?
Remember, at the beginning of this article, I mentioned that personal income is one of the most important factors that drive housing prices.
During the financial crisis, governments responded with monetary stimulus but not nearly enough fiscal stimulus.
During 2020, governments around the world have provided unprecedented levels of fiscal stimulus. Put simply, much of this fiscal stimulus has replaced the income of people who lost their job during the recession.
So, even though this recession is even more severe than the financial crisis, personal incomes have not been impacted in the same way due to the fiscal stimulus.
Which is a good thing.
However, the fiscal stimulus does not tell the whole story as to why house prices are rising. What really impacts the price of housing is the income of people who are in the market to buy a house.
Which is where the sad part of the story comes into play.
Low-income earners have been hit hardest in 2020
As illustrated in a research letter from the San Fransisco Federal Reserve, workers in the bottom 25% of earnings made up half of the job losses during this recession. While in comparison, high-income workers were less impacted.
Low-income workers have been hit hardest, but that would have little impact on the demand for houses because low-income earners can’t afford to buy houses; They rent.
It is the middle to high-income earners who buy houses, and their incomes were less impacted. Couple that with the fiscal stimulus and rock bottom interest rates, those higher income earners that were lucky enough to keep their job have been bidding up the price of houses.
Wealth inequality is on the rise
Consider the following facts.
Housing prices, the largest component of personal wealth, is at an all-time high.
The stock market is also at an all-time high.
Many high-income earners have been lucky enough to work from home and keep their jobs.
This allows them to invest more in housing and the stock market.
The lowest income earners have been hit the hardest.
All of this adds up to an increase in the wealth gap.
Future fiscal stimulus needs to be aimed at low-income earners
This story is not unique to the U.S. We see the same thing playing out in Canada and other OECD countries; The types of jobs that have been lost during this recession have disproportionately hit those with the lowest-income and lowest ability to weather a job loss.
This should provide a clear roadmap to governments; the easiest way to spur economic growth is for income supports to those with the lowest income.
Not only is it the right thing to do (helping those who need it the most.) It’s also the fastest way to spur economic growth.
Any fiscal stimulus received by people like me who have been lucky enough to be (financially) unaffected by this recession will only serve to drive up asset prices even further.
If the government sends me a check, I can tell you 100% of that is getting invested in the stock market. That is because I don’t need the money right now.
If the government sends a check to a low-income earner or someone who lost their job, that money will be spent on groceries and other living expenses.
That is what spurs economic growth and can help prevent inequality from growing at the pace it has been.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. All views and opinions are solely of the author.