Causes of the United States housing bubble
Mania for home ownership
Americans' love of their homes is widely known and acknowledged;cite news
title=Home $weet Home |work=Time
url=http://www.time.com/time/magazine/0,9263,7601050613,00.html] however, many believe that enthusiasm for home ownership is currently high even by American standards, calling the real estate market "frothy", [cite news |last=Greenspan |first=Alan |title=Greenspan Calls Home-Price Speculation Unsustainable |work=Bloomberg |date=2005-05-20 |url=http://quote.bloomberg.com/apps/news?pid=10000006&sid=ajYPxb8Ojdio&refer=home# |quote=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. ] "speculative madness",cite news |title=No mercy now, no bail-out later |work=
The Daily Telegraph|date=2006-03-23 |url=http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/03/23/ccfed23.xml&menuId=242&sSheet=/money/2006/03/23/ixcoms.html |quote= [T] he American housing boom is now the mother of all bubbles—in sheer volume, if not indegrees of speculative madness. ] and a "mania".cite episode | title = Episode 06292007 | series = Bill Moyers Journal| network = PBS| transcripturl = http://www.pbs.org/moyers/journal/06292007/transcript5.html | airdate = 2007-06-29] Many observers have commented on this phenomenon [cite news |title=The Oracle Speaks |work= CNNMoney.com|date=2005-05-02 |first=Jason |last=Zweig |url=http://money.cnn.com/2005/05/01/news/fortune500/buffett_talks/ |quote= [Warren Buffet:] Certainly at the high end of the real estate market in some areas, you've seen extraordinary movement... People go crazy in economics periodically, in all kinds of ways... when you get prices increasing faster than the underlying costs, sometimes there can be pretty serious consequences. ] [cite news |title=Soros predicts American recession |work= The Times|date=2006-01-09 |accessdate=2008-03-17 |url=http://www.timesonline.co.uk/tol/sport/football/european_football/article786656.ece |quote=Mr Soros said he believed the US housing bubble, a major factor behind strong American consumption, had reached its peak and was in the process of being deflated.] [cite news |first=Robert |last=Kiyosaki |title=All Booms Bust |publisher= Robert Kiyosaki|date=2005? |url=http://www.richdad.com/pages/article_dollar_crisis_part1.asp |archiveurl=http://web.archive.org/web/20060423172945/http://www.richdad.com/pages/article_dollar_crisis_part1.asp |archivedate=2006-04-23 |quote=Lately, I have been asked if we are in a real estate bubble. My answer is, 'Duh!' In my opinion, this is the biggest real estate bubble I have ever lived through. Next, I am asked, 'Will the bubble burst?' Again, my answer is, 'Duh! ] —as evidenced by the cover of the June 13, 2005 issue of " Time Magazine" (seen above, itself taken as a sign of the bubble's peakcite news
title=The Pin that Bursts the Housing Bubble |work=
accessdate=2008-03-17 ] )—but as a 2007 article in "
Forbes" warns, "to realize that America's maniafor home-buying is out of all proportion to sober reality, one needs to look no further than the current subprime lending mess... As interestrates—and mortgage payments—have started to climb, many of these new owners are having difficulty making ends meet... Those borrowers are much worse off than before they bought."cite news |title=Don't Buy That House |work= Forbes|date=2007-06-26 |url=http://www.forbes.com/2007/06/26/home-ownership-negatives-biz-dream0607_cx_ee_0626house_print.html ] The boom in housing has also created a boom in the real estateprofession; for example, California has a record half-million real estate licencees—one for every 52 adults living in the state, up 57% in the last five years. [cite news |title=New recorad: Nearly a half-million real estate licenses |work=Sacramento Business Journal |date=2006-05-23 |url=http://www.bizjournals.com/sacramento/stories/2006/05/22/daily20.html |quote=To accommodate the demand for real estate licenses, the DRE conducted numerous 'mega-exams' in which thousands of applicants took the real estate licenseexamination... 'The level of interest in real estate licensure is unprecedented' ]
The overall U.S. homeownership rate increased from 64 percent in 1994 (about where it was since 1980) to a peak in 2004 with an all time high of 69.2 percent.cite news |title=Census Bureau Reports on Residential Vacancies and Homeownership |date=2007-10-26 |publisher=
U.S. Census Bureau|format=PDF |url=http://www.census.gov/hhes/www/housing/hvs/qtr307/q307press.pdf ] Bush's 2004 campaign slogan "the ownership society" indicates the strong preference and societal influence of Americans to own the homes they live in, as opposed to renting. However, in many parts of the United States, rent does not cover mortgage costs; the national medianmortgage payment is $1,687 per month, nearly twice the median rent payment of $868 per month, although this ratio can vary significantly from market to market.cite news |title=For some, renting makes more sense |work= USA Today|date=2006-08-10 |url=http://www.usatoday.com/money/perfi/housing/2006-08-09-rent-1a-usat_x.htm ]
Some borrowers committed
mortgage fraud, which increased by 1,411 percent between 1997 and 2005 (based on Suspicious Activity Reports), to buy homes they could not afford. [ [http://www.fincen.gov/MortgageLoanFraud.pdf Reported Suspicious Activities ] ]
Belief that housing is a good investment
Among Americans, home ownership is widely accepted as preferable to renting in many cases, especially when the ownership term is expected to be at least five years. This is partly due to the fact that the fraction of a fixed-rate
mortgageused to pay down the principal builds equity for the homeowner over time, while the interest portion of the loan payments qualifies for a tax break, whereas, except for the personal tax deduction often available to renters but not to homeowners, money spent on rent does neither. However, when considered as an investment, that is, an assetthat is expected to grow in value over time, as opposed to the utility of shelter that home ownership provides, housing is not a risk-free investment. The popular notion that, unlike stocks, homes do not fall in value is believed to have contributed to the mania for purchasing homes. Stock prices are reported in real time, which means investors witness the volatility. However, homes are usually valuedyearly or less often, thereby smoothing out perceptions of volatility. This assertion that property prices rise has been true for the United States as a whole since the Great Depression,cite news |title=Housing Bubble—or Bunk? Are home prices soaring unsustainably and due for plunge? A group of experts takes a look—and come to very different conclusions |work= [Business Week] |date=2005-06-22 |url=http://www.businessweek.com/bwdaily/dnflash/jun2005/nf20050622_9404_db008.htm] and appears to be encouraged by the real estate industry.cite news |last=Roubini |first=Nouriel |title=Eight Market Spins About Housing by Perma-Bull Spin-Doctors... And the Reality of the Coming Ugliest Housing Bust Ever... |date=2006-08-26 |work=RGE Monitor |url=http://www.rgemonitor.com/blog/roubini/143257 |quote=A lot of spin is being furiously spinned around–often from folks close to real estateinterests–to minimize the importance of this housing bust, it is worth to point out a number of flawed arguments and misperception that are being peddled around. You will hear many of these arguments over and over again in the financial pages of the media, in sell-side research reports and in innumerous TV programs. So, be prepared to understand this misinformation, myths and spins. ] cite news |title=I want my bubble back |work= Motley Fool|date=2006-06-09 |url=http://www.fool.com/news/commentary/2006/commentary06060918.htm ] However, housing prices can move both up and down in local markets, as evidenced by the relatively recent price history in locations such as New York, Los Angeles, Boston, Japan, Vancouver, Seoul, Sydney, and Hong Kong; large trends of up and down price fluctuations can be seen in many U.S. cities (see graph). Since 2005, the year-over-year mediansale prices (inflation-adjusted) of single family homes in Massachusettsfell over 10% in 2006. [Plot of Massachusetts SingleFamily Home Inflation Adjusted Median Prices, 2004–2006.
Promotion in the media
In late 2005 and into 2006, there were an abundance of television programs promoting real estate investment and flipping. [cite news |title=TV's Hot Properties: Real Estate Reality Shows |date=2005-12-28 |work=
The Washington Post|url=http://www.washingtonpost.com/wp-dyn/content/article/2005/12/27/AR2005122701018_pf.html ] [Reality TV programs about "flipping" include:
HGTV's " House Hunters", "What You Get for the Money", " Designed to Sell" and " Buy Me".
BBC America's " Location, Location, Location".
Discovery Home's " Flip That House".
* A&E's "
Flip This House" and " Sell This House".
* Bravo's "
Million Dollar Listing", "a six-episode original series chronicling the high-stakes, cutthroat world of real estate in a thriving market."
Fine LivingprogramsFact|date=March 2008
The Learning Channel's "Property Ladder" and " The Adam Carolla Project" in which he "guts his childhood home with the goal of flipping it for more than $1 million."] In addition to the numerous television shows, book stores in cities throughout the United States could be seen showing large displays of books touting real-estate investment, such as NAR chief economist David Lereah's book "Are You Missing the Real Estate Boom?", subtitled "Why Home Values and Other Real Estate Investments Will Climb Through The End of The Decade - And How to Profit From Them", published in February 2005.cite book |last=Lereah |first=David |title=Are You Missing the Real Estate Boom? |year=2005 |publisher=Currency/Doubleday |isbn=0385514344 ] One year later, Lereah retitled his book "Why the Real Estate Boom Will Not Bust - And How You Can Profit from It".cite book |last=Lereah |first=David |title=Why the Real Estate Boom Will Not Bust - And How You Can Profit from It |year=2005 |publisher=Currency/Doubleday |isbn=0385514352 ]
However, following Fed chairman Ben Bernanke's comments on the "downturn of the housing market" in August 2006, [cite news |title=For Whom the Housing Bell Tolls | date=2006-08-10 |work=Barron's |url=http://online.barrons.com/public/article/SB115515894570031399-T3ogIr6mEOKDEd_HeplVcWwl6uQ_20070812.html ] Lereah said in an
NBCinterview that "we've had a boom marketplace: you've got to correct because booms cannot sustain itself forever ["sic"] ."cite news |title=Bubble Bursting |author= Michael Okwu|work=The Today Show |publisher= NBCThe video of the report is available at [http://housingpanic.blogspot.com/2006/08/today-show-report-from-few-weeks-ago.html an entry of 2006-08-19] on the blog "Housing Panic".] Commenting on the phenomenon of shifting NAR accounts of the national housing market (see David Lereah's commentscite news |last=Lereah |first=David |title=Average price of home tops $200,000 amid sales frenzy |work= Reuters|date=2005-05-25 |url=http://www.washingtontimes.com/business/20050525-121926-7231r.htm |quote=There's a speculative element in home buying now. ] cite news |title=Public remarks from NAR chief economist David Lereah |date=2006-04-27 |url=http://globaleconomicanalysis.blogspot.com/2006/04/new-gold-standard.html ] ), the Motley Foolreported, "There's nothing funnier or more satisfying ... than watching the National Association of Realtors (NAR) change its tune these days. ... the NAR is full of it and will spin the numbers any way it can to keep up the pleasant fiction that all is well."
Upon leaving the NAR in May 2007, Lereah explained to
Robert Siegelof National Public Radiothat using the word "boom" in the title was actually his publisher's idea, and "a poor choice of titles". [cite news |title=A Real Estate Bull Has a Change of Heart |date=2007-05-10 |publisher= National Public Radio|work= All Things Considered|url=http://www.npr.org/templates/story/story.php?storyId=10118254&ft=1&f=1018 ]
medianhome prices began to rise dramatically in 2000–2001 following the fall in interest rates, speculative purchases of homes also increased. [cite news |title=Steep Rise in Prices for Homes Adds to Worry About a Bubble |date=2005-05-25 |work= The New York Times|url=http://www.nytimes.com/2005/05/25/business/25home.html |quote='There's clearly speculative excess going on', said Joshua Shapiro, the chief United States economist at MFR Inc., an economic research group in New York. 'A lot of people view real estate as a can't lose.' ] "Fortune" magazine's article on housing speculation in 2005 said, "America was awash in a stark, raving frenzy that looked every bit as crazy as dot-com stocks."cite news |title=Lowering the Boom? Speculators Gone Mild |date=2006-03-15 |work=Fortune |url=http://money.cnn.com/magazines/fortune/fortune_archive/2006/03/20/8371785/index.htm | quote=America was awash in a stark,raving frenzy that looked every bit as crazy as dot-com stocks. ] In a 2006 interview in " BusinessWeek" magazine, Yale economist Robert Shillersaid of the impact of speculators on long term valuations, "I worry about a big fall because prices today are being supported by a speculative fever,"cite news |first=Maria |last=Bartiromo |title=Jitters On The Home Front |date=2006-03-06 |work= Business Week|url=http://www.businessweek.com/magazine/content/06_10/b3974141.htm |accessdate=2008-03-17 ] and former NAR chief economist David Lereah said in 2005 that " [t] here's a speculative element in home buying now." [Wikipedia:Footnotes| [broken footnote] Speculation in some local markets has been greater than others, and any correction in valuations is expected to be strongly related to the percentage amount of speculative purchases. [ cite news |author= June Fletcher|title=Is There Still Profit to BeMade From Buying Fixer-Upper Homes? |work= The Wall Street Journal|date=2006-03-17 |url=http://www.realestatejournal.com/columnists/housetalk/20060317-fletcher.html ] cite news |first=Andrew |last=Laperriere |title=Housing Bubble Trouble: Have we been living beyond our means? |work= The Weekly Standard|date=2006-04-10 |url=http://www.weeklystandard.com/Content/Public/Articles/000/000/012/053ajgwr.asp ] In the same " BusinessWeek" interview, Angelo Mozilo, CEO of mortgage lender Countrywide Financial, said in March 2006, "in areas where you have had heavy speculation, you could have 30% [home price declines] ... A year or a year and half from now, you will have seen a slow deterioration of home values and a substantial deterioration in those areas where there has been speculative excess." The chief economist for the National Association of Home Builders, David Seiders, said that California, Las Vegas, Florida and the Washington, D.C., area "have the largest potential for a price slowdown" because the rising prices in those markets were fed by speculators who bought homes intending to "flip" or sell them for a quick profit. [cite news |last=Seiders |first=David
title=Housing cooling off: Could chill economy |date=2006-03-06 |work=
San Diego Union Tribune|url=http://www.signonsandiego.com/news/business/20060306-1130-housingslowdown.html ] Dallas Fed president Richard Fisher said in 2006 that the Fed held its target rate at 1 percent "longer than it should have been" and unintentionally prompted speculation in the housing market.cite news |title=Official Says Bad Data Fueled Rate Cuts, Housing Speculation |date=2006-11-06 |work= The Wall Street Journal|url=http://www.realestatejournal.com/buysell/mortgages/20061106-ip.html?mod=RSS_Real_Estate_Journal&rejrss=frontpage |quote=In retrospect, the real Fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer than it should have been... In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets... Toda... the housing market is undergoing a substantialcorrection and inflicting real costs to millions of homeowners across the country. It is complicating the [Fed's] task of achieving... sustainable noninflationary growth. ] cite news |title=Fed's Bies, Fisher See Inflation Rate Beginning to Come Down |date=2006-11-03 |work=Bloomberg |url=http://www.bloomberg.com/apps/news?pid=20601103&sid=ad4ao57rKiy0&refer=news ]
It should also be noted that various gurus of real estate investments such as Russ Whitney openly advocated the use of no money down property flipping, which led to the demise of many speculators who followed this strategy such as
Casey Serin. [cite news |title=10 mistakes that made flipping a flop |date=2006-10-22 |work= USA Today|first=Noelle |last=Knox |url=http://www.usatoday.com/money/economy/housing/2006-10-22-young-flipper-usat_x.htm |accessdate=2008-03-17 ] [cite news |title= Russ Whitney Wants You to Be Rich |first=Randall |last=Patterson |work= The New York Times|date=2007-03-18 |url=http://query.nytimes.com/gst/fullpage.html?res=9F07E0DB1E31F93BA25750C0A9619C8B63&pagewanted=all |accessdate=2008-03-17 ]
Crash of the dot-com bubble
Several economists have argued that the stock market crash, especially in the dot-com and technology sectors, in 2000 and the subsequent 70% (or so) drop of the
NASDAQcomposite index resulted in many people taking their money out of the stock market and purchasing real estate, which many believed to be a more reliable investment.cite news |title=Is A Housing Bubble About To Burst? |work= BusinessWeek|date=2004-07-19 |url=http://www.businessweek.com/magazine/content/04_29/b3892064_mz011.htm |accessdate=2008-03-17] [cite news |last=Baker |first=Dean |title=The Housing Bubble Fact Sheet |publisher= Center for Economic and Policy Research|date=July 2005 |url=http://www.cepr.net/publications/housing_fact_2005_07.pdf |quote=The generalized bubble in housing prices is comparable to the bubble in stock prices in the late 1990s. The eventual collapse of the housing bubble will have an even larger impact than thecollapse of the stock bubble, since housing wealth is far more evenly distributed than stock wealth. ] Yaleeconomist Robert Shillerargued further that "irrational exuberance" was displaced from the fallen stock market to housing: "Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed."cite news |last=Shiller|first=Robert |title=The Bubble's New Home |work=Barron's |date=2005-06-20 |url=http://online.barrons.com/article/SB111905372884363176.html |quote=Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors. These days, the only thing that comes close to real estate as a national obsession is poker. ]
Historically low interest rates
Another important consequence of the dot-com crash and the subsequent 2001–2002 recession was that the Federal Reserve cut short-term
interest rates to historically low levels, from about 6.5% to just 1%. Former Federal Reserve Board Chairman Alan Greenspan admitted that the housing bubble was "fundamentally engendered by the decline in real long-term interest rates."cite news |last=Greenspan |first=Alan |title=A global outlook |work= Financial Times|date=2007-09-16 |url=http://www.ft.com/cms/s/0/976b7442-6486-11dc-90ea-0000779fd2ac.html ] In the United States, mortgage rates are typically set in relation to 10-year treasury bondyields, which, in turn, are affected by Federal Funds rates. The Federal Reserve acknowledges the connection between lower interest rates, higher home values, and the increased liquidity the higher home values bring to the overall economy. [cite news |last=Greenspan |first=Alan |title=HousingBubble Bursts in the Market for U.S. Mortgage Bonds |work=Bloomberg |date=2005-12-06 |url=http://www.bloomberg.com/apps/news?pid=10000103&sid=aDSB370ItSJU&refer=us |quote=Froth in housing markets may be spilling over into mortgage markets. ] A Federal Reserve report reads,
Like other asset prices, house prices are influenced by interest rates, and in some countries, the housing market is a key channel of monetary policy transmission. [cite news |title=International Finance Discussion Papers, Number 841, House Prices and Monetary Policy: A Cross-Country Study |publisher=For this reason some have criticized then Fed Chairman Alan Greenspan for "engineering" the housing bubble, [cite news |title=The American economy: A phoney recovery, Drug addicts get only a temporary high. America's economy, addicted to asset appreciation and debt, is no different |last=Roach |first=Stephen| work=
Federal Reserve Board|date=September 2005 |url=http://www.federalreserve.gov/pubs/ifdp/2005/841/ifdp841.pdf |quote=Like other asset prices, house prices are influenced by interest rates, and in some countries, the housing market is a key channel of monetary policy transmission. ] The Economist|date=2004-02-26
url=http://www.economist.com/finance/displayStory.cfm?story_id=2461875 |quote=The Fed, in effect, has become a serial bubble blower. ] [cite news |title=There Goes the Neighborhood: Why home prices are about to plummet—and take the recovery with them. | last=Wallace-Wells |first=Benjamin |work=
Washington Monthly|date=April 2004 |url=http://www.washingtonmonthly.com/features/2004/0404.wallace-wells.html] [cite news |title=Morgan Stanley Global Economic Forum: Original Sin |last=Roach |first=Stephen |publisher= Morgan Stanley|date=2005 |url=http://www.morganstanley.com/GEFdata/digests/20050425-mon.html See also James Wolcott's [http://jameswolcott.com/archives/2005/04/bubble_trouble.php comments] .] [cite book |title=American Theocracy: The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century |last=Phillips |first=Kevin |publisher=Viking |year=2006 |isbn=067003486X ] [cite news |title=Intimations of a Recession
last=Krugman |first=Paul | work=
The New York Times|date=2006-08-07 |url=http://select.nytimes.com/2006/08/07/opinion/07krugman.html ] [cite news |last=Fleckenstein |first=Bill |title=Face it: The housing bust is here |date=2006-08-21 |publisher= MSN|url=http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/FaceItTheHousingBustIsHere.aspx?page=all ] saying, e.g., "It was the Federal Reserve-engineered decline in rates that inflated the housing bubble." Between 2000 and 2003, the interest rate on 30-year fixed-rate mortgages fell 2.5 percentage points (from 8% to all-time historical low of about 5.5%). The interest rate on one-year adjustable rate mortgages (1/1 ARMs) fell 3 percentage points (from about 7% to about 4%). Richard Fisher, president of the Dallas Fed, said in 2006 that the Fed's low interest-rate policies unintentionally prompted speculation in the housing market, and that the subsequent "substantial correction [is] inflicting real costs to millions of homeowners."
A drop in mortgage interest rates reduces the cost of borrowing and should logically result in an increase in prices in a market where most people borrow money to purchase a home (for instance, in the United States), so that average payments remain constant. If one assumes that the housing market is efficient, the expected change in housing prices (relative to interest rates) can be computed mathematically. The calculation in the sidebox shows that a 1 percentage point change in interest rates would theoretically affect home prices by about 10% (given 2005 rates on fixed-rate mortgages). This represents a 10-to-1 multiplier between percentage point changes in interest rates and percentage change in home prices. For interest-only mortgages (at 2005 rates), this yields about a 16% change in principal for a 1% change in interest rates at current rates. Therefore, the 2% drop in long-term interest rates can account for about a 10 × 2% = 20% rise in home pricesif every buyer is using a fixed-rate mortgage (FRM), or about 16 × 3% ≈ 50% if every buyer is using an adjustable rate mortgage (ARM) whose interest rates dropped 3%.
Robert Shillershows that the inflation adjusted U.S. home price increase has been about 45% during this period, an increase in valuations that is approximately consistent with most buyers financing their purchases using ARMs. In areas of the United States believed to have a housing bubble, price increases have far exceeded the 50% that might be explained by the cost of borrowing using ARMs. For example, in San Diegoarea, average mortgage payments grew 50% between 2001 and 2004. When interest rates rise, a reasonable question is how much house prices will fall, and what effect this will have on those holding negative equity, as well as on the U.S. economyin general. The salient question is whether interest rates are a determining factor in specific markets where there is highsensitivity to housing affordability.
Between 2004 and 2006, the Fed raised interest rates 17 times, increasing them from 1% to 5.25%, before pausing.cite news |title=Fed holds rates for first time in two years |date=2006-08-08 |work=
Financial Times|url=http://www.ft.com/cms/s/09595e76-2562-11db-a12e-0000779e2340.html ] The Fed paused raising interest rates because of the concern that an accelerating downturn in the housing market could undermine the overall economy, just as the crash of the dot-com bubblein 2000 contributed to the subsequent recession. However, New York Universityeconomist Nouriel Roubiniasserted that "The Fed should have tightened earlier to avoid a festering of the housing bubble early on." [cite news |last=Roubini |first=Nouriel |title=Fed Holds Interest Rates Steady As Slowdown Outweighs Inflation |date=2006-08-09 |work= The Wall Street Journal|url=http://www.realestatejournal.com/buysell/markettrends/20060809-ip.html?refresh=on |quote=The Fed should havetightened earlier to avoid a festering of the housing bubble early on. The Fed is facing a nightmare now: the recession will come and easing will not prevent it. ]
There was a great debate as to whether or not the Fed would lower rates in late 2007. The majority of economists expected the Fed to maintain the Fed funds rate at 5.25 percent through 2008; [cite news |title=Poll: Fed to leave U.S. rates at 5.25 percent through end-2008 |date=2007-06-14 |work=
Reuters|url=http://www.reuters.com/article/ousiv/idUSL1441819820070614 ] however, on September 18, it lowered the rate to 4.75 percent. [cite news |title=In bold stroke, Fed cuts base rate half point to 4.75 percent |date=2007-09-17 |work=AFP |url=http://afp.google.com/article/ALeqM5gUqC8adFVuqJldLoqOnsF3bxEzOA ]
Risky mortgage products and lax lending standards
The recent use of subprime mortgages,
adjustable rate mortgages, interest-only mortgages, and stated income loans (a subset of "Alt-A" loans, where the borrower did not have to provide documentation to substantiate the income stated on the application; these loans were also called "no doc" (no documentation) loans and, somewhat pejoratively, as "liar loans") to finance home purchases described above have raised concerns about the quality of these loans should interest rates rise again or the borrower is unable to pay the mortgage.cite news |title=Adjustable-rate loans come home to roost: Some squeezed as interest rises, home values sag |work= [The Boston Globe] |date=2006-01-11 |url=http://www.boston.com/realestate/news/articles/2006/01/11/adjustable_rate_loans_come_home_to_roost?mode=PF ] cite news |title=Lenders Will Be SpottingIncome Fibs Much Faster |date=2006-10-01 |work= Hartford Courant|url=http://www.courant.com/business/hc-harney1001.artoct01,0,5083108.story ] cite news |title=24 Years Old, $2 Million in the Hole |date=2006-09-25 |work= Motley Fool|url=http://aol.fool.com/news/commentary/2006/commentary06092517.htm ] In many areas, particularly in those with most appreciation, non-standard loans went from almost unheard of to prevalent. For example, 80% of all mortgages initiated in San Diego region in 2004 were adjustable-rate, and 47% were interest only.
In 1995, Fannie Mae and Freddie Mac began receiving affordable housing credit for buying subprime securities [cite news|url=http://www.washingtonpost.com/wp-dyn/content/article/2008/06/09/AR2008060902626.html| title=How HUD Mortgage Policy Fed The Crisis|first=Carol D. |last=Leonnig|date= June 10, 2008|publisher=
Some borrowers got around downpayment requirements by using seller-funded downpayment assistance programs (DPA), in which a seller gives money to a charitable organizations that then give the money to them. From 2000 through 2006, more than 650,000 buyers got their down payments through nonprofits.cite news |url=http://www.bankrate.com/brm/news/mortgages/20071011_down_payment_assistance_a1.asp |title=Feds cut down-payment assistance programs |first=Holden |last=Lewis |publisher=Bankrate.com |accessdate=2008-03-17 ] According to a
Government Accountability Officestudy, there are higher default and foreclosure rates for these mortgages. The study also showed that sellers inflated home prices to recoup their contributions to the nonprofits. [cite web |url=http://www.gao.gov/new.items/d0624.pdf |format=PDF |date=November 2006| title=Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance| publisher= Government Accountability Office|accessdate=2008-03-17 ] On May 4, 2006 the IRS ruled that such plans are no longer eligible for non-profit status due to the circular nature of the cash flow, in which the seller pays the charity a "fee" after closing. [cite web |date=2006-05-04 |accessdate=2008-03-17 |url=http://www.irs.gov/newsroom/article/0,,id=156675,00.html |title=IRS Targets Down-Payment-Assistance Scams; Seller-Funded Programs Do Not Qualify As Tax Exempt |publisher= Internal Revenue Service] On October 31, 2007 the Department ofHousing and Urban Development adopted new regulations banning so-called "seller-funded" downpayment programs. Most must cease providing grants on FHA loans immediately; one can operate until March 31, 2008.
Some believe that mortgage standards became lax because of a
Moral hazard, where each link in the mortgage chain collected profits while believing it was passing on risk. [cite news |title='Moral hazard' helps shape mortgage mess |first=Holden |last=Lewis |publisher=Bankrate.com |url=http://www.bankrate.com/brm/news/mortgages/20070418_subprime_mortgage_morality_a1.asp?caret=3c |date=2007-04-18 ] Mortgage denial rates for conventional home purchase loans, reported under the Home Mortgage Disclosure Act, have dropped noticeably, from 29 percent in 1998, to 14 percent in 2002 and 2003.cite press release |title=(untitled) |date=2004-07-26 |publisher= Federal Financial Institutions Examination Council|accessdate=2008-03-18 |url=http://www.ffiec.gov/hmcrpr/hm072604.htm ]
In March 2007, the United States' subprime mortgage industry collapsed due to higher-than-expected home
foreclosurerates, with more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale.cite news |title=The Mortgage Mess Spreads |date=2007-03-07 |work= BusinessWeek|url=http://www.businessweek.com/investor/content/mar2007/pi20070307_505304.htm?chan=rss_topStories_ssi_5 ] " Harper's Magazine" warned of the danger of rising interest rates for recent homebuyers holding such mortgages, as well as the U.S. economy as a whole: "The problem [is] that prices are falling even as the buyers' total mortgage remains the same or even increases. ... Rising debt-service payments will further divert income from new consumer spending. Taken together, these factors will further shrink the “real” economy, drive downthose already declining real wages, and push our debt-ridden economy into Japan-style stagnation or worse."cite news |last=Hudson |first=Michael |title=The New Road to Serfdom| work=Harper's |date=May 2006 |volume=312 | number=1872 |pages=39–46 ] Factors that could contribute to rising rates are the U.S. national debt, inflationary pressure caused by such factors as increased fuel and housing costs, and changes in foreign investments in the U.S. economy. The Fed raised rates 17 times, increasing them from 1% to 5.25%, between 2004 and 2006. " BusinessWeek" magazine called the option ARM "the riskiest and most complicated home loan product ever created" and warned that over one million borrowers took out $466 billion in option ARMs in 2004 through the second quarter of 2006, citing concerns that these financial products could hurt individual borrowers the most and "worsen the [housing] bust."cite news |last=Der Hovanesian |first=Mara |title=Nightmare Mortgages |date=2006-09-01 |work= BusinessWeek
url=http://www.businessweek.com/magazine/content/06_37/b4000002.htm ] To address the problems arising from "liar loans", the
Internal Revenue Serviceupdated an income verification tool used by lenders to make confirmation of borrower's claimed income to be faster and easier. 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; the delinquency rate for Alt-A mortgages rose in 2007.cite news |title=Defaults Rise in Next Level of Mortgages |date=2007-04-10 |work= The New York Times|url=http://www.nytimes.com/2007/04/10/business/10lend.html ] 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.cite news |title=PIMCO's Gross |date=2007-06-27 |work= CNNMoney.com
Savings and Loan crisis
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