This link has been bookmarked by 1 people . It was first bookmarked on 16 Dec 2008, by Yule Heibel.
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16 Dec 08
Yule HeibelQuite a horrifying article about the depth (and breadth) housing's role in the financial crisis, and why the market is in the doldrums in a bad bad way.
QUOTE:
Home values have fallen before — during the Great Depression and in Texas after a 1980s oil boom, for example — but those drops were a response to other economic forces. This time, the housing price collapse is the cause of the nation's broad economic troubles, not just an effect.
UNQUOTEusatoday housing subprime_mortgage_crisis bailout financial_crisis economy
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More room to fall?
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As painful as the decline has been, history suggests home values still may have a long way to drop and may take decades to return to the heights of 2½ years ago.
"We will never see these prices again in our lifetime, when you adjust for inflation," says Peter Schiff, president of investment firm Euro Pacific Capital of Darien, Conn. "These were lifetime peaks."
The boom in home prices — fueled by heavily leveraged loans built on low or even no down payments — made it easy to forget that housing values had been remarkably stable for a half-century after World War II, rising at roughly the same pace as income and inflation. Prices soared in most of the country — especially in Arizona, California, Florida and Nevada and metro areas of Washington, D.C., and New York — during a brief period of easy lending, especially from 2002 to 2006. That era's over.
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"Homes are different than other goods and services," she says. "The fragility of our banking system is tied to the value of homes."
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Other economists see a brighter picture in the long term. Wachovia economist Adam York expects home values to keep falling until 2010 but is optimistic they will recover.
"The one saving grace is the population is growing by 3 million people a year," he says. "They need to live somewhere. That means more roofs."
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When the housing bubble began to deflate in 2006, history had a sobering lesson to teach. Home values had closely tracked three common-sense measures for many years:
•Income — Home values floated at about three times average household income from 1950 to 2000. In 2006, the average household income was $66,500. Under the traditional model, home prices should have been about $200,000. Instead, the typical home sold for $301,000.
•Rent — Homes traditionally have sold for about 20 times what it would cost to rent them for a year. In 2006, houses were selling for 32 times annual rent.
•Appreciation — Existing homes grew in value by less than 0.5% per year, after adjusting for inflation, from 1950 to 2000. From 2000 to 2006, home prices rose at an average annualized rate of 8.2% above inflation and peaked with a 12.3% jump in 2005. Housing prices began to fall in the second quarter of 2006.
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Low down payments and ARMs gave homeowners enormous financial leverage to pay high home prices. Leverage boosts buying power through debt, the same way a 100-pound woman uses a lever to jack up a 3,000-pound car.
Consider a couple with $20,000 cash. In 2006, they easily could get a 5% down mortgage to buy a $400,000 house. Today, a 10% down payment would limit the couple to a $200,000 house.
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The Great Depression of the 1930s was preceded by a real estate bubble, also fueled by loose lending standards and shrinking down payment requirements. Those real estate problems — and solutions — echo today's.
Florida real estate was the epicenter of speculation in the mid-1920s. Developers ran up prices by selling to borrowers who put as little as 10% down. Those were shockingly risky loans at a time when the standard mortgage lasted five years and required a 50% down payment.
The risky loans went bad first, but it was the spread of credit problems to the supposedly safe loans — five years and 50% down — that caused the housing market to collapse.
The five-year loans required no payments to reduce principal. Homeowners expected to refinance mortgages when the loans expired, usually with the same lender. The stock market crash led to a "liquidity crisis" — no money to borrow — that dried up mortgage refinancing.
Millions of families lost their homes to foreclosure. Falling prices on nearly everything — homes, farm crops, wages — made consumers reluctant to buy and banks afraid to lend.
As part of the New Deal, the government took control of millions of loans and restructured them into something new: the modern mortgage, with 20% down and principal that is repaid over the life of the loan. The government extended the mortgages to 15 years, then 25 and finally 30.
When World War II ended in 1945 and the Baby Boom began the following year, the 30-year, fixed-rate mortgage became a cornerstone of society and led to unprecedented levels of homeownership.
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The danger of rapidly falling home prices is that — similar to the Depression — potential buyers and lenders will stay away, fueling even sharper price declines.
During the housing boom, buyers expected prices to rise, so they were quick to buy, borrow and pay a premium. As prices drop, home buyers wait for better deals. says economist Dean Baker of the liberal Center for Economic Policy Research in Washington, D.C.
Lenders want bigger down payments to protect against the falling value of collateral. Homeowners lose equity, so they can't buy other houses. "Price declines can be a self-reinforcing mechanism," Wachter says.
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An out-of-control price collapse would have dire consequences, Baker says. Even the most conservative banks would find themselves carrying portfolios of toxic mortgage loans.
If housing prices don't stabilize at traditional levels, financial troubles could spread everywhere — to credit cards, car loans and commercial mortgages, Baker says. "The waves of bad debt will just keep coming," he says.
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