“Las Vegas is one of the leading indicators for [home] price action in the housing market, as we saw in 2008 and the recent frenzy. We are totally feeling the heat here. The buyer pool has largely dried up,” says Kristen Riffle, a real estate agent in Las Vegas. Fortune.

But it’s not just bubbly markets like Las Vegas and Boise that are feeling the pain: The housing downturn is picking up steam across the country. In fact, since last week, mortgage purchase applications have fallen by 38% year on year. That is the lowest reading since 2014.

Simply put: Housing activity is crashing.

Let’s be clear, though: This “crash” in housing activity – or as Fed Chairman Jerome Powell puts it in a “difficult correction” – did not appear out of thin air. It is by design. The Federal Reserve went into inflation-fighting mode this spring in hopes that rising interest rates would reduce activity in rate-sensitive sectors such as housing.

The Fed’s rationale for slowing the housing market boils down to two words: destroy demand. Historically, mortgage rates have risen as soon as central banks go into inflation-fighting mode. That mortgage rate shock reduces both new and existing home sales. As builders cut back, demand for commodities (such as lumber) and durables (such as refrigerators) declines. It also causes real estate and construction layoffs. Those economic contractions then spread quickly throughout the rest of the economy and, in theory, help weaken the labor market and stoke high inflation.

“The most common way we get into recession is for the Fed to raise rates to fight inflation. The leading indicator for this type of recession is housing,” said Bill McBride, author of the Certain Risk economics blog Fortune this summer. “Yes [housing] not the goal, but it [housing] it’s basically the goal.”

Of course, we are already seeing these housing-driven economic contractions. Housebuilders are cutting back. Real estate firms are shedding headcount. And some regional housing markets, like Boise and Seattle, have already slipped into a home price correction.

“Realtors are feeling big-time, as well. I called the Greater Las Vegas Association of Realtors, and the employee I spoke with said they were averaging about 300 new members every month. This month she estimated 120; however, she’s processing about 30 realtor withdrawals a day,” says Riffle. That means about 30 real estate agents in Las Vegas alone are calling it quits.

Now let’s go back to the introduction of this article. When analysts say “The Fed will push until something breaks,” they are implying that the Fed’s inflation campaign will continue until inflation decreases or that something pushes the economy into recession. That “thing” could be distress in the bond market, or perhaps liquidity issues at large financial firms. But there is also growing concern that the “something” could be on the housing market.

1981 and 2008

There is nothing unusual about a housing slump that helps trigger a recession. Look no further than economist Edward Leamer’s 2007 paper titled “Housing Is the Business Cycle.” Leamer found that 80% of post-World War II recessions followed a “substantial” housing slowdown.

But when analysts talk about housing being a “crash,” they’re talking about a housing slump not just contributing to the recession but being the root cause. The most famous historical examples of this are 1981 and 2008.

Back in the early 1980s, Fed Chairman Paul Volcker famously tackled the inflationary run that began in the 70s. The central bank succeeded in achieving its target but it was not until mortgage rates rose – rising to 18% in 1981 – that it created a housing downturn so severe that it sent the whole economy into recession . Although both home sales and construction levels collapsed, home prices remained relatively stable during the housing downturn of 1981.

The housing crash of 2008 was a different story, of course. Unlike 1981, the housing downturn in the 2000s was caused by a housing bubble. That slowdown began in 2005 after a series of Fed rate hikes. Over the following years, it would escalate into a full-blown housing bust that led to the Great Recession. Unlike 1981, the housing crash of the 2000s was underpinned by a perfect storm of rampant overbuilding, deteriorating household finances, historic levels of overvaluation, and toxic subprime mortgages.

Although the housing market downturn in 2022 does not fit much with either the 1981 or 2008 camp, it shares characteristics from each camp. Just like in 1981, the housing market in 2022 collapsed in the face of a historic mortgage rate shock. And like 2008, the housing market of 2022 is once again disconnected from economic fundamentals.

A historic affordability shock. That’s the best way to describe why the housing market might be the “something” that breaks.

The Pandemic housing boom – in which US house prices rose 43% in just over two years – combined with mortgage rates of simply 7% to push affordability beyond what many borrowers could afford . Relative to income, it is more expensive to buy now than it was at the height of the housing bubble.

Whenever the Fed moves into inflation-fighting mode, mortgage rates will rise. However, the magnitude of this mortgage rate spike – with mortgage rates jumping from 3% to 7% this year – has caught the industry off guard. Historically, mortgage rates have traded about 2 percentage points above the 10-year Treasury yield (currently trading at 4%). That spread is currently around 3 percentage points. The reason? With the Fed back buying MBS securities, investors—assumed that future 2022 mortgage borrowers will refinance and reduce their yields accordingly—they didn’t want to pick up the MBS securities.

Because of this divergence between Treasury yields and mortgage rates, industry insiders are calling the “broken MBS market.” Ironically, the broken “MBS market” has put the US housing market at higher risk of “breaking.”

There’s no doubt about it: The housing market took a nosedive over the summer. That said, the economic contractions are still not at the level you would expect to see before a Fed-induced recession.

Something stands in the way: building a house.

On one hand, single family housing starts are down 18.5% year on year. On the other hand, home builders stay busy. Due to supply chain constraints and a desire to cash in on the Pandemic Housing Boom, homebuilders have ramped up production over the past two years. That backlog is so big, they’re still working through it. And as long as builders and contractors stay busy, it will slow the spike in construction job cuts that usually precedes a Fed-induced recession.

Going forward, economists and analysts alike believe the housing market will continue to deteriorate.

This year, Wells Fargo projects sharp declines in new home sales (-10.5%), existing home sales (-7.4%), single family housing starts (-7.3%), and housing GDP (-10.1%). Then, in 2023, Wells Fargo expects another drop in new home sales (-6.5%), existing home sales (-13.1%), single-family housing starts (-12%), and housing GDP (16%) .

If Wells Fargo’s forecast – which also predicts a 5.5% decline in US home prices in 2023 – comes to pass, it would mean that the downturn in the housing market will reach a level that historically only occurs during recessions.

Although the housing downturn appears to be on a trajectory that could push the US economy into recession, nothing is certain. If inflation eases, the Fed could ease policy before locking in a recession. There is also the theory that a significant reduction in residential investment – which amounts to 4.6% of GDP – would not be as impactful in today’s economy which relies on less housing. While it is true that private investment exceeded a much higher share of GDP in 2005 (6.7%), we are slightly above the share seen in 1981 (4.4%). In other words, don’t estimate housing.

But “recession” or “no recession,” the housing industry is clearly feeling the pinch of the tightening cycle. It’s hard to see that changing anytime soon.

“I don’t have anything under contract. I’m a long shot, but I’d be lying if I said I wasn’t nervous,” says Kira Mason, a real estate agent in Philadelphia. Fortune.

Want to stay up to date on the housing downturn? Follow me on Twitter at @LambertNews.

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