The housing bubble that ended in 2006 was created by the Federal Reserve action that lowered interest rate all the way down to 1% in 2003 (Leonhardt, 2003). This allowed home buyers to obtain money cheaply and purchase houses that were bigger than they would have been able to purchase otherwise. It also allowed people the ability to purchase a home that would not have been able to if rates where at historical averages. Lastly, lenders created "fuzzy" financing which enable people to buy homes that should not have been able to because they were a high a risk for defaulting. Not only were they a high risk for default but they were lent money in a manner that worked around the rules which were in place to prevent the abuses that occurred.
Some individuals were allowed to take over 100% of the mortgage amount by borrowing the closing cost and adding or rolling them into the principle. Others were allowed to put a small down payment that was less than the historical standard of 20%. Moreover, many took out adjustable mortgages in order to lower the monthly payment to increase their ability to purchase a home. Even worse yet, both lenders and home buyers used these tactics to buy a bigger house than what they could afford.
I have a friend Richie that did just that. He did not take my advice and bought a 300K condo in Staten Island New York. He put no money down and took out an adjustable rate loan. He bought it around 2006 at the peak and his purchase price of 305K which has since shrunk to 280K. He did not have equity in the house to begin with because he put 5% down but rolled the closing cost into the principle. Now his debt burden has gone from 0 to 25K. I wonder how many Richie’s are out there.
The future direction of housing prices and the overall economy will depend on an Americas ability to expand their wealth through home equity appreciation because
"Homeownership is one of the primary ways that households can builds wealth"
(Chomsisengphet and Pennington-Cross, 2006). However, to the peril of the United States, housing prices, and economy that will not happen for a long time.
The housing boom was supported by the subprime borrower which in 2006 accounted for 20% of the mortgage market while housing investors (individual with second homes) made up 23% of the market in 2005 (Lee 2006; Perkins, 2005). Moreover, the ongoing credit crunch has frozen the banking system and money is no longer free flowing. The latest restrictions in loans include
"cash-out refinancing, loans with anything less than full documentation of borrower income, credit and assets, mortgages for certain second-home purchases, investment loan applications where the buyer already owns at least three other rental properties, mortgages to borrowers with "nontraditional" credit, such as "thin files", short-term construction loans that convert to permanent mortgages, adjustable-rate mortgages where the first rate adjustment occurs within 60 months after closing and lastly some of those high-loss loan products — mass-marketed option ARMs with minimal down payments and "stated" incomes, for instance — probably never will be seen again"
(Harney, 2008).
It is clear that 43% of the mortgage market has been wiped out for ever and for that matter 43% of the housing demand has just evaporated in less than two years! The high appreciation housing markets that were hot over the past few years are going to be affected more on the way down when compared to the markets with less aggressive appreciation because
"any concentration of foreclosed property can potentially adversely impact the value of property in the neighborhood" (Chomsisengphet and Pennington-Cross, 2006). Moreover, The subprime debacle is worse than is being reported because "In Ohio, for example, I’m being told that it can take two to six months to get your filings in the system"."In states like Michigan, we’re hearing from some of the trustees who actually do the foreclosures that the lenders have asked them to slow down because they don’t want to process any more into a market that won’t absorb the properties back through sales."" In Florida, a St. Lucie County court actually added a night shift to handle the massive backlog of foreclosure filings. The clerk of the courts was quoted as saying the caseload has become, just horrendous." "The court used to handle about forty filings per month. In January they were tracking 715 foreclosure filings. Some are reporting lower numbers because the numbers simply can’t get into the system."
says Rick Sharga of RealtyTrac.
Therefore some of the higher appreciation areas of the housing market that have higher rates of sub-prime borrows like Southern California, Arizona, Nevada, the suburbs of Washington, DC, and New York City to name a few will be hardest hit on the way down. Often stock prices can be reflective of how any particular sector will perform and if home builder stocks are any indication of how housing will do we are in trouble. Just about all the housing stocks have sunk over 50% from their highs. Moreover, the average housing price appreciation had gone parabolic and will sooner or later it will revert back to its mean which is also another ominous prediction. How long will it last and when will it bottom? Nobody knows for sure but Economist Robert Prechter of Elliotwave International is predicting that we will not be out of our current economic troubles until the 2010-2012 range. My suggestion is to wait and rent until there are clear signs that the credit crunch, housing prices, and stock market have stabilized.
References
Harney, R. Kennetth (2008) Mortgage-market credit restrictions expand. The Seattle Times. May, 3. http://seattletimes.nwsource.com/...
Lee, Mara (2006) Subprime Mortgages: A Primer. NPR. http://www.npr.org/...
Leonhardt, David (2003) Federal Reserve Lowers Key Rate to 1%, Lowest level since 1958. New York Times. June 26, 2003. http://query.nytimes.com/...
Perkins, Broderick (2005) Speculators Could Be the Pin to Pop the Housing Bubble. March, 15. Realty Times.
Souphala Chomsisengphet and Anthony Pennington-Cross (2006) The Evolution of the Subprime Mortgage Market. Federal Reserve Bank of St. Louis Review. 88, 1, 31-56.