Monday, December 19, 2011

America's Housing Boom and Bust - Who Is Really to Blame?

At long, long last, the fine folks at the Federal Reserve have figured out who is to blame for America's multiyear housing market crash.  No, it's not their own tempting policy of ultra-low interest rates and no, no one on Wall Street is to blame in any way.  The answer to this pressing question is to be found in the Federal Reserve Bank of New York's Liberty Street Economics analysis entitled ""Flip This House":  Investor Speculation and the Housing Bubble".

The authors, Andrew Haughwout, Donghoon Lee, Joseph Tracy and Wilbert van der Klauuw, begin by noting that the cause of the rise and fall of the housing market in the United States during the 2000s has been the subject of much speculation.  Virtually all purchasers of homes use debt to purchase a home thereby allowing themselves to purchase a larger home than they could afford if they had to pay cash.  Most borrowers are solely motivated as owner-occupants who intend to live in their homes but there is a class of residential real estate purchasers who wish to purchase homes as an investment.  It is these homeowners that are more likely to walk away from their homes if the value of the home drops to a level below the value of the mortgage.  These investors pushed prices up during the mid-2000s and then when prices started to turn down in early 2006, they defaulted in large numbers; a process that contributed to the intensity of the down cycle in the real estate market.

Here are two graphs which show the number of first lien mortgages (aka first mortgages by non-central bankers) held by individuals as a share of the total number of mortgages remembering that each property can only have one first or primary mortgage, noting that the four colours represent the number of first mortgages for borrowers:


From the left graph, you'll note that in 2006, nearly 35 percent of all first mortgages issued in the United States were issued to multiple residence owners.  On the right graph, you can see the data for the "sun'n'sand" states of Arizona, California, Florida and Nevada showing that in 2006, nearly 45 percent of all mortgages were issued to multiple mortgage holders.  It is these states that have seen the largest price "readjustments".  As well, from 2000 to 2006, the number of multiple mortgage holders in the four states nearly doubled from 24 percent to 45 percent.  What is shocking to me is the rapid growth in the number of consumers that held first mortgages on four or more properties (in purple); by 2006, nearly 10 percent of all mortgages in the four state area were held by consumers with four or more properties, up from 3 percent in 2000.  That's a lot of house!

Individuals who invest in three or more properties are highly unlikely to ever occupy all three properties, in fact, during the early part of the decade, these owners were more likely to flip their properties relatively quickly as the real estate market rose.  On top of their buy and flip modus operandi, these owners tended to make higher bids for houses since their intention is to sell as soon as they reach a modest level of profit and, as you may recall, it appeared that the rise in housing prices in the first half of the 2000s appeared to be a never-ending wealth creation machine.  The fact that these borrowers intended to flip their investments quickly meant that they were more likely to shop around for cut-rate deals on mortgages, often using subprime credit to make their purchases as shown on these graphs and paying a very low downpayment:


Note the rise in the use of subprime credit as the decade passed, particularly in the four aforementioned states.  Since these owners had very little money "in the game", they had very little to lose once the market started to turn down, making it very simple to just walk away and never look back.  After all, one can't get homesick if it was never home, can one?

Now let's look at how these speculators did as the housing market started to correct on these two graphs, once again, with the same colour scheme representing the number of first lien mortgages:


When measured using mortgage delinquency, multiple mortgage holders tended to do well in the first half of the 2000s because house prices were on that uphill treadmill.  Things rapidly changed in late 2006 and early 2007 when house prices started to drop.  Multiple first mortgage holders across the United States were responsible for only 10 to 15 percent of serious delinquencies during the first half of  the 2000s.  This changed dramatically, and by the fourth quarter of 2007, multiple first mortgage holders were responsible for just over 30 percent of delinquencies.  In the "sun'n'sand" states, multiple first mortgage holders were responsible for just under 40 percent of delinquencies.  That's a pretty stunning number!

The authors of the study conclude that speculative real estate investors were more important for the formation and collapse of America's housing market than was first thought.  The availability of ultra-low interest rates (particularly teaser rates), the use of minimal (or no) down payments and other creative financing obligations allowed unsophisticated American investors to buy the "dream" several times over.  Unfortunately, as the market started to fold back on itself, not only were speculators driven out of the market, but honest American families who prudently put a 20 percent down payment on their dream home and paid their monthly "pound of flesh" were collateral damage as housing prices collapsed to lows not seen since the early part of the decade.  Unfortunately, the Federal Reserve seems unable to see that they paid a role in this horror story; it is their policy of easy, nearly free credit that is in large part responsible for the genesis of the problem.  That, and their pals on Wall Street who used subprime mortgages as a self-perpetuating revenue creating machine.  It would appear that all of them have not learned their lesson as well.



20 comments:

  1. The Fed is not the worst offender in blindness on who to blame. The Republicans have been trying pin all the blame on Democrats since 2008, if not earlier. Readable summary here.

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  2. ModeratePoli

    Thanks for the link. I think that if we knew the whole story, there would be a lot more anger. I'm not sure if you have read "The Big Short" by Michael Lewis but it gives a very interesting view on just how "creative" Wall Street was with their use of MBS and how they thought that they could not lose because they did not suspect just how bad the real estate market could get (even though the Depression example was quite clear).

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  3. Collateral for housing should include the house of residence. Walk away from a house, the bank repossesses the house of residence as well.

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  4. And where are the Banks who lent the money to these 3 or 4 house owner, walk aways. What, did these borrowers just twist these banks arms and the lenders just said, here, take what you want..Are not the banks accountable for some of this housing fiasco that has befallen this country. The banks/lenders always had the power to say NO to that borrower, always!

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  5. Bush deregulated finance industry because it generated tax revenue whilst he borrowed heavily for the war. Bush new the "bill" would have to be paid eventually but not while he was in office. This dovetailed with the conservative right intent to bankrupt the country so they can claim the constitution only permit taxation for defense. Anyone bailed out of a house should have reduced Social Security payments upon retirement as a consequence of their greed. Putting it all on the average joe is patently unfair when it is the greedy that put us where we are.
    Thomas E. Shafoaloff

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  6. Rep. Barney Frank (D) allowed Fannie Mae and Freddie Mac to purchase loans from borrowers not qualified to repay loans supposedly so Barney could have fun with his boyfriends at Fannie and Freddie.

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  7. Silly posters, BUSH doesn't regulate GSE's....Congress has that power. Those committees involve a bipartisan committee and Dems didn't push for any additional oversight. BUSH and Republicans did.

    If only you knew how the govt worked, it wouldn't be so easy in your mind to blame the Rs.

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  8. Barney Frank was a member of the minority party from 1995 to 2007. He didn't have the power to "allow" anything. In any case Fannie and Freddie didn't drive the housing bust. It was Wall St banks buying, repackaging and reselling mortgages that were eating the GSE's business in conjunction with unregulated retail mortgage lenders like Countrywide and New Century who were peddling NINJA junk to every house flipper from CA to FL. The GSEs were getting killed by Wall St competition and under severe pressure by hedge fund managers, congress, and the mortgage companies loosened their standards.

    http://www.nytimes.com/2008/10/05/business/05fannie.html?pagewanted=all

    “You’re becoming irrelevant,” Mr. Mozilo told Mr. Mudd, according to two people with knowledge of the meeting who requested anonymity because the talks were confidential. In the previous year, Fannie had already lost 56 percent of its loan-reselling business to Wall Street and other competitors.

    “You need us more than we need you,” Mr. Mozilo said, “and if you don’t take these loans, you’ll find you can lose much more.”

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    1. As Barry Ritholz has said, the CRA and Frank were small potatoes compared to the real housing bubble, hatched at Basel 2 in 1998 and applied in mid 2003 with private MBS with phony AAA ratings. People who listen to Faux need to wake up as they are living in a stupor and a lie.

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  9. Bush appointed De Marco acting head of the FHFA which oversees the GSEs. These are still quasi governmental/private businesses. Now owned by the government but still run like a for profit business. Obama has tried appoint a permanent head of the FHFA. Republicans in congress blocked the appointment so we can assume the status quo is what the GOP prefers.

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  10. Sorry, the housing bubble was hatched at Basel 2 in 1998. Both the risk management and hiding of bad loans to be securitized were hatched there.

    The Fed is one of the central banks involved.

    That is why it is completely ethical to walk away from your toxic housing loan.

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  11. I just have to add that buying too much home did not happen when underwriters did their jobs. These authors are not only stupid, but they are unethical morons.

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    1. Sorry, I meant the Fed authors are the morons. The blog article is awesome!

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  12. Flippers were certainly a factor in helping inflate the bubble, but oftentimes they are lumped in with "home buyers" when they should be in their own category, investors. Another type lumped in with buyers is straw buyers, who are also not buying to live in the home but are co-conspirators in complex mortgage fraud schemes involving many industry people.

    The govt surely is/was a big factor, too, for so-called regulatory agencies did little, or could do little, to stop rampant mortgage fraud, which was being carried out 80% of the time by the industry itself according to early 2000s FBI reports.

    But the real perpetrator was the housing and banking industry itself. Appraisal fraud, constant hype about "it's a great time to buy," (still going on!), shoddy new house construction, toxic loans pushed by lenders and builders in-house lenders, and forgery and all manner of fraud in title co's, and all manner of industry insiders. No one in the industry could honestly claim they didn't know what was going on.

    Further complicating things were the so-called hot shot investors on Wall Street who claim no one could've seen the housing bust coming. They stupidly bought toxic loans and ratings agencies stupidly (fraudulently?) rated them highly.

    I saw this coming in the early 2000s because I saw the consumer complaints and the govt documens, etc, that showed the industry was screwing the country big time. In 2008, the crooked banks were given a bailout of $750 billion as a reward for helping take out the economy. The FBI warned, too, that this white collar crime could take out the economy and was denied the resources to fight it, (also in the early 2000s). Really nothing much was done until banks began to be burned by their own lack of due diligence. When it was just "people" complaining, they were told their cases were not worth enough. Large companies settled even criminal investigations by paying fines. Small companies often saw their CEO's charged criminally, but most are probably back out on the street by now.

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  13. In my opinion many of these so-called "home" buyers were just as greedy and moronic investors or flippers. This is the case of crying because they have buyers remorse, nothing more. It just kills me when the market rises the greedy walk around like their shite doesn't stink but when it falls they are victims. Spare me, and my family their mistakes. Let them eat this mess alone.

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  14. THE ARTICLE STATES - The authors of the study conclude that speculative real estate investors were more important for the formation and collapse of America's housing market than was first thought. The availability of ultra-low interest rates (particularly teaser rates), the use of minimal (or no) down payments and other creative financing obligations allowed unsophisticated American investors to buy the "dream" several times over.

    HELLO ! ! ! WITHOUT ULTRA-LOW INTEREST RATES (COURTESY OF THE FED AND SIR ALAN) AND NO DOWN PAYMENT BANK SCAMS, THERE WOULD BE NO HOUSING BUBBLE AND NO HOUSING CRASH.

    THE FED AND THE BANKS KILLED OUR ECONOMY. AND UNCLE TOM OBAMA JUST GAVE THE BANKS A GET OUT OF JAIL FREE CARD IN RETURN FOR UNLIMITED CAMPAIGN CONTRIBUTIONS FOR HIS RE-ELECTION. GIVE ME A BREAK.

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  15. It started with the Community Reorganization Act under Carter. That spawned ACORN who would sue banks that didn't give out high risk loans to credit risks. Clinton further gave more gas to this act through executive acts.

    Then just before Clinton left the office the congress passed the bipartisan repeal of the Glass Stegall Act which was suppose to prevent banking institutions from doing speculations on the markets. Clinton then signed it. The big financials took the risky NIJA loans and bundled them with good loan and sold them, with regulator approval and contrived ratings, to gullible investors as Mortgage Stock Derivatives.

    It's K street in bed with Washington. And they rig the game so that no matter who wins the presidency they win. It's been this way since Eisenhower and before. Kennedy was the exception but we all know what happened to him.

    But then many voters are too blame for being irresponsible and gullible. They vote for government entitlements instead of independence. They buy big but think small. And they listen to the big media shrill.

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  16. Excellent article. Thanks for putting this together! -June

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  17. The housing bust was something to look back upon.

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  18. I have got a new listing in Tiba Resort from £8,140

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