Worrying about the housing market is nothing new. From anxious homeowners wondering about the value of their property to institutional investors holding on to securitised mortgages, the direction of housing prices has been top of mind for some time now.
And rightfully so. Housing is a crucial component of our economy, and the recovery in the sector so far has not been earth-shattering. We will need to see housing truly be nursed back to health before we can finally put the Great Recession behind us, so keeping track of the industry is important to anyone trying to track our broader economic progress.
During the next two weeks, we'll look at how we got into this mess, where we are now, and why I'm not optimistic things are going to improve in the near term.
How We Got Here
There is no one, or right, answer to the question of how this mess got started. The truth is that it was a confluence of factors that led to the huge asset bubble and its subsequent decline. And the fact that many of these root causes have now reversed themselves, it is easier to see why the housing recovery has been slow, and why it might not speed up anytime soon.
One of the more obvious places to look at what caused the bubble is monetary policy. After the tech bubble burst, the Federal Reserve aggressively loosened the supply of money to soften the blow of a faltering stock market. This led to a scenario where we had inexpensive mortgages, lots of people with money still afraid to invest in stocks after the tech bubble, and a sense that housing prices would never go down. It isn't that shocking then that Americans starting putting more money into houses.
This was all assisted of course by an easing of lending standards by banks. Exotic new mortgages entered the scene, and the requirements for documentation and down payments plummeted. And since banks could quickly move the loans off their books and into mortgage securities, they weren't all that concerned with the credit quality of the borrowers. This made it all that much easier for the marginal homebuyer to jump into the market.
It also is impossible to discount the psychology of Americans who were caught up in the irrational exuberance. Watching your friends and family see huge paper gains in their homes had to be a huge inducement for getting into the market. And you had realtors out there encouraging people to reach for the biggest house they could find, even if it was more house than they needed. There really was also a palpable sense that not buying a house or not upgrading your home meant you were really missing out.
These factors helped push home prices to nose-bleed levels, but as we all know, it didn't last for long. Home prices began their decline even before the weakness of the entire economy was evident. The huge supply glut took its toll as developers started cutting deals to fill empty units. And as the economy began to shake, things only got worse. Subprime borrowers showed signs of having trouble keeping up with their huge new mortgage payments, and even higher-credit-quality borrowers found themselves in trouble.
It turns out that housing was the canary in the coal mine for the broader economy. Almost every other sector began to shake, and soon the entire financial system was in a full-blown credit crisis. As the recession took hold and deepened, the outlook for housing only got worse. Prices kept falling year-over-year, and like much of the economy, no one quite knew when they would bottom.
Where We Are Now
But things did eventually stabilise; by 2010 housing prices had mostly settled at 2003 levels, according to the S&P Case-Shiller Housing Index which tracks housing prices across 20 major metropolitan areas. However, prices haven't moved much since then.
Stabilisation was caused by a few factors. First was the initial wave of homebuyer credit from the federal government that created a new financial incentive to get buyers into homes. These programmes turned out to be very popular and got people thinking about real estate again. Support from the Federal Housing Administration and other agencies likely also played a role in stopping the free-fall and providing financing when the mortgage market was in disarray.
The Federal Reserve pitched in too by keeping rates low and allowing mortgage rates to fall even below where they were during the bubble. These cheap rates allowed adjustable-rate mortgages to reset to lower levels making homes more affordable for some and staving off more forced sales.
New supply also plummeted, helping the market reclaim the supply-and-demand balance. Housing starts are up slightly from the bottom, but they are still well below historical levels and could stay at this depressed level for some time. Demand has also come back as lower prices make buying look more attractive versus renting. In many areas, it is now cheaper to own a home versus renting which is something that was manifestly not true during the bubble.
But even though the market has stabilised, there haven't been many signs that things are truly on the upswing. Although the foreclosure crisis has crested from its peak, there are still huge numbers of people losing their homes. Not to mention the nearly one fourth of mortgage holders who are underwater right now. The continued forced bank sales and huge inventory of unsold homes continue to weigh on prices.
This give and take in the housing market is holding back the rest of the recovery. Many construction workers remain unemployed, and banks continue to be saddled with bad real estate loans. Furthermore, consumers aren't spending as much because they feel less wealthy with their biggest asset often worth less than what they paid for it. I'm not hopeful that this situation will turn around soon.
What do you think? What caused the housing bubble? Has housing really stabilised? What are the biggest headwinds facing the sector?
Next week, I'll look at some reasons that the housing market could be in for an extended rough patch.
Bearish markets editor Bearemy Glaser is the worry-prone alter-ego of markets editor Jeremy Glaser. Each week, Bearemy will share what's topping his list of concerns and invites you to reply or add your own in the comments section below.
