U.S. housing market boom and bust cycles

U.S. Housing Market Boom to Bust

Housing Market - Boom to Bust

House Prices Rose at Unprecedented Levels.

US housing prices have risen at an unprecedented level for nearly a decade, ending boldly in 2007. According to Leonard housing appreciation climbed from the 1983-2006 average of 7.4% to the staggering 12.7% appreciation which was nationally common just prior to the current decline. Leonard also stresses that individuals took full advantage of these boom housing appreciation percentages for the first time as home equity loan products came on to the markets in record numbers, something that was unheard of until after 1981. The illiquidity of real property prior to 1981 kept consumers relatively safe from declines, and their equity safe from overspending as they took full advantage of home equity loan products and are not only likely to be paying off a loan that exceeds the current value of their mortgage but could also be paying off a loan (sometimes called a second mortgage) that exceeds yet more the value as housing appreciation rates decline, come to a standstill and since 2007 actually begin to decline for the first time since the early 1990s and in a more substantial manner. (Leonard, 2010, p. 87) Though there were some who were early in their assessment of the potential for a rapid decline, who called the housing appreciation figures unsustainable, referring to the record level appreciation of 8% in 2005, the highest recorded growth since 1975 as a bubble, consumers and banks sought ways to maintain this artificial curve by changing the manner in which they lend and borrow. The institutions and individuals who had interest in receiving revenue from increased assessment values of homes simply changed the borrowing and lending strategies to respond to any potential downturn in housing prices and it was this action that created the instability. (Weller, 2006) Had consumers of home equity loans as well as new mortgages that were reflective of higher assessment values, simply been forced by the national lending strategies to happily sit on their appreciated value homes, in a state of illiquidity, as they have in the past the economy and those individuals would be riding a much smaller wave down as housing prices decline during a normal trend in the economy. (Schiller, 2006) Sadly they did not as they were fundamentally preyed upon by unscrupulous lenders seeking to keep new mortgage and equity loan sales high and are now sitting on mortgages that in some cases far exceed the value of their homes, (Reich, 2006) some of these individuals in the wake of the economic downturn are also experiencing an inability to pay these mortgages as real job loss and other economic factors drive the percentages down. Reich stresses that most banks on a regional level are healthy as a response to their ability to cost contain during this emerging crisis (speaking from a 2006 window) but that at least 4 factors contributed to the home boom; "a growing economy, interest rates that have remained near 40-year lows and general home price appreciation that has risen to extraordinary levels in some markets. And some would add a fourth factor, innovative mortgage loan products." (Reich, 2006, p.4) Reich speaking from the perspective of a banking professional, one who nonetheless has interest in responsible lending through is affiliations with the Office of Thrift Supervision is kind to banks and bankers and many are now referring to the last factor "innovative mortgage loan products," (Reich, 2006, p. 4) as predatory lending practices. The unprecedented growth of U.S. house prices can also be viewed from the perspective of rents, as a foundational litmus to the overall health of the growth. The ratio of house prices to rents has grown at an unprecedented rate of 78%, despite the fact that these statistics normally rise together at a nominal rate making renting only slightly less expensive than buying and keeping it possible for profits on rent to be at least marginally in the positive. (Killelea, 2010)

Aggressive sale of Sub-Prime Mortgages.

Usually when house prices rise, demand moderates, as fewer people have the ability to afford the mortgage payments on properties with excessive value, and historically banks have lent responsibly to support the ideal of not getting homeowners in over their heads. However in the case of the U.S. housing market, mortgage lenders were desperate to maintain sales. Therefore they just found new ways to sell the more expensive houses. Though we have hinted at this previously in the work this section of the work will provide greater detail about these so called "innovative mortgage loan products," (Reich, 2006, p. 4). These products are more broadly known as subprime lending practices, yet have more recently been titled predatory lending practices, as consumers feel more and more appalled by the ferocity with which banks and brokers pushed them into through marketing and even substitution borrowing at higher rates than was acceptable just ten years ago, under the false home that the economy would continue to rise and that somewhere between now and then (some mythical place in the future) consumers would be able to afford new mortgage rates and unusually high mortgage rates, based on reduced percentage demands for down payments and unusually high housing assessment values. First let us very briefly look at how a prime or traditional mortgage works. At the onset individuals apply based on their income (not on income potential) and their existing credit, and the amount they have saved for a down payment and they are "prequalified" for a loan amount that fits into their budget and then they can look for a home in that price range, determined by their personal financial health and potentially receive a mortgage on it. The down payment on a traditional (prime) mortgage is between 10 and 15%, with a few creative exceptions for special loans such as to first home buyers or veterans. Without exception this has been the standard practice in mortgage lending for more than a century as banks had no real interest in lending to people who would default and cause the banks to carry the debt. If an individual had marginal or bad credit based on previous credit history, a low income or no or limited down payment savings they simply were not eligible for a mortgage and had to get their personal finances in check or not buy a home. Yet, creative bankers and mortgage brokers began to apply different standards as home prices climbed to unprecedented levels, i.e. where they were financially out of reach to new home buyers. A particularly troubling trend was to transplant a system of subprime lending which had previously only been applied to wealthy investors who saw an opportunity to buy but were in the short-term low on capital, capital they would likely realize very soon and refinance or pay off the loan. This tactic known as the optional adjustable rate mortgage, where a low initial payment was required for a short period and then the mortgage payment was adjusted up over time. This form of subprime lending was never designed for the masses, as the risk was meant to be acquired only by individuals or entities that held value in other properties and assets that were only temporarily illiquid and would allow the loan holder the opportunity to resolve the issue or pay the higher mortgage based on the realization of these assets at a later date. (Der Hovanesian, 2006) This aspect of lending the ARM mortgage loan was then mass marketed as an alternative for individuals who could not realistically meet the financial demands of it, as well as with some other great additions, i.e. balloon payments (large payments due at a later date to offset the low initial payments) as well as very low down payment percentages, such as 0-3%.

The term Subprime mortgage is a compact and nice way of saying that the mortgage product is not prime, or the best there is to offer, in most cases this means that the consumer is not fundamentally capable of realizing the debt without serious potential risk and the mortgage lender takes on significant risk in allowing it, yet these subprime lending practices became foundational when housing prices climbed to such a high rate that people simply had no real ability to prequalify for home purchases that would meet their families need under the traditional mortgage standards, described above. Though many lending institutions and banking professionals would like to call back to the old standard, buyer beware excuses, buyers do not purchase homes every day where lenders lend on homes everyday and there is a clear sense that the marketing of subprime loan packages was so substantial it was a difficult time for an individual to see past the next year or so and therefore many call foul and reiterate that these lending practices are and always were predatory, a bold attempt by lenders to balk a traditional trend decline in demand which is naturally formed to correct for unsustainable housing price growth. (Der Hovanesian, 2010)

Increased Promotion of Discounted mortgages.

The way that subprime lending practices, and some call predatory lending practices affect the housing market has yet to be realized on such a large scale, as these tactics have always been carefully controlled by lending institutions, due in large part to their historical long-range view. Subprime lending on the other hand is fundamentally not a long-term view practice; it is a short-term tactic that is now being dealt with on a massive scale as foreclosures mount and more and more families see foreclosure looming in their future and more and more banks take on this debt, with the added burden of holding on to mortgages that far exceed the new depleted value of homes as the market corrects naturally from the housing bubble. The marketing for such subprime lending was absolutely saturated as nearly every individual was admonished to buy a home or refinance their home before the extremely low interest rates began to rise again and before housing prices were even further out of reach. Lending institutions, even the big name banks, in an attempt to compete with the fly by night unscrupulous agencies began to adopt their tactics, likely with much internal pressure to market and lend in situations that previously would have been unheard of. ARM mortgages, low down payment mortgages and introductory interest rate loans, usually relegated to much smaller lending situations like auto loans became par for the course and individuals are now struggling to pay for them and banks are sitting on loads of debt, offset marginally by federal assistance. It seems that from 2000 on the marketing for subprime lending loans was unending, and lending institutions were not lying, they really were lending at unprecedented levels. In general a; "predatory "loan" generally refers to a loan that takes financial advantage of an unsophisticated borrower who has accumulated equity in his or her home, but who may be unable to repay the obligation," (Ornstein, Tallman & Holahan, 2006, p. 54) but many argue that the pressure to compete with unscrupulous lenders demanded that traditional lenders relax their lending practices and to some degree in doing so they became predatory lenders.

Increased use of Variable Adjustable Mortgages.

This is supported foundationally by the increased availability of ARM mortgages, especially among low income families and even in the middle classes where real wages had not adjusted to the new cost of buying a home during the housing bubble. (Weller, 2006) the rise in Adjustable mortgages is most prominent amongst low income families, likely because they were historically most likely to be turned down for a traditional mortgage, and therefore the area was a previously untapped market, though many would argue that the market was untapped for very good reasons. The growth in ARMs between 2000 and 2004 accounted for about two-thirds of the relative increase in variable interest debt. (Weller, 2006) According to Woll this increase in opportunity and loan product offerings was as a result of the lending institutions desire to retain growth of the previous years and maintain a really high operational infrastructure, that they had developed during the housing boom. "So in order to feed that operational capacity, new products were seen as a way to attract new consumers." (2007, p.52) There is no sense that this makes a great deal of long-term sense, to grow and industry that should have naturally declined but nonetheless that is what happened and now consumers above all others are paying the price for excess.

Rising Interest Rates.

Because of weakness in other areas of the economy monetary policy was loosened in 2002. Regarding economic growth and inflation this was very positive; however it ignored the implications for the housing market. Low interest rates were a stimulus for those on low income and bad credit records to buy a house for the first time. However as interest rates have increased from 1% to 5% it has increased the cost of mortgage payments for homeowners. For example a 2% rise in interest rates can increase the cost of mortgage interest payments by 40%. (Killelea, 2010) That extreme of an increase in mortgage payments will be felt for some time, even as those who might have been eligible for fixed rate and traditional mortgage structures sought to borrow as much as they could given the rosy sales tactics and the fundamental ideation that the housing boom and a great national economy would continue to rise indefinitely, despite real evidence of the fallacy of this false sense of security, in part brought on by marketing of subprime lending options.

Speculation

This trend of subprime lending and the current financial crisis is also reflective of massive housing market speculation, where individuals who were not receiving the kind of percentage returns associated with the stock market began to heavily invest in property. This challenges every aspect of the market, including but not limited to rent rates and other things that have traditionally always fallen in line with mortgage prices and other economic trends. (Killelea, 2010) the real decline in this area will likely be seen as a significant change in the market, as developers and investors seek ways to exit, with no real exit strategy as when the demand decreases (as it should have years ago) and lending gets tight (as it should have years ago) there is less ability for those invested to get a return on their investment. Some of the most ardent investors are seeing substantial losses in net worth and for those on the riskier end of the speculation market bankruptcy risk and reality. (Leonard, 2010) Even some of the more traditionally conservative lenders put far to much speculative capital in the mortgage market;

The boom and bust in the housing market precipitated serious strains in financial markets. These strains resulted in the onset of the financial crisis in August 2007 with the collapse of the asset-backed commercial paper market. This collapse occurred because the solvency of a number of large financial firms was threatened by huge losses in complex structured financial securities. Why did these firms have such high concentrations in mortgage-related securities? Given the information available to firms at the time, these high concentrations in mortgage related securities violated basic principles of modern risk management…this failure to apply well-understood risk management principles was a result of principal agent problems internal to the firms and to breakdowns of corporate governance systems designed to overcome these principal-agent problems. (Lang & Jagtiani, 2010, p. 123)

The result of this have yet to be fully realized as many investors and lenders playing in the speculation market are simply hoping to ride out the downturn and recover in the future, but this is largely a pipe dream as real housing assessments decline further and are not likely to fully recover for some time to come.

In 2007 some economists were still feeling considerably sunny about the situation. The economist Joe Light of Money magazine claimed that the housing market was cooling of considerably and yet at the same time the laws of supply and demand still dominated, if demand is high and availability is low prices will still grow. He also contended that where the economy was still strong the housing market was still strong. One important observation that Light makes is that the bubble market, which is the description many have given to the exponential market gains of the past 15 years, is in danger of popping if developers sell to each other at inflated prices, which many did to share the decline and attempt an artificial exit strategy. He stated that when you begin to see rows of for rent signs, or for sale signs that stay up for a very long time, there is cause for worry, and this reality was largely realized all over the country since his assessment in 2007. In this sort of market the home owner should be prepared to hang on to what they have until the market stabilizes. In one observation, of interest he detailed a community that still has growth rate in the market as a result of other regional markets being inflated. (Light, 2007, p. 53-54) in retrospect the situation got far worse than was expected and we have yet to realize even marginally the rapid recovery that was hoped by some

It is also important to note that many economists in the 2007 and even later decided to take a regional approach to the situation, seeking out markets that were least affected and those who were most affected to try to make sense of the mess. Gopal from Business Week noted in 2007, that regional differences in the housing market are important, and that the NE seems to be faring better than other regions, in his opinion, because the down turn began in that area before others. For this economist this was evidence that recovery will begin soon in other areas, but he was unwilling to conjecture about the degree and nature of the recovery, a wise move given most of his assessment is only good on paper.

Even as existing home prices in October tumbled in the South and West, prices in the Northeast rose 1.3% compared to a year ago -- the sixth straight month of appreciation, according to the NAR, which released its monthly home price report on Nov. 28. Home prices nationwide declined 5.1% in October compared to October, 2006. The South dropped 6.7%; the West, 6.9%; and the Midwest, 1.6%. The Northeast's gain follows five straight months of higher prices on a year-over-year basis, including a 0.2% rise in September to a 6.4% bump in July. The Northeast, as defined by the Census Bureau, includes Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. It doesn't include the slumping Washington [D.C.] market. (Gopal, 2007, p. 1)

Gopal described a complicated market that he was not willing to make too many predictions about, but that the NE statistics were a positive sign in the development of a possible reversal of the decline in home market growth.

"You cannot make a pronouncement now that the Northeast has recovered and all is well," says Jonathan Miller, an appraiser and research director at Radar Logic, a New York-based property research firm. "It's early with rising foreclosure rates, rising inventories of homes, the number of sales transactions dropping significantly, and concern about a recession. So other than a 1.3% increase in existing home sales, what other indicator is there that the Northeast has bottomed out?" (Gopal, 2007, p. 1)

Celia Chen from Moody's Economy.com that the NE and other areas in the country may have to wait more than a year for a clear sign of recovery, and that the reason it is holding its own has to do with relative wealth of the region and more limited subprime lending. Again subprime loans frequently end in situations where people cannot pay mortgages and the real value of the home is lower than the loaned amount, a reality that has hit home far to many times since 2007, and even regionally in places where less of it took place, due in large part to regional loan regulations responding more rapidly than loose national standards. As has been stated previously this loan tactic has been utilized by many in an attempt to gain first mortgages or bad credit mortgages that do not realistically fit into their budget, and this is being felt much more today than it was in 2007, as is the shared culpability noted above between consumers and lenders. Chen also noted that in the NE home prices did not rise as much as they did in other areas of the country. The NE is still, according to Chen experiencing reduced demand in home sales. (Gopal, 2007, p. 1)

"It is looking a little less dark in the Northeast than in the rest of the country," Chen says. "But I don't expect housing activity to pick up substantially in the Northeast in the next six months. There's going to be further correction in terms of sales falling and prices declining. A lot of these markets, such as Boston and New York, are still overpriced, overvalued, and do have excess inventory." (Gopal, 2007, p. 1)

In short the housing market is in a down swing, and it is and will continue to have a significant impact on the overall economy. The level to which it will fall is unknown, but most experts even in 2007 agreed that the market would likely begin to dip to such a degree that homes all over the nation would actually lose value, rather than simply experiencing slower value growth, a reality that has been realized not just regionally but internationally between 2007 and now. The manner in which this will affect the economy is legitimately an unknown, though it is known that the construction and lending industries are significant employers in the nation, and when these markets slow, the overall market slows, considerably and again these 2007 hopes and dreams largely became pipe dreams as nearly every aspect of the housing market ground to a standstill and took the national and international economies with it. It remains to be seen if the market has hit bottom and if it will begin to recover, but it is the hope of many that this is the case and that the whole institution will be changed for the better in the process. The greatest hope is that the changes seen will fundamentally respond to better consumer protection, lesser or no subprime lending and greater consumer control over realistic spending.

Excess Supply

It is also important to discuss the fact that the housing boom also spurned increased building, as more and more people saw the potential to buy more and more expensive homes builders and developers responded tenfold and now that the housing market has declined and has yet to level out that excess is being felt. The housing supply now far exceeds demand as fewer people are able to get loans, because the lending institutions have been put on notice regarding their marginally unethical lending practices of the last decade or so and because they simply have much less capital to work with due in large part to carrying bad paper mortgages and increased foreclosures. As proof of this fundamental supply excess housing starts, and home inventory statistics must be viewed: