Research Paper on "U.S. Housing Market Boom to Bust"

Research Paper 15 pages (5097 words) Sources: 6

[EXCERPT] . . . .

U.S. Housing Market Boom to Bust

Housing Market - Boom to Bust

House Prices Rose at Unprecedented Levels.

US housing prices have risen at an unprecedented level for nearly a decade, ending boldly in 2007. According to Leonard housing appreciation climbed from the 1983-2006 average of 7.4% to the staggering 12.7% appreciation which was nationally common just prior to the current decline. Leonard also stresses that individuals took full advantage of these boom housing appreciation percentages for the first time as home equity loan products came on to the markets in record numbers, something that was unheard of until after 1981. The illiquidity of real property prior to 1981 kept consumers relatively safe from declines, and their equity safe from overspending as they took full advantage of home equity loan products and are not only likely to be paying off a loan that exceeds the current value of their mortgage but could also be paying off a loan (sometimes called a second mortgage) that exceeds yet more the value as housing appreciation rates decline, come to a standstill and since 2007 actually begin to decline for the first time since the early 1990s and in a more substantial manner. (Leonard, 2010, p. 87) Though there were some who were early in their assessment of the potential for a rapid decline, who called the housing appreciation figures unsustainable, referring to the record level appreciation of 8% in 2005, the highest recorded growth since 1975 as a bubble, consumers and banks sought ways to maintain this artificial curve by changing the manner in which they lend and borrow. The institutions and individuals who had interest in receiving revenue from increased assessment values of homes simply changed the borrowing and lending strategies to respond to any potential downturn in housing prices and it was this action that created the instability. (Weller, 2006) Had consumers of home equity loans as well as new mortgages that were reflective of higher assessment values, simply been forced by the national lending strategies to happily sit on their appreciated value homes, in a state of illiquidity, as they have in the past the economy and those individuals would be riding a much smaller wave down as housing prices decline during a normal trend in the economy. (Schiller, 2006) Sadly they did not as they were fundamentally preyed upon by unscrupulous lenders seeking to keep new mortgage and equity loan sales high and are now sitting on mortgages that in some cases far exceed the value of their homes, (Reich, 2006) some of these individuals in the wake of the economic downturn are also experiencing an inability to pay these mortgages as real job loss and other economic factors drive the percentages down. Reich stresses that most banks on a regional level are healthy as a response to their ability to cost contain during this emerging crisis (speaking from a 2006 window) but that at least 4 factors contributed to the home boom; "a growing economy, interest rates that have remained near 40-year lows and general home price appreciation that has risen to extraordinary levels in some markets. And some would add a fourth factor, innovative mortgage loan products." (Reich, 2006, p.4) Reich speaking from the perspective of a banking professional, one who nonetheless has interest in responsible lending through is affiliations with the Office of Thrift Supervision is kind to banks and bankers and many are now referring to the last factor "innovative mortgage loan products," (Reich, 2006, p. 4) as predatory lending practices. The unprecedented growth of U.S. house prices can also be viewed from the perspective of rents, as a foundational litmus to the overall health of the growth. The ratio of house prices to rents has grown at an unprecedented rate of 78%, despite the fact that these statistics normally rise together at a nominal rate making renting only slightly less expensive than buying and keeping it possible for profits on rent to be at least marginally in the positive. (Killelea, 2010)

Aggressive sale of Sub-Prime Mortgages.

Usually when house prices rise, demand moderates, as fewer people have the ability to afford the mortgage payments on properties with excessive value, and historically banks have lent responsibly to support the ideal of not getting homeowners in over their heads. However in the case of the U.S. housing market, mortgage lenders were desperate to maintain sales. Therefore they just found new ways to sell the more expensive houses. Though we have hinted at this previously in the work this section of the work will provide greater detail about these so called "innovative mortgage loan products," (Reich, 2006, p. 4). These products are more broadly known as subprime lending practices, yet have more recently been titled predatory lending practices, as consumers feel more and more appalled by the ferocity with which banks and brokers pushed them into through marketing and even substitution borrowing at higher rates than was acceptable just ten years ago, under the false home that the economy would continue to rise and that somewhere between now and then (some mythical place in the future) consumers would be able to afford new mortgage rates and unusually high mortgage rates, based on reduced percentage demands for down payments and unusually high housing assessment values. First let us very briefly look at how a prime or traditional mortgage works. At the onset individuals apply based on their income (not on income potential) and their existing credit, and the amount they have saved for a down payment and they are "prequalified" for a loan amount that fits into their budget and then they can look for a home in that price range, determined by their personal financial health and potentially receive a mortgage on it. The down payment on a traditional (prime) mortgage is between 10 and 15%, with a few creative exceptions for special loans such as to first home buyers or veterans. Without exception this has been the standard practice in mortgage lending for more than a century as banks had no real interest in lending to people who would default and cause the banks to carry the debt. If an individual had marginal or bad credit based on previous credit history, a low income or no or limited down payment savings they simply were not eligible for a mortgage and had to get their personal finances in check or not buy a home. Yet, creative bankers and mortgage brokers began to apply different standards as home prices climbed to unprecedented levels, i.e. where they were financially out of reach to new home buyers. A particularly troubling trend was to transplant a system of subprime lending which had previously only been applied to wealthy investors who saw an opportunity to buy but were in the short-term low on capital, capital they would likely realize very soon and refinance or pay off the loan. This tactic known as the optional adjustable rate mortgage, where a low initial payment was required for a short period and then the mortgage payment was adjusted up over time. This form of subprime lending was never designed for the masses, as the risk was meant to be acquired only by individuals or entities that held value in other properties and assets that were only temporarily illiquid and would allow the loan holder the opportunity to resolve the issue or pay the higher mortgage based on the realization of these assets at a later date. (Der Hovanesian, 2006) This aspect of lending the ARM mortgage loan was then mass marketed as an alternative for individuals who could not realistically meet the financial demands of it, as well as with some other great additions, i.e. balloon payments (large payments due at a later date to offset the low initial payments) as well as very low down payment percentages, such as 0-3%.

The term Subprime mortgage is a compact and nice way of saying that the mortgage product is not prime, or the best there is to offer, in most cases this means that the consumer is not fundamentally capable of realizing the debt without serious potential risk and the mortgage lender takes on significant risk in allowing it, yet these subprime lending practices became foundational when housing prices climbed to such a high rate that people simply had no real ability to prequalify for home purchases that would meet their families need under the traditional mortgage standards, described above. Though many lending institutions and banking professionals would like to call back to the old standard, buyer beware excuses, buyers do not purchase homes every day where lenders lend on homes everyday and there is a clear sense that the marketing of subprime loan packages was so substantial it was a difficult time for an individual to see past the next year or so and therefore many call foul and reiterate that these lending practices are and always were predatory, a bold attempt by lenders to balk a traditional trend decline in demand which is naturally… READ MORE

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