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The Housing Bubble, Still Burst

POSTED: 08:10 AM ET, 09/ 3/2008 by The Editors

With the summer drawing to an end, we figure it's time to update the three-part series we published in June on how the housing bubble grew and popped.

The series, recalls reporter Zachary Goldfarb, examined excesses in mortgage lending, the exotic Wall Street securities that masked the real risks of the bubble and made the bust so crushing, and how the downturn touched the lives of ordinary Americans. The report also looked at the government's response -- first restrained, then aggressive.

So what's happened in the meantime?

Banks: A number of small, medium and large banks have failed, many of them because of weakness in their portfolio of residential and commercial real estate loans. Most notably, California-based IndyMac experienced a run earlier this summer and the federal government was forced to take it over. In all, nine banks have failed. Many analysts are expecting more to fall. The government reported last week that "late loan payments and defaults by commercial and residential developers have soared to the highest levels since the early 1990s, threatening the health of some small banks."

Structured finance: Wall Street's top banks have been struggling with a variety of exotic securities. In some cases, regulators have forced them to allow investors to return a type of security, known as an auction-rate security, that they had believed to be safe. There has been concern on Wall Street about famed investment house Lehman Brothers. Merrill Lynch has been selling collateralized debt obligations, fancy securities based on layers of mortgages and other debt, for 22 cents on the dollar to rid itself of the plagued investments. Federal agents arrested and are building a case against former employees of hedge funds associated with felled investment bank Bear Stearns. The collapse of those hedge funds helped spark the credit crunch.

Fannie Mae and Freddie Mac: The government-charted mortgage finance companies, which had bought pools of subprime mortgage securities to fulfill their mandate of expanding national homeownership, have suffered blistering losses, with some analysts predicting that the government will be forced to bail them out. Congress has given the Treasury the authority to do whatever it needs to save Fannie and Freddie, including buying billions of dollars of their shares or nationalizing them. Treasury Secretary Hank Paulson hopes to take such measures only in the most severe scenario.

Alan Greenspan: The former Fed chair has been working hard to defend his legacy, trying to counter claims that a period of low rates and lax regulation led to excess lending. He has written commentaries, most recently in the Financial Times, in which he describes the underpinnings of the financial crisis and concludes that the crisis must have been "unanticipated." He also has given a front-page interview to the Wall Street Journal and is updating his popular book, An Age of Turbulence, to reflect the crisis.

Ben Bernanke and the Fed: After seven substantial rate cuts over eight months to ease tight credit market and spur lending, the Fed has a new boogeyman on its mind: inflation. With energy and food costs skyrocketing, the Fed has been contemplating raising rates to slow rising prices, though it has so far resisted doing so because of the fragile state of the overall economy. Meanwhile, Bernanke has been pushing for broader powers to oversee the inner-workings of the financial system.

Housing market and mortgage loans: Many analysts believe that the worst problems with subprime loans--made to people with inferior credit history--may have now passed. But they are concerned about growing defaults and delinquencies with better quality loans, primarily a type called Alt-A. Alt-A loans were made to people with better credit histories, but did not require proof of income or employment. Overall, housing prices have continued to fall, and most analysts believe they must fall more before a recovery in the housing market. A bright spot, however, is that sales of new homes are stabilizing.

The Treasury: The point man at the Treasury for the financial crisis, under secretary for domestic finance Robert Steel, has abandoned ship to lead Wachovia, a big national bank ailing from subprime losses.

Global markets: Through much of the summer, the global impact of the credit crunch continued to grow. The International Monetary Fund said recently that banks have already written down nearly $500 billion of bad loans and are likely to suffer more -- perhaps $1 trillion.

— Zachary Goldfarb

By The Editors |  September 3, 2008; 8:10 AM ET Post Investigations
Previous: Sen. Grassley Seeks Records from Michelle Obama's Employer | Next: The Daily Read

Comments

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Is it time to reconsider - or reconfigure - Fannie Mae and Freddie Mac and "their mandate of expanding national homeownership"?

Or did they not HAVE TO buy subprime mortgage securities to fulfill that mandate?

These are only two of the "stabilizers" the government put in place for the benefit of the economy, specifically, and the citizenry at large. Add in all the others in your list - Greenspan, Bernancke, the Treasury, etc. - and it could be argued that government not only didn't prevent the bubble and its bursting, but caused it.

Lin Ennis, author of Let Your Mortgage Make You Rich!

Posted by: Lin Ennis | September 3, 2008 11:46 AM

Prices are going to continue to correct downward to re-align with fundamentals.

Enable a borrower with a 3% interest only loan, with a $1800 a month to spend and he/she has the ability to service a $720,000 mortgage. Add a healthy dose of hype where prevailing belief becomes housing is a can't miss way to get rich and you get people using all the purchasing power a lender will give them to bid up home prices to levels that cannot be sustained once the excessive purchasing power is removed.

Now, in 2008 this same borrower still has the same $1800 to spend, but now it's 6.5% fully amortized. This payment of $1800 can only services a $284,000 mortgage. The difference between the 720k and the 284k is the bubble.

Historically, home prices have been 4 times income levels at the most. When you do the math realizing the maximum lenders will allow a borrower to borrow is 28% of income, this pencils out.

Bubble home prices got to 10 times income levels in some areas. When you go from 10 to 1 back to 4 to 1, that's 60% correction.

To learn the historical income to home price ratios for your zip-code and what happens to prices when price re-align check out Home Price Ceiling tool at www.UsHousingMeltdown.org

Posted by: RealEstateEconomist | September 3, 2008 12:47 PM

Some of the worst enablers of this nasty bubble need to be identified so we can be put on notice and invite them to share our pain. The Freddie Mac board of directors, who knew, or should have known, that Freddie Mac's senior executive were cooking the books to qualify for incredibly generous and totally unearned bonuses should be first up in the lineup. Freddie Mac falsely claimed it was busy keeping "America's Dream" alive by promoting home ownership to more and more people. The "dream" has turned into a nightmare because the senior executives pursued their own dreams of megadollars instead of looking into large numbers of "creative financing" mortgages that should never have been executed. As an absolute minimum, I recommend that the board members, at their own personal expense, take out at least a quarter-page ad in the WSJ and apologize for their costly negligence AND pledge that they will open up Freddie Mac's books so all Americans can see how much money senior executives make and how much is spent on their travel, meetings, etc. Absent an effort of this nature, I recommend they resign and make way for people who actually care about homeownerss. What a wonderful dream that would be.

Posted by: Mel Lott | September 3, 2008 1:24 PM

Mel, you seem quite misinformed about FM. I suggest you do more research into the accounting issues, as well as the amount of 'creative' loans you think FM sponsored and why.

Posted by: Anonymous | September 3, 2008 1:39 PM

RealEstateEconomist - where was this site in 2005 or 2006? According to the numbers on that site, anyone that bought since 2000 is probably going to be underwater for at least another 10 years. What are you suggesting be done GOING FORWARD?

Posted by: JS | September 3, 2008 1:57 PM

Housing prices rose without any supporing increase in borrower income or rental income. It was all driven by cheap, easy financing and speculative apetites. The choice now is whether to let real estate prices fall, or to bail out the buyers and investors by inflation and subsidies. Negative real interest rates will shift wealth from savers to debtors. The big investment houses and funds believe in "free markets," yes, but only on the up-side. Heads they win, tails the public loses.

Exactly who is buying all the distressed portfolios from Wachovia, Lehman, and Cit? Who is extending them the credit? Who takes the hit if the properties depreciate further?

Posted by: jkoch | September 3, 2008 2:18 PM

Both the EU and the USA put-off requirements that brought concealed financial instruments onto corporate books.

In addition, the FBI has only 500 officers for financial crime investigations.

These acts bring well-considered fear to financial managers.

Posted by: Thomas C. Inskip | September 3, 2008 3:06 PM

If there is a shred of Democracy and Laws in this Country,Bank/Mortgage officers,Real Estate agents and Home owners who took loans for Exotic Holidays & to buy Hammers,should go to Jail for LIFE. I am in the market to buy a house since 2005 and i can't find one in a Decent price,eventhough i am full documented i could had signed one of those Exotic loans,but i didn't.

Posted by: Dick | September 3, 2008 3:25 PM

JS,

Most that bought in 2000 should be okay provided they did not pull a bunch of cash out and use their home as an ATM. It's 2005 and 2006 where prices in most areas peaked and in bubble areas doubled from 2000.

Keep in mind, it takes a 4% rise in incomes to enable home price to rise 1%, all other things being equal. (when you do the math on this using the current lender criteria of 28% of income permitted to make mortgage payments.)

Up until the recession started, incomes on a national basis have been rising at about 3% per year. Now that the recession is on, incomes have stagnated and may even decline.

As to what someone can do, first assess how much risk you have to additional price declines. There is a Home Price Ceiling and Floor tool that provides insights on the top and bottom of home prices for specific properties on the site at www.UsHousingMeltdown.org/home-value.asp

The tighter the spread between the Ceiling and the Floor the more stable prices will be and the less risk there is to more price declines.

The wider the spread between Ceiling and Floor the less stable price will be and the more risk there is to further price declines.

If you are in this category keep your eye on land prices and price scenarios of new supply coming to market. Land values are the most volatile component of housing costs. If new supply is coming to market at prices lower than comparable existing supply that is negative for prices of existing inventory.

Posted by: RealEstateEconomist | September 3, 2008 5:09 PM

I need to correct an item in the post immediately above. To asses the risk to further price declines, compare the current market price to the Floor price. Market prices tend to bounce up and down between the Ceiling and the Floor. The tighter the spread between Ceiling and Floor the less risk to further price declines. The wider the spread, the more likely prices will continue to fall.

Posted by: RealEstateEconomist | September 3, 2008 5:19 PM

Check out this website, very interesting facts.

Http://housingcrisisexposed.blogspot.com

Posted by: HCE | September 10, 2008 4:20 PM

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