The Rise and Fall of the Housing Market Edward Maher University of Maryland University College ECON201 August 18, 2011 Introduction The collapse of the housing market had far and wide ranging effects in the economy of the United States. While the effects were felt throughout the country, California, Florida, New York, Michigan, Illinois were dealt devastating blows to their respective economy. Throughout the country, foreclosures rose to staggering numbers and jobs lost were in the millions.
This research paper will concentrate on the causes and consequences of the housing crisis and will attempt to determine if there is any fault for not controlling the crisis. Causes of the Housing Crisis The term bubble has been used synominously with the housing crisis. What is a bubble? According to the Webster dictionary an economic bubble is, “a state of booming economic activity that often ends in a sudden collapse. American economist Robert Shiller of Yale University describes an economic bubble as “A bubble occurs when exaggerated expectations of future prices increase unusual demand either by people who fear being priced out of a market or by investors hoping to make a lot of money fast. A bubble is a self-fulfilling prophecy for a while, as successive rounds of buyers push prices higher and higher. But the willingness to pay higher and higher prices in fragile: It will end whenever buyers perceive that prices are no longer going up. Hence bubbles carry the seeds of their own destruction.
Only time is needed for bubbles to end. ” While there are many variations defining a bubble, all are consistent that there will be a “pop” or end to the bubble. Over the last half of the century the US Government has pushed an intrinsic notion that owning a home is part of the American dream. The government has mad homeownership as a public policy goal and offers numerous incentives such as ability to deduct interest accrued from their mortgage and deducting property taxes. In 1938 during the Great Depression banks were strapped for cash as borrowers were defaulting on their loans.
Through the authority of President Franklin D. Roosevelt and Congress created the Federal National Mortgage Association commonly known as Fannie Mae. Created as part of FDR’s New Deal, Fannie Mae was established in an attempt to raise home ownership levels and the affordable housing by providing banks with federal money to finance mortgages. Fannie Mae was set up to operate as a “national savings and loan,” banks now had the ability to offer loans to middle income buyers who otherwise would not be credit worthy.
In 1968, Fannie Mae became a public company after enormous pressure during the Vietnam War to remove Fannie Mae’s debt portfolio from the government’s balance sheet. To prevent a Fannie Mae from monopolizing the industry Freddie Mac was instituted and also eventually went public in 1989. Fannie Mae consistently started initiatives such as the $10 billion “Opening Doors to Affordable Housing”, the goal was a commitment to offer loans to low to moderate income and special needs housing and at one point “one out of every seven home loans mortgages made in the US. While there is not a general consensus of when the housing bubble began, many economists feel when the Federal Reserve cut short term interest rates dramatically in 2001 “from about 6. 5% to 1%” due to the crash of dot-com bubble was the start of the housing bubble. Prior to the drastic reduction in interest rates, the cost of owning a home and renting a home were almost identical. However, with low mortgage interest rates during this period saw the cost of owning a home drop drastically while the cost of renting a home did not and home ownership was on the rise.
Homeownership rates rose from “63. 9%” in the mid 80’s and saw a “7. 8%” change from 1994-2004. While the percentage does appear to be small, to put the percentage into perspective there was an increase of over 6 million new homeowners. With the demand of homeownership steadily rising home appreciation rose as well and new home builders responded by building new homes. Between 2004 and 2006, the Federal Reserve Board raised interest rates from 1% and capping out at to 5. 25%. Even with interest rates on the rise, the housing bubble continued to grow.
Why did the bubble continue to grow when typically interest rates increase homeownerships typically declines as well? Economists look at the lending practices before and after the bubble. Prior to the bubble standard typically included, “documentation of credit histories of prospective borrowers, their current income and assets, evidence of job stability and pay, and related factors that in theory help a lender assess a potential borrower’s ability to pay for a mortgage. ” During the 2000’s lending practices eased with the government continuing to push their policy on continuing to grow homeownership numbers.
To continue homeownership lenders developed new innovative loans such as, “piggy back loans (80/20), adjustable rate mortgages, stated income loans, negative amortization mortgages, and multi-layered risked. ” These loans gave homeowners many options as with piggy back loans, allowed consumers to purchase a home without having to put down a down payment, however they would have a first and second mortgage. Many consumers also opted for adjustable rate mortgages such as interest only loans.
These loans allowed the consumer to purchase a home that would most likely be out of their monetary range, with the inclination that the value of their home value would continue to increase and would be able to refinance their loan a few years later. The demand saw home values skyrocketing to an “unheard of increase in home values of 124% between 1997-2006. ” Many homeowners took advantage of the increase in property value and refinanced their homes and took out second mortgages against the value of their home to use towards spending, such as home improvement. The amount of debt to income per family rose by over 30%.
Most consumers thought these loans, especially 100% financing and interest only was a dream come true, most would come to realize the nightmare it created. As all economists agree the housing bubble would burst at some point no one could predict the significant impact it had on the country. Once home values stopped rising, there was no incentive to buy as interest rates were high and ultimately the home prices started to decline. Annual sales of existing homes “fell by 30% and new construction of such homes dropped by a mind-boggling 64% decline” The decline in the stock market and the surge of unemployment exacerbated the situation.
The housing market was now in deep distress and was quickly hit with a massive amount of foreclosures that swept throughout the country. The steep drop in home values saw many homeowners once saw the appreciation of their homes, many now owed more on their home than what it was worth. Core Logic performed a study that showed, “23% of homeowners were underwater, with figures in some areas more than 40%. ” Another survey performed by RealtyTrac, showed that “nearly 6 million homeowners received foreclosure notices in 2009 and 2010, with more than 3. million likely in 2011. ” This survey has been updated and the new projection for 2011 will likely see an additional 250,000 foreclosures. With nowhere else to turn many consumers were forced to file for bankruptcy protection. The government’s attempt to fix the crisis was not to provide direct aid to the homeowners but to commit billions of dollars (TARP Funds) to many firms on the verge of collapse in anticipation of the crisis being averted. Who is to blame for the crisis, the Feds, government policy or the consumers? Late governor Edward M.
Gramlich, warned about such a crisis and felt that a “fast-growing new breed of lenders was luring many people into risky mortgages that they could not afford. ” Leaders of various housing agencies approached Greenspan and all came away with the notion he didn’t seem to care about the crisis. Greenspan later defended his actions by stating, “That the Fed was not equipped to investigate deceptive lending and that it is not to blame for the housing bubble and its eventual bust. ” Some economists suggest that government policy encourage the growth of the housing crisis.
Through legislation like the Community Reinvestment Act, which loosened up lending practices and claim loans where being made to non creditworthy consumers. Some economists suggest that the consumer played a large role in the crisis. Consumers made purchases on the notion that housing prices would continue to appreciate and encouraged consumer to take out subprime loans with the understanding they would not be able to afford the payment. Consumers bought with the thought that they would refinance or purchase a new home prior to the adjustable rate going up.
Many homeowners choose to stop paying and walk away from their homes allowing the bank to reclaim the property. While there isn’t a definitive party to blame, many consumers live were drastically changed for the worse. My family was personally involved in the housing crisis. We purchased a home to take advantage of the tax incentives offered by the government and to live the supposed dream of owning a home. Within the first few years our home appreciated as we expected on the basis of our realtor. When the bottom dropped out, our home value decreased tremendously and soon we were over $100,000 under water without anywhere to turn.
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