United_States_housing_bubble

United States housing bubble

The United States housing bubble is an economic bubble in many parts of the United States housing market including areas of California, Florida, New York, Michigan, the Northeast Corridor, and the Southwest markets. On a national level, housing prices peaked in early 2005, began declining in 2006 and may not yet have hit bottom. Increased foreclosure rates in 2006–2007 by U.S. homeowners led to a crisis in August 2007 for the subprime, Alt-A, Collateralized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007 the U.S. Treasury Secretary called the bursting housing bubble "the most significant risk to our economy."

Housing bubbles may occur in local or global real estate markets. They are typically characterized, in their late stages, by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This may be followed by decreases in home prices that can result in many owners holding negative equity—a mortgage debt higher than the value of the property. The underlying causes of the housing bubble are complex; factors include historically-low interest rates, lax lending standards, and a speculative fever. This bubble may be related to the stock market or dot-com bubble of the 1990s. This bubble is roughly coincident with real estate bubbles in the United Kingdom, Spain and even South Korea.

Bubbles may be definitively identified only in hindsight, after a market correction, which began for the U.S. housing market in 2005–2006. Former U.S. Federal Reserve Board Chairman Alan Greenspan said "we had a bubble in housing" and also said in the wake of the subprime mortgage and credit crisis in 2007, "I really didn't get it until very late in 2005 and 2006." The mortgage and credit crisis was caused by a large number of home owners unable to pay the mortgage as their low introductory rate (sub-prime) mortgages reverted to regular interest rates. Freddie Mac CEO Richard Syron concluded, "We had a bubble", and concurred with Yale economist Robert Shiller's warning that home prices appear overvalued and that the correction could last years with trillions of dollars of home value being lost. Greenspan warned of "large double digit declines" in home values "larger than most people expect." Problems for home owners with good credit surfaced in mid-2007, causing the U.S.'s largest mortgage lender Countrywide Financial to warn that a recovery in the housing sector is not expected to occur at least until 2009 because home prices are falling "almost like never before, with the exception of the Great Depression." The impact of booming home valuations on the U.S. economy since the 2001–2002 recession was an important factor in the recovery because a large component of consumer spending came from the related refinancing boom, which simultaneously allowed people to reduce their monthly mortgage payments with lower interest rates and withdraw equity from their homes as values increased. Any collapse of the U.S. Housing Bubble has a direct impact not only on home valuations, but the nation's mortgage markets, home builders, real estate, home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks, increasing the risk of a nationwide recession. Concerns about the impact of the collapsing housing and credit markets on the larger U.S. economy caused President George W. Bush and Chairman of the Federal Reserve Ben Bernanke to announce a limited bailout of the U.S. housing market for homeowners unable to pay their mortgage debts.

In 2008 alone, the United States government allocated over $900 billion to special loans and rescues related to the US housing bubble, with over half of those going to the quasi-government agencies of Fannie Mae, Freddie Mac, and the Federal Housing Administration.

Timeline

Identifying the housing bubble

Although some claim that an economic bubble is difficult to identify except in hindsight, many economic and cultural factors have led several economists to argue that a housing bubble exists in the U.S. However, recently claims of lack in warning of the crisis were repudiated in The New York Times which recently reported that Richard F. Syron, the CEO of Freddie Mac, received a memo from David Andrukonis, the company's former chief risk officer in 2003, warning him, that Freddie Mac was financing risk-laden loans which threatened Freddie Mac's financial stability. In his memo, Mr. Andrukonis wrote that these loans "would likely pose an enormous financial and reputational risk to the company and the country. The article revealed that more than two-dozen high-ranking executives said that Mr. Syron simply decided to ignore those warnings. Other warnings came as early as 2001 when the recently deceased Federal Reserve governor Edward Gramlich warned about the risks of subprime mortgages. Reuters reported in October 2007 that a Merrill Lynch analyst issued similar warnings in 2006 that companies could suffer from their subprime investments.

The Economist magazine said that "the worldwide rise in house prices is the biggest bubble in history, so any explanation must consider global causes as well as those specific to the United States. Then Federal Reserve Board Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) ... it's hard not to see that there are a lot of local bubbles"; Greenspan admitted in 2007 that froth "was a euphemism for a bubble." President Bush said of the U.S. housing boom in early 2006: "If houses get too expensive, people will stop buying them... Economies should cycle.

Based on markedly declining 2006 market data, including lower sales, rising inventories, falling median prices, and increased foreclosure rates, some economists have concluded that the correction in the U.S. housing market began in 2006. A May 2006 Fortune magazine report on the US housing bubble states: "The great housing bubble has finally started to deflate ... In many once-sizzling markets around the country, accounts of dropping list prices have replaced tales of waiting lists for unbuilt condos and bidding wars over humdrum three-bedroom colonials." The chief economist of Freddie Mac and the director of Harvard University's Joint Center for Housing Studies (JCHS) deny the existence of a national housing bubble and express doubt that any significant decline in home prices are possible, citing consistently rising prices since the Great Depression, expected increasing demand by the Baby Boom generation, and healthy employment. However, some have suggested that the funding that the JCHS receives from the real estate industry may have affected their judgment. David Lereah, former chief economist of the National Association of Realtors (NAR), distributed "Anti-Bubble Reports" in August 2005 to "respond to the irresponsible bubble accusations made by your local media and local academics. Among other statements, the reports say that people "should [not] be concerned that home prices are rising faster than family income", that "there is virtually no risk of a national housing price bubble based on the fundamental demand for housing and predictable economic factors", and that "a general slowing in the rate of price growth can be expected, but in many areas inventory shortages will persist and home prices are likely to continue to rise above historic norms. Following reports of rapid sales declines and price depreciation in August 2006, Lereah admitted that "he expects home prices to come down 5% nationally, more in some markets, less in others. And a few cities in Florida and California, where home prices soared to nose-bleed heights, could have 'hard landings'."

National home sales and prices both fell dramatically in March 2007 — the steepest plunge since the Savings and Loan crisis in 1989 — according to NAR data, with sales down 13% to 482,000 from the peak of 554,000 in March 2006 and the national median price falling nearly 6% to $217,000 from the peak of $230,200 in July 2006.

John A. Kilpatrick, of Greenfield Advisors, was cited by Bloomberg News on June 14, 2007, on the linkage between increased foreclosures and localized housing price declines. "Living in an area with multiple foreclosures can result in a 10 percent to 20 percent decrease in property values." He went on to say, "In some cases that can wipe out the equity of homeowners or leave them owing more on their mortgage than the house is worth. The innocent houses that just happen to be sitting next to those properties are going to take a hit.

The US Senate Banking Committee held hearings on the housing bubble and related loan practices in 2006, titled "The Housing Bubble and its Implications for the Economy" and "Calculated Risk: Assessing Non-Traditional Mortgage Products". Following the collapse of the subprime mortgage industry in March 2007, Senator Chris Dodd, Chairman of the Banking Committee held hearings and asked executives from the top five subprime mortgage companies to testify and explain their lending practices. Dodd said that "predatory lending practices" endangered the home ownership for millions of people. Moreover, Democratic senators such as Senator Charles Schumer of New York are already proposing a federal government bailout of subprime borrowers in order to save homeowners from losing their residences.

Causes

National bubble or local bubbles?

Home price appreciation has been non-uniform to such an extent that some economists, including former Fed Chairman Alan Greenspan, have argued that United States did not have a nationwide housing bubble per se, but rather a number of local bubbles. However, in 2007 Greenspan admitted that there was a bubble in the US housing market, and that "all the froth bubbles add up to an aggregate bubble." Despite greatly relaxed lending standards and low interest rates, many regions of the country have seen very little growth during the "bubble period". Out of 20 largest metropolitan areas tracked by S&P/Case-Shiller house price index, six (Dallas, Cleveland, Detroit, Denver, Atlanta, and Charlotte) have seen less than 10% price growth in inflation-adjusted terms in 2001–2006. Seven metropolitan areas (Tampa, Miami, San Diego, Los Angeles, Las Vegas, Phoenix, and Washington DC) have appreciated more than 80% in the same period of time.

Furthermore, housing bubble did not manifest itself in each one of these seven areas at the same time. San Diego and Los Angeles maintained consistently high appreciation rates since late 1990s. Las Vegas and Phoenix didn't develop a bubble until 2003 and 2004, respectively.

Somewhat paradoxically, as the housing bubble deflates, some metropolitan areas (such as Denver and Atlanta) are experiencing high foreclosure rates, even though they didn't record much house appreciation in the first place, and, therefore, did not appear to be part of the national bubble. This was also true of some cities in the Rust Belt such as Detroit and Cleveland where weak local economies caused little appreciation early in the decade, but had declining values and increased foreclosures in 2007. The CRA - Community Reinvestment Act is suspected to have caused or contributed to these defaults, according to libertarian Thomas DiLorenzo . California, Michigan, Ohio and Florida are currently states with the highest foreclosure rates.

By July 2008 year to date prices declined in 24 of 25 U.S. metropolitan areas. California and the southwestern witnessed the largest price drops. According to the reports only Milwaukee had an increase in house prices since July 2007.

Side effects

Unprecedented runup in house prices between 1997 and 2005 had a number of wide ranging effects on the economy of the United States.

  • One of the most direct effects was on construction of new houses. In 2005, 1,283,000 new single-family houses were sold, compared with an average of 609,000 per year during 1990–1995. Largest home builders, such as D. R. Horton, Pulte, and Lennar, saw their largest share prices and revenues in 2004–2005. D. R. Horton's stock went from $3 in early 1997 to all-time high of $42.82 on July 20, 2005. Pulte Corp's revenues grew from $2.33 billion in 1996 to $14.69 billion in 2005.
  • Mortgage equity withdrawals - primarily home equity loans and cash-out refinancings - grew considerably since early 1990s. According to estimates by US Federal Reserve, in 2005, homeowners extracted $750 billion from equity of their homes (up from $106 billion in 1996), spending two thirds of it on personal consumption, home improvements, and credit card debt.
  • It is widely believed that increased economic activity caused by expanding housing bubble in 2001–2003 was partly responsible for prevention of full-scale recession in U.S. economy following the dot-com burst.
  • Rapidly growing house prices and increasing price gradients forced many residents to flee expensive centers of many metropolitan areas, resulting in explosive growth of exurbs in some regions. Population of Riverside County, California almost doubled from 1,170,413 in 1990 to 2,026,803 in 2006, due to its relative proximity to San Diego and Los Angeles. On the East Coast, Loudoun County, Virginia, near Washington, DC, saw its population triple between 1990 and 2006.

Real estate market correction of 2006–2007 resulted in reversal of these trends. As of August 2007, D.R.Horton's and Pulte Corp's shares were down to 1/3 of their respective peaks, as new residential home sales fall. Some cities and regions that experienced fastest growth during 2000–2005 began to show high foreclosure rates. Weakness in housing industry and loss of mortgage equity withdrawal driven consumption could lead to a recession, but as of mid-2007 this recession was not ascertained. In March 2008, Thomson Financial reported that the "Chicago Federal Reserve Bank's National Activity Index for February sent a signal that a recession [had] probably begun...

Share prices of Fannie Mae and Freddie Mac plummets in 2008 as investors worry that they do not have sufficient capital to cover losses on their $5 trillion portfolio of loans and guarantees on loans.

Housing market correction

NAR chief economist David Lereah's Explanation of "What Happened" from the 2006 NAR Leadership Conference

  • Boom ended August 2005
  • Mortgage rates rose almost one point
  • Affordability conditions deteriorated
  • Speculative investors pulled out
  • Homebuyer confidence plunged
  • Resort buyers went to sidelines
  • Trade-up buyers to sidelines
  • First-time buyers priced out of market

Based on the historic trends in valuations of U.S. housing, many economists and business writers have predicted a market correction, ranging from a few percentage points, to 50% or more from peak values in some markets, and, in spite of the fact that this cooling has not affected all areas of the U.S., some have warned that it could and that the correction would be "nasty" and "severe". Chief economist Mark Zandi of the economic research firm Moody's Economy.com predicted a "crash" of double-digit depreciation in some U.S. cities by 2007–2009. In a paper presented at a Federal Reserve Board economic symposium in August 2007, Yale University economist Robert Shiller warned, “the examples we have of past cycles indicate that major declines in real home prices—even 50 percent declines in some places—are entirely possible going forward from today or from the not too distant future.”

Bubble bursts

The booming housing market appears to have halted abruptly for many parts of the U.S. in late summer of 2005, and as of summer 2006, several markets are facing the issues of ballooning inventories, falling prices, and sharply reduced sales volumes. In August 2006, Barron's magazine warned, "a housing crisis approaches", and noted that the median price of new homes has dropped almost 3% since January 2006, that new-home inventories hit a record in April and remain near all-time highs, that existing-home inventories are 39% higher than they were just one year ago, and that sales are down more than 10%, and predicts that "the national median price of housing will probably fall by close to 30% in the next three years ... simple reversion to the mean." Fortune magazine labelled many previously strong housing markets as "Dead Zones;" other areas are classified as "Danger Zones" and "Safe Havens". Fortune also dispelled "four myths about the future of home prices." In Boston, year-over-year prices are dropping, sales are falling, inventory is increasing, foreclosures are up, and the correction in Massachusetts has been called a "hard landing". The previously booming housing markets in Washington, D.C., San Diego, Phoenix, and other cities have stalled as well. Searching the Arizona Regional Multiple Listing Service (ARMLS) shows that in summer 2006, the for-sale housing inventory in Phoenix has grown to over 50,000 homes, of which nearly half are vacant (see graphic). Several home builders have revised their forecasts sharply downward during summer 2006, e.g., D.R. Horton cut its yearly earnings forecast by one-third in July 2006, the value of luxury home builder Toll Brothers' stock fell 50% between August 2005 and August 2006, and the Dow Jones U.S. Home Construction Index was down over 40% as of mid-August 2006. CEO Robert Toll of Toll Brothers explained, "builders that built speculative homes are trying to move them by offering large incentives and discounts; and some anxious buyers are canceling contracts for homes already being built. Homebuilder Kara Homes, known for their construction of "McMansions", announced on September 13, 2006 the "two most profitable quarters in the history of our company", yet filed for bankruptcy protection less than one month later on 6 October. Six months later on April 10, 2007, Kara Homes sold unfinished developments, causing prospective buyers from the previous year to lose deposits, some of whom put down more than $100,000.

As the housing market began to soften in winter 2005 through summer 2006, NAR chief economist David Lereah predicted a "soft landing" for the market. However, based on unprecedented rises in inventory and a sharply slowing market throughout 2006, Leslie Appleton-Young, the chief economist of the California Association of Realtors, said that she is not comfortable with the mild term "soft landing" to describe what is actually happening in California's real estate market. The Financial Times warned of the impact on the U.S. economy of the "hard edge" in the "soft landing" scenario, saying "A slowdown in these red-hot markets is inevitable. It may be gentle, but it is impossible to rule out a collapse of sentiment and of prices... If housing wealth stops rising... the effect on the world's economy could be depressing indeed. "It would be difficult to characterize the position of home builders as other than in a hard landing", said Robert Toll, CEO of Toll Brothers. Angelo Mozilo, CEO of Countrywide Financial, said "I've never seen a soft-landing in 53 years, so we have a ways to go before this levels out. I have to prepare the company for the worst that can happen. Following these reports, Lereah admitted that "he expects home prices to come down 5% nationally", and said that some cities in Florida and California could have "hard landings." National home sales and prices both fell dramatically again in March 2007 according to NAR data, with sales down 13% to 482,000 from the peak of 554,000 in March 2006 and the national median price falling nearly 6% to $217,000 from the peak of $230,200 in July 2006 . The plunge in existing-home sales is the steepest since 1989. The new home market is also suffering. The biggest year over year drop in median home prices since 1970 occurred in April 2007. Median prices for new homes fell 10.9 percent according to the Commerce Department.

Based on slumping sales and prices in August 2006, economist Nouriel Roubini warned that the housing sector is in "free fall" and will derail the rest of the economy, causing a recession in 2007. Joseph Stiglitz, winner of the Nobel Prize in economics in 2001, agreed, saying that the U.S. may enter a recession as house prices decline. The extent to which the economic slowdown, or possible recession, will last depends in large part on the resiliency of the U.S. consumer spending, which now makes up approximately 70% of the US$13.7 trillion economy. The evaporation of the wealth effect amid the current housing downturn could negatively affect the consumer confidence and provide further headwind for the U.S. economy and that of the rest of the world. The World Bank recently lowered the global economic growth rate due to a housing slowdown in the United States, but it does not believe that the U.S. housing malaise will further spread to the rest of the world. The Fed chairman Benjamin Bernanke said in October 2006 that there is currently a "substantial correction" going on in the housing market and that the decline of residential housing construction is one of the "major drags that is causing the economy to slow"; he predicted that the correcting market will decrease U.S. economic growth by about one percent in the second half of 2006 and remain a drag on expansion into 2007. The White House Council of Economic Advisers recently lowered their outlook for U.S. economic growth in 2008 from 3.1 percent to 2.7 percent and forecast higher unemployment, reflecting turmoil in the credit markets and residential real-estate market. The Bush Administration economic advisers also revised their unemployment outlook and predict the unemployment rate could rise slightly above 5 percent, up from the current unemployment rate of 4.6 percent.

Others speculate on the negative impact of the retirement of the Baby Boom generation and the relative cost to rent on the declining housing market. In many parts of the United States, it is significantly cheaper to rent the same property than to purchase it; the national median mortgage payment is $1,687 per month, nearly twice the median rent payment of $868 per month. However, the appreciation of home prices in many parts of the country has lured many renters to become homeowners. Yet the appreciation of home values far exceeded the income growth of many of these homebuyers, pushing them to leverage themselves beyond their means. They borrowed even more money in order to purchase homes that were far more expensive than their ability to meet their mortgage obligations. Many of these homebuyers took out adjustable-rate mortgages during the period of low interest rates to purchase homes of their dreams. Initially, they were able to meet their mortgage obligations due to their low "teaser" rates in the first few years. However, as the Federal Reserve Bank exercised monetary contraction policy in 2005, many homeowners were stunned when their adjustable-rate mortgages began to reset to much higher rates in mid-2007 and their monthly payments jumped far above their ability to meet the monthly mortgage payments. Some homeowners began to default on their mortgages in mid-2007 and the cracks in the U.S. housing foundation began to appear.

Subprime mortgage industry collapse

In March 2007, the United States' subprime mortgage industry collapsed due to higher-than-expected home foreclosure rates, with more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale. The stock of the country's largest subprime lender, New Century Financial, plunged 84% amid Justice Department investigations, before ultimately filing for Chapter 11 bankruptcy on April 2, 2007 with liabilities exceeding $100 million. The manager of the world's largest bond fund PIMCO, warned in June 2007 that the subprime mortgage crisis was not an isolated event and will eventually take a toll on the economy and whose ultimate impact will be on the impaired prices of homes. Bill Gross, a "most reputable financial guru", sarcastically and ominously criticized the credit ratings of the mortgage-based CDOs now facing collapse:

AAA? You were wooed Mr. Moody's and Mr. Poor's, by the makeup, those six-inch hooker heels, and a "tramp stamp." Many of these good looking girls are not high-class assets worth 100 cents on the dollar... [T]he point is that there are hundreds of billions of dollars of this toxic waste... This problem [ultimately] resides in America's heartland, with millions and millions of overpriced homes".

Business week has indicated financial analysts predicting that the subprime mortgage market meltdown would result in earnings reductions for large Wall Street investment banks trading in mortgage-backed securities, especially Bear Stearns, Lehman Brothers, Goldman Sachs, Merrill Lynch, and Morgan Stanley. The solvency of two troubled hedge funds managed by Bear Stearns was imperiled in June 2007 after Merrill Lynch sold off assets seized from the funds and three other banks closed out their positions with them. The Bear Stearns funds once had over $20 billion of assets, but lost billions of dollars on securities backed by subprime mortgages. H&R Block reported that it made a quarterly loss of $677 million on discontinued operations, which included subprime lender Option One, as well as writedowns, loss provisions on mortgage loans and the lower prices available for mortgages in the secondary market for mortgages. The unit's net asset value fell 21% to $1.1 billion as of April 30, 2007. The head of the mortgage industry consulting firm Wakefield Co. warned, "This is going to be a meltdown of unparalleled proportions. Billions will be lost." Bear Stearns pledged up to US$3.2 billion in loans on June 22, 2007 to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages. Peter Schiff, president of Euro Pacific Capital, argued that if the bonds in the Bear Stearns funds were auctioned on the open market, much weaker values would be plainly revealed. Schiff added, "This would force other hedge funds to similarly mark down the value of their holdings. Is it any wonder that Wall street is pulling out the stops to avoid such a catastrophe?... Their true weakness will finally reveal the abyss into which the housing market is about to plummet. The New York Times report connects this hedge fund crisis with lax lending standards: "The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them struggling to stay in their homes."

On August 9, 2007, BNP Paribas announced that it could not fairly value the underlying assets in three funds as a result of exposure to U.S. subprime mortgage lending markets. Faced with potentially massive (though unquantifiable) exposure, the European Central Bank (ECB) immediately stepped in to ease market worries by opening lines of €96.8 billion (US$130 billion) in low-interest credit. One day after the financial panic about a credit crunch swept through Europe, U.S. Federal Reserve Bank conducted an "open market operation" to inject US$38 billion in temporary reserves into the system to help overcome the ill effects of a spreading credit crunch, on top of a similar move the day before. In order to further ease the credit crunch in the U.S. credit market, the chairman of the Federal Reserve Bank Ben Bernanke decided to lower the discount window rate, which is the lending rate between banks and the Federal Reserve Bank, by 50 basis points to 5.75% from 6.25% at 8:15 a.m. on August 17, 2007. The Federal Reserve Bank stated that the recent turmoil in the U.S. financial markets raised the risk of an economic downturn.

In the wake of the mortgage industry meltdown, Senator Chris Dodd, Chairman of the Banking Committee held hearings in March 2007 and asked executives from the top five subprime mortgage companies to testify and explain their lending practices; Dodd said, "predatory lending practices" endangered the home ownership for millions of people. Moreover, Democratic senators such as Senator Charles Schumer of New York are already proposing a federal government bailout of subprime borrowers, like the one use in the Savings and Loan crisis, in order to save homeowners from losing their residences. Opponents of such proposal assert that government bailout of subprime borrowers is not in the best interests of the U.S. economy because it will simply set a bad precedent, create a moral hazard, and worsen the speculation problem in the housing market.

Lou Ranieri of Salomon Brothers, inventor of the mortgage-backed securities market in the 1970s, warned of the future impact of mortgage defaults: "This is the leading edge of the storm. … If you think this is bad, imagine what it's going to be like in the middle of the crisis." In his opinion, more than $100 billion of home loans are likely to default when the problems in the subprime industry appear in the prime mortgage markets. Former Federal Reserve Chairman Alan Greenspan praised the rise of the subprime mortgage industry and the tools which it uses to assess credit-worthiness in an April 2005 speech. Because of these remarks, along with his encouragement for the use of adjustable-rate mortgages, Greenspan has been criticized for his role in the rise of the housing bubble and the subsequent problems in the mortgage industry. Greenspan later admitted about the subprime mortgage mess that, "I really didn't get it until very late in 2005 and 2006."

On September 13, 2007, the British bank Northern Rock applied to the Bank of England for emergency funds caused by liquidity problems related to the subprime crisis. This precipitated a bank run at Northern Rock branches across the UK by concerned customers who took out "an estimated £2bn withdrawn in just three days".

Alt-A mortgage problems

Subprime and Alt-A loans (including "stated income loans", which are loans made to home buyers without the verification of their incomes; as home buyers tend to overstate their incomes in order to get the loan amounts they desire to purchase their dream homes, the term "liar's loans" is often used to describe them) account for about 21 percent of loans outstanding and 39 percent of mortgages made in 2006. In April 2007, financial problems similar to the subprime mortgages began to appear with Alt-A loans made to homeowners who were thought to be less risky. American Home Mortgage said that it would earn less and pay out a smaller dividend to its shareholders because it was being asked to buy back and write down the value of Alt-A loans made to borrowers with decent credit; causing company stocks to tumble 15.2 percent. American Home Mortgage filed for bankruptcy in August 2007. The delinquency rate for Alt-A mortgages has been rising in 2007. In June 2007, Standard & Poor's warned that U.S. homeowners with good credit are increasingly falling behind on mortgage payments, an indication that lenders have been offering higher risk loans outside the subprime market; they said that rising late payments and defaults on Alt-A mortgages made in 2006 are "disconcerting" and delinquent borrowers appear to be "finding it increasingly difficult to refinance" or catch up on their payments. Late payments of at least 90 days and defaults on 2006 Alt-A mortgages have increased to 4.21 percent, up from 1.59 percent for 2005 mortgages and 0.81 percent for 2004, indicating that "subprime carnage is now spreading to near prime mortgages."

Foreclosure rates increase

The 30-year mortgage rates increased by more than a half a percentage point to 6.74 percent during May–June 2007, affecting borrowers with the best credit just as a crackdown in subprime lending standards limits the pool of qualified buyers. The national median home price is poised for its first annual decline since the Great Depression, and the NAR reported that supply of unsold homes is at a record 4.2 million. Goldman Sachs and Bear Stearns, respectively the world's largest securities firm and largest underwriter of mortgage-backed securities in 2006, said in June 2007 that rising foreclosures reduced their earnings and the loss of billions from bad investments in the subprime market imperiled the solvency of several hedge funds. Furthermore, a number of big commercial banks such as Citibank and investment banks such as Merrill Lynch have announced significant write-offs against 3rd and 4th quarter 2007 earnings. As a result, Citigroup's Board of Directors ousted its CEO Charles Prince and replaced him with Vikram Pandit, a former Morgan Stanley executive and hedge-fund manager, and Merrill Lynch's Board of Directors replaced its CEO Stanley O'Neal with John Thain, an alumni of Goldman Sachs and former CEO of NYSE Euronext. Mark Kiesel, executive vice president of a California-based Pacific Investment Management Co. said,

It's a blood bath. ... We're talking about a two- to three-year downturn that will take a whole host of characters with it, from job creation to consumer confidence. Eventually it will take the stock market and corporate profit.

Government bailouts

Many in the U.S. Congress and Administration are proposing government bailouts of the mortgage and credit crisis, similar to the Savings and Loan crisis of the 1980s. Critics of such proposals quickly rebuffed the idea of government bailouts and calling such bailouts irresponsible. They further argued that bailouts would only promote imprudence in the future.

Following the collapse of the subprime mortgage industry in March 2007, Democratic Senator Charles Schumer of New York proposed a federal government bailout of subprime borrowers in order to save homeowners from losing their residences (or to save big banks from losing billions of dollars with taxpayers' money).

Concerns about the impact of the collapsing housing and credit markets on the larger U.S. economy caused President Bush and Fed Chairman Ben Bernanke to announce a limited bailout of the U.S. housing market for homeowners unable to pay their mortgage debts on August 31, 2007. Mr. Bush said that his administration wished to alleviate the subprime mortgage crisis by "helping people who have good credit but who have not made all of their payments on time because of rising mortgage payments" with FHA-Secure. However, homeowners with subprime loans have poor credit by definition; therefore, the immediate intent and scope of Bush's announced plan is not entirely clear. President Bush's largest campaign contributor was Roland E. Arnall, the former CEO of the largest subprime lender in the U.S., Ameriquest, which has since gone out of business; Bush nominated Arnall as the U.S. Ambassador to the Netherlands. On December 6, 2007, Bush announced a plan to voluntarily and temporarily freeze the introductory mortgage rates (so-called "teaser rate") of a limited number of mortgage debtors holding ARMs for five years, declaring "I have a message for every homeowner worried about rising mortgage payments: The best you can do for your family is to call 1-800-995-HOPE". Government officials denied that this proposal is a bailout and acknowledged that it is not a panacea to cure the housing ailment. Treasury Secretary Henry Paulson admitted that there is no easy solutions to the housing problem and this plan provides more a temporary relief to homeowners facing mortgage-rate resets than a long-term solution to stabilize the housing market. However, some experts criticized this plan as "a Band-Aid when the patient needs major surgery", a "teaser-freezer", and a "bail-out" in which "the liars have won."

Whether the bursting of the U.S. housing bubble will become a partisan issue in the 2008 presidential election is uncertain. During a live interview on CNBC with Maria Bartiromo, New York Senator and 2008 Democratic Presidential Candidate Hillary Rodham Clinton suggested the government set up a $5 billion fund to assist homeowners on the brink of losing their homes. Moreover, she argued that nationwide foreclosures would devastate communities and invite crimes into these neighborhoods. However, skeptics of such schemes questioned whether the $5 billion fund would be sufficient to help 1.4 million homeowners who are expected to lose their homes in 2008 and the first-half of 2009 once their "teaser" mortgage rates are reset to variable market rates which could reach between 11 and 13 percent. On Jan 11, 2008, Democratic presidential contender Hillary Clinton proposed a $70 billion emergency spending package to help victims of the U.S. housing crisis. A potential conflict of interest might arise because Senator Hillary Clinton has been the recipient of major contributions from the mortgage banking industry and her strategist Mark Penn has been linked to Countrywide Mortgage, one of the major subprime lenders.

Some economists say a bail out will create a moral hazard that encourages future risky lending and borrowing by signaling that in extreme circumstances, the government will bail out bad lenders and borrowers They further argue that government bailouts will only encourage more speculative activities in markets other than housing. Such bailouts will prolong the inevitable consequences of the housing crisis and exacerbate other financial crisis in the future. They also asserted the taxpayers-funded bailout would merely assist real-estate speculators, irresponsible homebuyers, and mortgage fraudsters.

A September 2007 national poll by NBC News and the Wall Street Journal found widespread opposition to a bailout of subprime borrowers facing foreclosure, with 59% of respondents opposing a federal role in preventing foreclosures. Most respondents argued that a government interference in private transactions between homebuyers and lenders would set a bad precedent. Some of them wondered whether the government could compel credit-card companies to freeze the introductory rates of zero percent initially offered to credit-card debtors when debtors got into trouble paying their credit-card bills. Economic experts opined that only market-based solutions would eventually solve the current housing problem. Any non-market-based solutions will only put artificial floor in housing prices across the nation. According to former Fed Chairman Alan Greenspan, the credit crunch in the financial market would not end until the inventory of homes on the market is liquidated and declines in residential real-estate prices played themselves out. In other words, supply of and demand for homes must first come to equilibrium before any recovery in U.S. housing market and, after enjoying the housing boom from 2002 to 2007, homeowners must sit through this subsequent housing bust patiently. As former Fed Chairman Alan Greenspan warned before he completed his tenure at the Federal Reserve Bank:

Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.

Translated into plain English, risk-averse investors would demand higher yields on their investments, thus driving down asset prices especially highly leveraged assets such as real-estate. Therefore, homeowners must deleverage themselves by putting more equities into their homes in order to keep their homes and future homebuyers may have to deposit significant amounts of down-payment in order to get mortgage loans. The protracted period of Americans buying homes with zero down-payment and getting mortgage loans with no or little documentations has finally come to an abrupt end.

See also

References and notes

Further reading

External links

* The Housing Bubble Blog - blog. - Ben Jones's news-oriented blog.
* Housing Panic - blog, broke the iamfacingforeclosure.com "liar loan" story.
* Bubble Meter - blog.
* Calculated Risk - blog.
* patrick.net - blog.
* Professor Piggington - blog.
* New Jersey Housing Bubble - blog.
* House Bubble - blog.
* David Lereah Watch - blog, monitors the statements of National Association of Realtors.
* Matrix - blog.
* Housing Bubble Casualty - blog.
* Paper-Money - blog, also streams video of the Senate Banking Committee's housing bubble hearings, publishes Bubble News Network and Bubble Times

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