Housing Market in the US - Essay Example

? Housing Market in U.S Housing Market in U.S Housing bubble refers to a run-up in housing prices fueled by demand, speculation, andthe belief that recent history is an infallible forecast of the future. Essentially, housing bubbles start with an increase in demand in the face of limited supply that takes quite a long time to replenish and increase. In mean time, speculators find their way in the market believing of making profits through short-term buying and selling. This drives to an increase in demand but at some point, demand decreases or stagnates with a subsequent increase in supply resulting to a sharp drop in prices (Baker, 2008). The bubble finally bursts. In housing bubble, very low interest rates and a consequent loosening of credit underwriting standards attract many borrowers in the market. In this case, a decline in demand due to high interest rates and a tightening of credit standards leads to bursting of the bubble. This paper discusses in depth about the rise and fall of the housing market in U.S. and its impact in the society. Scholarly research depicts that an economic bubble is difficult to identify with the exception of in hindsight. However, a number of cultural and economic factors have led to justification of the argument of several economists that a housing bubble existed in the U.S. As an economic bubble, the United States housing bubble grew up alongside the stock bubble in the mid-90s. Usually, low interest always motivates firms to borrow more and invest more. In this case, assets that are more productive match greater indebtedness (Shiller, 2006). However, the U.S housing market interest rates greatly differed with the investment. Although the country’s economy grew, many American families had to borrow more debt to refinance their mortgages and spend some of the proceeds. As long as the housing prices rose due to lower interest rates, the Americans ignored the growing indebtedness. An increase in demand in the supply of housing led to an ultimate increase in price. An incredible increase in price incorporated most affected areas into expectations that made homebuyers pay more than they would have otherwise thus making the expectations self-fulfilling. To attract many people in borrowing more money, credit standards were lowered thus fueling growth in the so-called subprime mortgages. Additionally, new products were invented lowering upfront payments and making it easier for individuals to take bigger mortgages. The biggest problem that arose from these mortgages was that some had negative amortization (Baker, 2002). This is because payments made by some of the borrowers did not even meet the interest due thus making the debt grow more. By 2002, the housing prices had shoot to nearly 30 percent even after adjusting for inflation. Statistical analysis evidences an impact of housing prices to the housing market upon a speculative bubble rather than the fundamentals. To fuel the housing market, Federal Reserve Board chairperson Alan Greenspan suggested that it was much better for homebuyers to procure houses on flexible rates rather than set rates since this would enable them pay for the house at ease. In 2003, homebuyers had the opportunity to afford larger mortgages due to the adjustable rates that were available at that moment. The lower interest rates hastened the run-up in house prices hence increasing at a supplementary 31.6 percent. On the other hand, the run-ups had predictable effect on savings and consumption. Consumption increased thus lowering the savings rate by 1 percent (Hardaway, 2011). Several factors contributed to the rise of the housing bubble. One major factor encompasses the desire of people to own too many houses. Many of the Americans despite their incapability of managing many houses went ahead and purchased them rather than renting houses, which is alternatively cheaper. Buying the houses for speculation rather than shelter was another insight to housing bubble. Due to the wealth possessed by most of the Americans, they decided to buy houses for pleasurable purposes rather than as homes for stay. Their extravagance and misuse of money made them bankrupt and incapable of paying back the debts for their mortgages (Soros, 2009). The fact that low interest rates were charged upon the homebuyers motivated them in buying more houses thus ignoring the payments they had to pay. Moreover, the mortgages practiced bad lending practices. They ought to have considered payments of houses before issuing an individual another house. The homebuyers also contributed to the growth of housing bubble by taking all the money left money and putting it in residential real estate for safety immediately after the bubble burst. This ultimately led to hiking of house prices. A further increase in supply and high house prices led to less demand and ultimately the burst of the housing bubble in 2007. As prices tend to decline, more homeowners face foreclosure. This in turn becomes a voluntary and involuntary involvement. Involuntarily, some people who would like to keep their homes borrow against equity if they fail to meet their monthly mortgage payments. This option is eliminated if at all falling house prices destroy equity (Baker, 2008). The voluntary foreclosure occurs when people realize that their debts exceed the value of their home, and henceforth decide that paying off their mortgage is unfair and in essence a bad deal. In cases where a home is valued lower than the amount of the outstanding mortgage, homeowners effectively pocket hundreds of thousands of dollars by simply walking away from their mortgage. The lending standards became even more relaxed during the run-up bubble. A rapid fall of price in the housing market resulted to severe tightening of down payments of 20 or even 25 percent. Many potential buyers were excluded from the market. Evidently, plunging house prices destroyed much of the existing homeowners’ equity thus creating difficulties for them in making large down payments. By the end of 2007, real house prices had declined to about 20 percent from the peak (Shiller, 2006). An accelerated decline of price in the housing market meant a loss of more than $7 trillion in the housing bubble wealth. This great loss approximated to about 50% of the market’s GDP leading to a serious financial stress. One of the demographic groups that were greatly affected by the housing bubble is the banks. The homebuyers in order to clear their debt had to seek assistance from the banks. To maximize safety, the banks ensured an honest appraisal and collateral in the house that would cover the value of the loan. Appraisers had to maintain a strong incentive in order to adopt a high-side bias in their appraisals in fear of not being hired again by the bank. To enhance security in the secondary market, the issuers ensured that they issued as many mortgages as possible to avoid risks once the mortgage was sold in the secondary market. The issuers had in mind the criteria used in giving loans to qualifying mortgages for sale (Baker, 2002). The banks bought and bundled loans into Mortgage Banked Securities that aimed at maximizing volume with little regard for the actual quality of the loans that were being issued. It is important to note that the ability of the banks to issue their loans of questionable quality depended entirely on the ability to secure good credit rating for their bonds. Another twist due to the economic drift of the housing market led to the creation of Structured Investment Vehicles ostensibly independent companies that formulated yet another layer in the complex web of finance that concealed the risk that was building in the financial structure. The banks would then sell shares to these SIVs companies thus keeping their liabilities off their balance sheet. It is important to note that this period of crash saw a colossal propagation of Credit Default Swaps. The CDSs provided maximum insurance against defaults that were issued by major banks. They were a source of security to lenders against the risk of questionable quality and default. Moreover, the spread of CDSs ensured that the banks were able to sell their loans at the desired rates. Although this housing bubble has led to great financial loses, it is worth noting that many of the financial actors have made themselves enormously wealthy despite the decline of their companies (Hardaway, 2011). For example the CEO of Countrywide Financial, Angelo Mozila ,depicted as one of the nation’s largest originators of subprime mortgages, earned himself quite a number of million dollars in reimbursement over the last decade. After his success, he showed less concern to his company which is presently being taken over by Bank of America at a price that is a small fraction of its levels at the peak of the bubble. Similarly, James E. Cayne, the boss who led Bear Stearns to bankruptcy, also pocketed hundreds of millions of dollars for his work. The same is undoubtedly true for many hedge fund managers who got 20 percent of large gains during the good years, but who are now watching their clients lose much of their investment during the down market. Consequently, a desirable end of the housing bubble will certainly lead to more financial turbulence (Soros, 2009). It is important to not that many banks have indeed encountered great losses with the decline of the housing market. Research depicts that the decline experienced in the housing market affected regions such as Case-Shiller 20 City Index, Las Vegas, Phoenix, and Los Angeles. Although great losses have been experienced in these areas, there is a possibility that housing prices will stop dropping in the near future. References Baker, D. (2002). “The Run-Up in House Prices: Is It Real or Is it Another Bubble.” Washington, D.C.: Center for Economic and Policy Research. Accessed from [http://www.cepr.net/index.php/publications/reports/the-run-up-in-home-prices-is-it-real-or-is-it-another-bubble/]. Baker, D. “The Housing Bubble and the Financial Crisis”, real-world economics review, issue no. 46, 20 May 2008, pp. 73-81. Hardaway, M. R. (2011). The Great American Housing Bubble: The Road to Collapse. California : ABC-CLIO. Shiller, R. (2006). Irrational Exuberance (2nd edition). Princeton, NJ: Princeton University Press. Soros, G. (2009). The Crash of 2008 and What It Means: The New Paradigm for Financial Markets. New York: PublicAffairs. Read More