U.S. housing price - Term Paper Example

? U.S. housing price Introduction The financial crisis of the United s happened at the backdrop of the US mortgage housing bubble. The housing crisis led to the distortion in the demand for the housing in the United States. The lack of liquidity and inability to buy houses led the people to stay with their parents or share rooms with other people. The homeownership drastically declined for the people belonging to the mainstream workforce. A reduction in the incomes of the individuals and an increase in the rate of poverty were noticed in the country. The situation became worse with the reduction in the availability of credit. This made it impossible for the willing prospects to pay for home ownership. This paper makes an attempt to investigate the housing problems of the US and the future that lies ahead of this sector. The project would also provide a direction to the prospective buyers of the houses and would help to determine how the prices of the new housing projects could be reduced. Necessary graphs and charts have been provided to present the statistics that would support the arguments put forward in the paper. How serious is housing price problem in the USA? Studies have proved that in the United States there exists inequality in the distribution of wealth among the population of the country. Federal Reserve has stated that out of the total net worth of the individuals, 27% is accounted for household real estate. An average American would allocate almost 66 % of his or her wealth for housing. On the other hand the high net worth individuals of the country generally keeps their money invested in form of a variety of financial assets. The major part of the investment portfolios of these people do not consist of housing investments. Therefore this group of people generally react less to the fluctuation in the housing prices. Thus when there is a rise in the housing prices the people belonging to the middle get mostly affected by it (Krugman, 2009). On the other hand the wealthier persons would bother more about the stock markets because their investments are in the liquid forms mostly in the securities market. Thus during the year of 2009, the financial conditions of the wealthy people were much better because the stock markets provided them with a return of 22%. On the other hand the people who had their money invested in their primary residence faced the brunt. Generally the housing prices indices have been used to analyze the prices of the housing investments throughout the country (Holt, 2009). However, it cannot be generalized easily because there are regional disparities in the prices of the housing. The size and location of the housing has an effect on the prices that would exist in the market. There might also be defect in the construction of the housing prices index. These data on these indices present certain surprising information. Situations of distress sales of the housing have caused the builders to review their price setting procedure (Talbott, 2003). However, the homes which have been valued at a very high rate have faced a decline in their values with the problems in the housing market. There are a host of reasons for this. The debt to income ratio of the loans and the amount of down payment that the buyers could make for purchasing a house had been low. Along with this, the loans that were provided were not underwritten in the proper manner. The long term interest rates in the country have been rising in the recent past. This has also posed a threat to the housing market. If the rate of interest on the bonds rises, people would shy away from making housing investments and would park their money for the long term because such investments would be riskless for the investor. Figure 1: Long term interest rates in 2013 Source: Nothaft, 2013 Thus the affordability of housing is quite low for those families that lie in the middle income group. This is especially true in the metro areas of the country. Again at a time of a boom in the housing prices, the real activities taking place in the economy rises. This leads to an increase in the employment and production related to the housing sector. However, this results in a decrease in the economic activities of the other sectors of the economy. These forces build up the housing bubble. When this bubble bursts, the entire process is reversed. In other words the activities in the housing sector would decrease and that of the other sectors would increase. Again with an increase in the price of the houses the homeowners feel rich and they start spending more amount of money. This however, leads to a reduction in the rate of savings among the individuals (Zandi, 2009). Again the opposite happens when the housing bubble bursts. Since the capital gains of the investors become low in this case they try to switch to alternative forms of investment. As a result of the fall in the net worth of the individuals the consumption falls. The reasons why housing price keep rising The population of the United States is expected to grow to 403 million till the end of 2050. These people would be needed proper housing and therefore the demand for housing in the United States of America keeps on increasing. The graph below shows the present status of the ownership of housing based on the age of the people. It has been observed that the demand for housing has been the most for the people who belong to the middle age group of the entire population. This trend has remained constant over a long period of time from 1990 to the year 2010. So it is expected that this trend would prevail even in the forthcoming years. Figure 2: Home Ownership rates by Age Source: Pendall, Freiman, Myers and Hepp, 2012 At the end of the Second World War the population of the country grew to a huge extent. A large numbers of babies born during that time were known as the baby boomers. Sixty years have passed since the world war and those children now comprise of the major part of the senior population of the United States. Te group of these senior people demand for housing that are affordable for them. The life expectancy of the senior people of the country has also increased which has led to the increase in the sexagenarian population to 14.2 million. Along with this there would also be a lot of diversity in this group of people who would want to purchase a house. People may become sick at this point of time and they want companionship at this juncture. Thus they would look for the housing that would be able to meet their needs. In such cases when the prices of the housing rises it becomes difficult for this group of people to afford the kind of houses that they would want to own. On the other had the people who belong to the younger generations would also grow with the growing number of immigrants in the country. These people would want to stay in the housing with single occupancy. Thus the demand for multifamily housing has been on the decline. Thus while the present housing markets are mainly governed by the demand of the older generation, the next two decades depend on the present young generation who are less than 30 years of age. The following graph depicts the expected changes in the pattern of the household. The Echo boomers or the young generation under each of the scenarios would for the major part of the people demanding for the new houses. Figure 3: Expected Changes in Household Source: Pendall, Freiman, Myers and Hepp, 2012 It has also been projected that ratio of home owners to the renters would go up over the period from 2010 to 2020 in case the recovery of the housing markets are strong this means that people would prefer to purchase houses rather than renting a housing property. However, most of the demand for the rental housing would be done by the younger generation. The main reason behind this is that most of the people belonging to this group often relocate from their place of residence due to jobs. Therefore they may not want to own a house at a particular place. The country has also faced several problems of racial discrimination and this has been reflected in the housing markets as well. The ownership of housing had been noticed more among the non Hispanics rather than the non-Hispanics and the people of African origin. Therefore most of the people of the country would be demanding for the ownership of housing which would increase the housing prices. The size of the households in the United States has also declined. In the graph below it is seen that during 1940 the number of people who lived in one house was a little more than 3.5 on an average. However, this reduced and the average number of people living in a household is just above 2.5 in 2010. However, the population of the country has also increased over these years. This indicated that the numbers of houses that these people would live in altogether would also increase. This also shows the reason for the increase in the demand for housing and in turn the prices of affordable housing. Figure 4: Mean Household Size Source: Pendall, Freiman, Myers and Hepp, 2012 On the other hand the mortgage interest rates have also been low which induced people to make investments in this sector which is relatively less risky compared to the other asset classes. A lot of foreign investments also took place in this sector because of the low risk and the high return from this sector. Investments came in from the countries like China and Japan. People also started investing in the mortgage backed securities that were devised by the Fannie Mae and Freddie Mac. Being government institution these companies also received high credit rating scores from the top credit rating agencies. Thus although the prices of housing rose the low rates of mortgage interest rate encouraged the people to invest in the housing market. The short term interest rates were also low which in turn fuelled the demand for the adjustable mortgages. Along with that the rate at which the prices of housing increased is much higher than that of the increase in income of an average household. Therefore it is becoming difficult for the middle income group of people to afford the high priced homes. One of the biggest problems that the country faced was the lenient way in which mortgages have been approved by the lending institutions. With the advent of the Internet the organizations providing loans allowed credit to the people without the proper evaluation of the repayment capability. The mortgage standards were extremely relaxed owing to the changes in the competitive framework of the present day. In order to have a better market share the companies providing mortgage finance would lower their standards of approval and would relax their credit terms. This would make the credit quality worse for the loan providers worse. How to fix this problem Though the housing problem would take a long time to recover completely that would last a long period of time, it is not unwise to think of a situation that would provide for a way for the housing market to function in tune with a stable economy (Shiller, 2008). In this context it should be mentioned that since the prices of the housing are determined by the market forces, there are a host of factors that are instrumental in having their impact on the market forces of supply and demand. The factors that drive the supply of the homes in the country are comparatively less significant compared to the demand drivers. In case of the supply of the existing homes the inventory level seems to be excess for a period of six months only. However, there are also several other groups of houses which are either closed down or in a state of delinquency. Therefore there are a much larger number of houses or housing projects in the country which are not being used productively or purchased by any individual (Sowell, 2009). There are also several new constructions that are being undertaken in the country. Thus to compensate for this excess supply in the housing market, the demand for housing should rise. Changes in the demographics of the Unites States have resulted in the formation of the new households. The debt burden among the unemployed university students has retarded the growth of the household formation. Since the access of the individuals to mortgage credit is low, the people of the country have stepped back from purchasing houses. The credit scores and the stringent regulatory framework have prevented even the willing consumers from taking loans (Demyanyk and Hemert, 2008). Adding to this the financial crisis had an impact on the general public and they are reluctant to make any big investment in view of the financial crises. Providing a satisfactory solution to these root causes would help in the revival of the US mortgage financing markets (Foldvary, 2007). Therefore with the fall in the level of unemployment in the US economy, the people of the country would be able to gain back the confidence on the investments in various assets as well as housing investments. This would give rise to a self correction of the housing market and the prices of housing would smooth out. The financial institutions also need to extend credit to the buyers of the houses so that the willing buyers can buy the products. Conclusion The analysis provides an insight into the housing market along with the root cause of the problems faced by an average American. It is clear that the reason for the rise in the prices is the shortage in the supply of housing in the US. The cost of construction of the housing is also very high because most of the projects have been delayed due to the rising costs. The regulatory aspects also need to be critically reviewed from the point of view of both the approval of the construction of projects as well as the credit approval for the prospective borrowers. The regulatory bodies of the US need to be more stringent in the approval of the mortgage backed securities. The demographic patterns exhibit the fact that the demand for the housing especially among the senior population would increase. Therefore there is a need for the construction of the affordable housing. The low cost housing would be able to meet the immediate needs of the senior people. The techniques like restrictive zoning would allow the builders to construct the houses as per the lot size. This would help in the increase of the cost of construction of the housing projects. References Holt, J. (2009). A Summary of the Primary Causes of the Housing Bubble and the Resulting Credit Crisis: A Non-Technical Paper. The Journal of Business Inquiry. Vol. 8(1). Zandi, M. (2009). Financial Shock: A 360° Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis. Upper Saddle River, New Jersey: Pearson Education. Krugman, P. (2009). The Return of Depression Economics and the Crisis of 2008. New York: W.W. Norton & Company. Foldvary, F.E., 2007. The Depression of 2008. Berkeley: The Gutenberg Press. Shiller, R. J. (2008). The Subprime Solution: How Today’s Global Financial Crisis Happened and What to Do about It. Princeton, New Jersey: Princeton University Press. Sowell, T. (2009). The Housing Boom and Bust. New York: Basic Books. Pendall, R., Freiman, L., Myers, D. and Hepp, S. (2012). Demographic Challenges and Opportunities for U.S. Housing Markets. Housing Commission: Bipartisan Policy Center. Nothaft, F.E. (2013). What Happens When Interest Rates Rise? U.S. Economic & Housing Market Outlook: Freddie Mac. Talbott, J.R. (2003). The Coming Crash in the Housing Market. New York: McGraw-Hill. Demyanyk, Y. and Hemert, O.V. (2008). Understanding the Subprime Mortgage Crisis. Supervisory Policy Analysis Working Paper, Federal Reserve System. Read More