The first domino to fall, and the main reason that the recession has been so severe, was the government’s initiative to increase the homeownership rate in the United States. For decades, a homeownership rate of 62 percent seemed to have been a stable, sustainable rate. In order to increase the rate, it was necessary for the government to exert pressure on Fannie Mae and Freddie Mac to loosen their standards. With governmental direction and significant pressure, the table was set for these government-sponsored enterprises to facilitate people buying houses who could not afford them. At the same time, in the early 2000s, the Federal Reserve kept interest rates too low for too long, another key ingredient in this process. This set the stage for the private sector participants to take advantage of the government’s “push homeownership” initiatives. When Congress decided to interfere with the free market, as they thought it would be better for the country to increase the percentage of Americans owning homes, they left a window wide open.
Another misconception about the crisis is that with proper regulation it would have been averted. Clearly, there were millions of foolish loans made during the housing boom. Some say that banks took advantage of unsuspecting borrowers while others say that borrowers’ lies took advantage of banks. Both of these perspectives are probably equally correct. Lender fraud was, however, not the overriding cause of the crisis; therefore, additional regulation would likely not have prevented it.
If we look at the housing meltdown carefully, we see three distinct phases. In the first, Fed Chairman Alan Greenspan kept interest rates too low for too long, which not only inflated the housing asset bubble but created a very steep yield curve where short-term rates were so low that they encouraged adjustable-rate loans. The percentage of floating rate loans ballooned during this period. These mortgages, which had exceptionally attractive rates in the first few years of the loan, attracted speculators and flippers just looking to make a fast buck. Mortgage equity withdrawal hit all-time highs as homes replaced ATM machines as the fastest way for Americans to put cash in their pockets. Loose underwriting standards, precipitated by what Fannie and Freddie were instructed to do, let many people qualify who never should have. These adjustable-rate loans were the first to hit the fan.
In the second phase, the myth that average home prices never fall was shattered. Across the country, values plummeted, leaving nearly one-quarter of homeowners with mortgage balances in excess of the value of their houses. When this happened, owners responded by sending their keys back to the bank. With Fannie and Freddie under pressure to get Americans into homes they owned, mortgages with overly accommodative terms like miniscule downpayments, low initial interest rates or even negative amortization were abundant and the results were devastating. While the S & P / Case-Shiller index showed average prices falling by about 22 percent nationwide, several markets were really battered, including Miami, Las Vegas, Phoenix and many areas of California. In fact, Florida, Nevada, Arizona and California are home to nearly half of all foreclosures nationwide. Not surprisingly, there appears to have been more speculators and flippers in those markets than anywhere else.
In the third phase of the housing crisis, we have seen stress caused by traditional recessionary pressures, particularly unemployment, which, if you are a frequent reader of Concrete Thoughts, you know I believe has a more profound impact on real estate fundamentals than anything else. These pressures have been magnified by the conditions that preceded this phase of the crisis.