The U.S. housing market is teetering on recession. Will the economy soon follow?

The last time the housing market suffered a major meltdown in 2006, it took the entire U.S. economy with it. But history never follows the exact same script twice.

The weakening housing market is undoubtedly going to hurt the economy. Single-family home construction fell to a 1 million annual pace rate in May from a 15-year high of 1.31 million in December. Permits to build more homes also tumbled.

It’s probably going to get worse, too.

Home prices had already surged to a record high when the Federal Reserve in March began to quickly raise interest rates to combat high inflation. The central bank’s aggressive action pushed the 30-year fixed mortgage to more than 6% from just 2.75% last fall.

The combination of more costly mortgages and ultra-high prices has made it hard for most buyers to purchase a home. Affordability has fallen to the lowest level in 16 years, the National Association of Realtors said.

As housing goes, so goes the U.S. economy, according to an old saying. The resulting slowdown in construction is set to subtract a large chunk of growth from gross domestic product in the second quarter. And fewer sales means fewer new owners spending money to furnish their homes.

Yet the housing market is very different now than it was in 2006, and by itself, it’s unlikely to drive the economy into a ditch. The U.S. might very well dip into recession in the next year or two, economists say, but housing won’t be the chief cause.

” We expect sales to decline further over the coming months, but we don’t expect a repeat of the 2000s collapse,” said Alex Pelle, U.S. economist at Mizuho Securities

Little sign of a bubble

The housing market today bears very little resemblance to the go-go 2000s.

For one thing, the typical buyer has a high credit score and is less likely to default. Only about 2% of all new mortgages are granted to so-call subprime buyers, or those with weaker credit scores.

By contrast, some 15% of borrowers had subprime credit at the height of the housing bubble almost two decades ago, research from the Wall Street firm Jefferies shows.

Many of those borrowers lost their homes in the 2007-2009 recession and real estate values plummeted, robbing millions of Americans of paper wealth and making them feel poorer. A massive stock market selloff added to their woes.

The negative “wealth effect” helped contribute to a sharp decline in consumer spending that deepened the recession. Consumers account for almost 70% of everything that goes on in the economy.

The current slowdown in housing, however, probably won’t lead to sinking prices and lower home values.

For starters, the U.S. has suffered from a housing shortage for years even as the number of new families being formed has pushed demand to fresh heights. The pandemic has also dramatically increased the number of people working from home and the clamor for more housing.

Demand for housing is strong in part “because of the rise of remote work and changes in lifestyles,” said chief economist Bill Adams of Comerica Bank.

Builder have tried to meet most of that demand. Construction on new homes and rental units rose to an annual pace of 1.8 million in April — a 16-year high — before higher mortgage rates really kicked in. But that’s still below a record 2.2 million clip in early 2006 when the population was 11% smaller.

It’s not going to get much better soon, either. Construction fell sharply in May and is likely to continue to slow, further reducing the supply of homes for sale and keeping upward pressure on prices.

Silver linings

High home prices aren’t entirely a bad thing, though, especially for those who already own their own homes. Stable home values can partly insulate the economy from recession.

How so? Home owners are likely to feel better off financially than they did in 2006 because their main nest egg is still appreciating.

What’s more, millions of home owners took advantage of the record-low interest rates during the pandemic to refinance and save themselves a bundle. Most of them also chose fixed mortgages, leaving them immune from rising rates.

That wasn’t the case in the mid-2000s, when half of all mortgages were adjustable. Surging interest rates force millions of home owners to pay high monthly mortgage expenses and many who could not afford to do so defaulted.

Now only about 10% of all mortgages are adjustable. In addition, the percentage of income home owners have to devote to their mortgages is at a record low.

“The linkages between housing and consumption are likely to be weaker than in the past,” said Aneta Markowska, chief economist at Jefferies.

What could put a bigger dent in the housing market is a large increase in unemployment that causes more people to default.

Yet with the jobless rate at just 3.6% and a labor shortage expected to persist for years, some economists question whether businesses will resort to mass layoffs if the U.S. enters recession.

In the meantime, the housing market is still holding up relatively well despite soaring interest rates and high prices. Sales and spending on new construction are hovering near pre-pandemic levels, suggesting the bottom won’t drop out like it did in 2006.

Of course, some experts said the same thing thing 15 years ago. “Researchers say that the recent housing downturn doesn’t necessarily mean an end to economic growth,” an article in The Christian Science Monitor said back then.

What followed was the worst recession in decades.