Interest Rate Roundup

Monday, October 22, 2007

The real reason the housing market took off ...

Don't miss this Business Week story. It's titled "A Troubled 'Ownership Society'" and it focuses on figures from Goldman Sachs and a study from the Federal Reserve Bank of Atlanta. Both parties tried to identify the primary reason for the surge in the homeownership rate since 1995. Their conclusions (with my emphasis added)?

"Surprising new research published by the Federal Reserve Bank of Atlanta concludes that the bulk of the increase was caused by innovations in the mortgage market, in particular the explosion of 'piggyback' or 'combo' loans that made it possible for people to make small or zero down payments. Young families with little savings flocked to those loans to buy first homes."

I especially like this excerpt:

"Many analysts have fingered easy lending as a contributor to the housing boom, but the Atlanta Fed paper may be the first to quantify its effect in a rigorous way. Using math-heavy econometric analysis, the authors conclude that the availability of new kinds of mortgages, mainly ones with low down payments, accounted for 56% to 70% of the decade-long increase in the U.S. homeownership rate, while demographic changes accounted for only 16% to 31% of the effect."

My take? I believe the boom STARTED OUT healthy, with reasonable, late-1990s gains in home sales, home prices, and homeownership rates fueled by rising incomes and a REASONABLE loosening in lending standards. But then the economy slumped in the wake of the dot-com bust.

Rather than allow a normal, healthy, cyclical economic and housing market slowdown to play out, the Fed panicked. It slashed interest rates to the bone and kept them there for far too long. Lenders decided to get more "creative" with their mortgage offerings because they could offload the risk to any Tom, Dick, and Harry hedge fund looking to squeeze a few more basis points out of his portfolio. Regulators completely abandoned any pretense of active supervision/regulation. All heck broke loose, speculation exploded, and we experienced the biggest U.S. housing bubble in modern history.

In other words, the primary forces driving the boom weren't immigration, Baby Boomer demand for second homes, and all those other forces that real estate industry players kept citing during the bubble. It was plain and simple easy money and excess credit, in all their many forms. Now, we're all stuck trying to mop up the mess.


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