Increased foreclosure rates in 2006-2007 among U.S. homeowners led to a crisis in August 2008 for the subprime, Alt-A, collaterized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007, the U.S. Secretary of the Treasury called the bursting housing bubble “the most significant risk to our economy.”
Any collapse of the U.S. housing bubble has a direct impact not only on home valuations, but the nation’s mortgage markets, home builders, real estate, home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks, increasing the risk of a nationwide recession. Concerns about the impact of the collapsing housing and credit markets on the larger U.S. economy caused President George W. Bush and the Chairman of the Federal Reserve Ben Bernanke to announce a limited bailout of the U.S. housing market for homeowners who were unable to pay their mortgage debts.
In 2008 alone, the United States government allocated over $900 billion to special loans and rescues related to the U.S. housing bubble, with over half going to Fannie Mae and Freddie Mac (both of which ware government-sponsored enterprises) as well as the Federal Housing Administration (which is a United States Government agency). On December 24, 2009, the Treasury Department made an unprecedented announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years despite acknowledging losses in excess of $400 billion so far.
Background
Housing bubbles may occur in local or global real estate markets. In their late stages, they are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This may be followed by decreases in home prices that result in many owners finding themselves in a position of negative equity – a mortgage debt higher than the value of the property. The underlying causes of the housing bubble are complex. Factors include tax policy (exemption of housing from capital gains), historically low interest rates, lax lending standards, failure of regulators to intervene, and speculative fever.
While bubbles may be identifiable in progress, bubbles can be indefinitely measured only in hindsight after a market correction, which in the U.S. housing market began in 2005-2006. Former U.S. Federal Reserve Board Chairman Alan Greenspan said “We had a bubble in housing”, and also said in the wake of the subprime mortgage and credit crises in 2007, “I really didn’t get it until very late in 2005 and 2006.”
The mortgage and credit crises was caused by the inability of a large number of home owners to pay their mortgages as their low introductory-rate mortgages reverted to regular interest rates. Freddie Mac CEO Richard Syron concluded, “We had a bubble”, and concurred with Yale economist Robert Shiller’s warning that home prices appear overvalued and that the correction could last years, with trillions of dollars of home value being lost.
Problems for home owners with good credit surfaced in mid-2007, causing the U.S.’s largest mortgage lender, Countrywide Financial, to warn that a recovery in the housing sector was not expected to occur at least until 2009 because home prices were falling “almost like never before, with the exception of the Great Depression.” The impact of booming home valuations on the U.S. economy since the 2001-2002 recession was an important factor in the recovery, because a large component of consumer spending was fueled by the related refinancing boom, which allowed people to both reduce their monthly mortgage payments with lower interest rates and withdraw equity from their homes as their value increased.
Identification
The burst of the housing bubble was predicted by a handful of political and economic analysts, such as G. Edward Griffinin in his 1994 book, “The Creature from Jekyll Island,” and Jeffery Robert Hunn in a March 3, 2003, editorial. Hunn wrote:
“[W]e can profit from the collapse of the credit bubble and subsequent stock market divestment [(decline)]. However, real estate has not yet joined in a decline of prices fed by selling (and foreclosing). Unless you have a very specific reason to believe that real estate will outperform all other investments for several years, you may deem this prime time to liquidate investment property (for use in more lucrative markets).”
Many contested any suggestion that there could be a housing bubble, particularly at its pea from 2004 to 2006, with some rejecting the “house bubble” label in 2008. Claims that there was no warning of the crisis were further repudiated in an August 2008 article in the New York Times, which reported that in mid-2004 Richard Syron, the CEO of Freddie Ma, received a memo from David Andrukonis, the company’s former chief risk officer, warning that Freddie Mac was financing risk-laden loans that threatened Freddie Mac’s financial stability. In his memo, Mr. Andrukonis wrote that these loans “would likely pose an enormous financial and reputational risk to the company and the country.” The article revealed that more than two dozen high-ranking executives said that Mr. Syron had simply decided to ignore the warnings.
Other cautions came as early as 2001, when the late Federal Reserve governor Edward Gramlich warned of the risks posed by subprime mortgages. In September 2003, at a hearing of the House Financial Services Committee, Congressman Ron Paul identified the housing bubble and foretold the difficulties it would cause: “Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, the homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss.” Reuters reported in October 2007 that a Merrill Lynch analyst too had warned in 2006 that companies could suffer from their subprime investments.
The Economist magazine stated, “The worldwide rise in house prices is the biggest bubble in history,” so any explanation needs to consider its global causes as well as those specific to the United States. The then Federal Reserve Board Chairman Alan Greenspan said in mid-2005 that “at a minimum, there’s a little ‘froth’ (in the U.S. housing market) … it’s hard not to see that there are a lot of local bubbles”. Greenspan admitted in 2007 that froth “was a euphemism for a bubble.
Throughout the bubble period there was little if any mention of the fact that housing in many areas was (and still is) selling for well above replacement cost.
On the basis of 2006 market data that were indicating a marked decline, including lower sales, rising inventories, falling median prices and increased foreclosure rates, some economists have concluded that the correction in the U.S. housing market began in 2006. A May 2006 Fortune magazine report on the U.S. housing bubble states: “The great housing bubble has finally started to deflate … In many once-sizzling markets around the country, accounts of dropping list prices have replaced tales of waiting lists for unbuilt condos and bidding wars over humdrum three-bedroom colonials.”
The chief economist of Freddie Mac and the director of Joint Center for Housing Studies (JCHS) denied the existence of a national housing bubble and expressed doubt that any significant decline in home prices was possible, citing consistently rising prices since the Great Depression, an anticipated increased demand from the Baby Boom generation, and healthy levels of employment. However, some have suggested that the funding received from JCHS from the real estate industry may have affected their judgment. David Lereah, former chief economist of the National Association of Realtors (NAR), distributed “Anti-Bubble Reports” in August 2005 to “respond to the irresponsible bubble accusations made by your local media and local academics.”
Among other stages, the reports stated that people “should [not] be concerned that home prices are rising faster than family income”, that “there is virtually no risk of a national housing price bubble based on the fundamental demand for housing and predictable economic factors”, and that “a general slowing in the rate of price growth can be expected but in many areas inventory shortages will persist and home prices are likely to continue to rise above historic norms.” Following reports of rapid sales declines and price depreciation in August 2006, Lereah admitted that the expected “home prices to come down 5% nationally, more in some markets, less in others. And a few cities in Florida and California, where home prices soared to nose-bleed heights, could have ‘hard landings’.”
John A. Kilpatrick, of Greenfield Advisors, was cited by Bloomberg News on June 14, 2007, on the linkage between increased foreclosures and localized housing price declines: “Living in an area with multiple foreclosures can result in a 10 per cent to 20 per cent decrease in property values.” He went to say, “In some cases that can wipe out the equity of homeowners or leave them owing more on their mortgage than the house is worth. The innocent houses that just happen to be sitting next to those properties are going to take a hit.”
The U.S. Senate Banking Committee held hearings on the housing bubble and related loan practices in 2006, titled “The Housing Bubble and its implications for the Economy” and “Calculated Risk: Assessing Non-Traditional Mortgage Products”. Following the collapse of the subprime mortgage industry in March 2007, Senator Chris Dodd, the Chairman of the Banking Committee held hearings and asked executives from the top five subprime mortgage companies to testify and explain their lending practices. Dodd said that “predatory lending practices” had endangered home ownership for millions of people. In additional, Democratic senators such as Senator Charles Schumer of New York were already proposing a federal government bailout of subprime borrowers in order to save homeowners from losing their residences.
Causes
Observers and analysts have attributed the reasons for the 2001-2006 housing bubble and its 2007-10 collapse in the United Stages to “everyone from home buyers to Wall Street, mortgage brokers to Alan Greenspan”. Other factors that are named included “Mortgage underwriters, investment banks, rating agencies, and investors”, “low mortgage interest rates, low short-term interest rates, relaxed standards for mortgage loans, and irrational exuberance.” Politicians in both the Democratic and Republican parties have been cited for “pushing to keep derivatives unregulated” and “with rare exceptions” giving Fannie Mae and Freddie Mac “unwavering support”.
Extent
Home price appreciation has been non-uniform to such an extent that some economists, including former Fed Chairman Alan Greenspan, have argued that United States was not experiencing a nationwide housing bubble per se, but a number of local bubbles. However, in 2007 Greenspan admitted that there was in fact a bubble in the U.S. housing market, and that “all the froth bubbles add up to an aggregate bubble.”
Despite greatly relaxed lending standards and low interest rates, many regions of the country saw very little growth during the “bubble period”. Out of 20 largest metropolitan areas tracked by the S&P/Case-Shiller house price index, six (Dallas, Cleveland, Detroit, Denver, Atlanta, and Charlotte) saw less than 10% price growth in inflation-adjusted terms in 2001-2006. During the same period, seven metropolitan areas (Tampa, Miami, San Diego, Los Angeles, Las Vegas, Phoenix, and Washington, D.C.) appreciated by more than 80%.
Somewhat paradoxically, as the housing bubble deflates some metropolitan areas (such as Denver and Atlanta) have been experiencing high foreclosure rates, even though they did not see much house appreciation in the first place and therefore did not appear to be contributing to the national bubble. This was also true of some cities in the Rust Belt such as Detroit and Cleveland, were weak local economies had produced little house price appreciation early in the decade but still saw declining values and increased foreclosures in 2007. As of January 2009, California, Michigan, Ohio and Florida were the states with the highest foreclosure rates.
By July 2008, year-to-date prices had declined in 24 of U.S. metropolitan areas, with California and the southwest experiencing the greatest price falls. According to the reports, only Milwaukee had seen an increase in house prices after July 2007.
Side effects
Prior to the real estate market correction of 2006-2007, the unprecedented increase in house prices starting in 1997 produced numerous wide-ranging effects in the economy of the United States.
- One of the most direct effects was on the construction of new houses. In 2005, 1,283,000 new single-family homes were sold, compared with an average of 609,000 per year during 1990-1995. The largest home builders, such as D. R. Horton, Pulte, and Lennar, saw their largest share prices and revenues in 2004-2005. D. R. Horton’s stock went from $3 in early 1997 to all-time high of $42.82 on July 20, 2005. Pulte Corp’s revenues grew from $2.33 billion in 1996 to $14.69 billion in 2005.
- Mortgage equity withdrawals – primarily home equity loans and cash out refinancings – grew considerably since early 1990s. According to U.S. Federal Reserve estimates, in 2005 homeowners extracted $750 billion of equity from their homes (up from $106 billion in 1996), spending two-thirds of it on personal consumption, home improvements, and credit card debt.
- It is widely believed that the increased degree of economic activity produced by the expanding housing bubble in 2001-2003 was partly responsible for averting a full-scale recession in the U.S. economy following the dot-com bust.
- Rapidly growing house prices and increasing price gradients forced many residents to flee the expensive centers of many metropolitan areas, resulting in the explosive growth of exurbs in some regions.
- Extreme regional differences in land prices. The differences in housing prices are many due to differences in land values, which reached 85% of the total value of houses in the highest priced markets at the peak. High land values contribute to high living costs in general and are part of the reason for the decline of the old industrial centers while new automobile plants, for example, were built throughout the South, which grew in population faster than the other regions
The share prices of Fannie Mae and Freddie Mac plummeted in 2008 as investors worried that they lacked sufficient capital to cover the losses on their $5 trillion portfolio of loans and loan guarantees. On June 16, 2010 it was announced that Fannie Mae and Freddie Mac would be delisted from the New York Stock Exchange; shares now trade on over-the-counter market.
Housing market correction
Basing their statements on historic U.S. housing valuation trends, in 2005 and 2006 many economist and business writers predicted market corrections ranging from a few percentage points to 50% or more from peak values in some markets, and although this cooling had yet not affected all areas for the U.S., some warned that it still could, and that the correction would be “nasty” and “severe”. Chief economist Mark Zandi of the economic research firm Moody’s Economy.com predicted a “crash” of double-digit depreciation in some U.S. cities by 2007-209. In a paper he presented to a Federal Reserve Board economic symposium in August 2007, Yale University economist Robert Shiller warned, “The examples we have of past cycles indicate that major declines in real home prices-even 50 per cent declines in some places-are entirely possible going forward from today or form the not-too-distant-future.”
To better understand how the mortgage crisis played out, a 2012 report from the Universality of Michigan analyzed data from the Panel Study of Income Dynamics (PSID), which surveyed roughly 9,000 representative households in 2009 and 2011. The data seem to indicate that, while conditions are still difficult, in some ways the crisis is easing: Over the period studied , the percentage of families behind on mortgage payments fell from 2.2 to 1.9; homeowners who thought it was “very likely or somewhat likely” that they would fall behind on payments fell from 6% to 4.6% of families. On the other hand, family’s financial liquidity has decreased: “As of 2009, 18.5% of families had no liquid assets, and by 2011 this had grown to 23.4% families.”
Sources:
http://en.wikipedia.org/wiki/U.S._housing_bubble
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