2000s United States housing market correction

A United States housing market correction is a market correction or "bubble bursting" of a United States housing bubble; the most recent one started in 2005. A real estate bubble is a type of economic bubble that occurs periodically in local or global real estate markets.A housing bubble is characterized by rapid increases in the valuations of real property such as housing until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This in turn is followed by a market correction in which decreases in home prices can result in many owners holding negative equity, a mortgage debt higher than the value of the property.

Timeline

Timeline 1985–ongoing

• 1985–1991: Savings and Loan crisis
  • January 1989: One-month drop sales of 12.6 percent.
  • 1986–1991: New homes constructed dropped from 1.8 to 1 million, the lowest rated since World War II.
• 1991–1997: Flat Housing prices
  • 1991: US recession, new construction prices fall, but above inflationary growth allows them to return by 1997 in real terms.
  • 1997: Mortgage denial rate of 29 percent for conventional home purchase loans
  • September 23, 1998: New York Fed brings together consortium of investors to bail out Long-Term Capital Management
  • 1998: Inflation-adjusted home price appreciation exceeds 10%/year in most West Coast metropolitan areas
  • 1999: Gramm-Leach-Bliley Act, repealed the Glass-Steagall Act of 1933, allowed commercial and investment banks to consolidate.
  • 1995–2001: Dot-com bubble
    • March 10, 2000: Dot-com bubble collapse NASDAQ Composite index peaked
• 2000–2003: Early 2000s recession (exact time varies by country)
• 2001–2005: United States housing bubble (part of the world housing bubble)
  • 2001: US Federal Reserve lowers Federal funds rate 11 times, from 6.5% to 1.75%.
  • 2002–2003: Mortgage denial rate of 14 percent for conventional home purchase loans, half of 1997
  • 2002: Annual home price appreciation of 10% or more in California, Florida, and most Northeastern states.
  • 2004: U.S. homeownership rate peaked with an all time high of 69.2 percent.
  • 2004–2005: Arizona, California, Florida, Hawaii, and Nevada record price increases in excess of 25% per year.
• 2005–ongoing: United States housing market correction ("bubble bursting")
  • 2005: Boom ended August 2005. The booming housing market halted abruptly for many parts of the U.S. in late summer of 2005.
  • 2006: Continued market slowdown. Prices are flat, home sales fall, resulting in inventory buildup. U.S. Home Construction Index is down over 40% as of mid-August 2006 compared to a year earlier.
  • 2007: Year-to-year decreases in both U.S. home sales and home prices accelerates rather than bottoming out, with U.S. Treasury secretary Paulson calling the "the housing decline ... the most significant risk to our economy."

Timeline 2007

• • 2007: Home sales continue to fall. The plunge in existing-home sales is the steepest since 1989. In Q1/2007, S&P/Case-Shiller house price index records first year-over-year decline in nationwide house prices since 1991. The subprime mortgage industry collapses, and a surge of foreclosure activity (twice as bad as 2006) and rising interest rates threaten to depress prices further as problems in the subprime markets spread to the near-prime and prime mortgage markets. The U.S. Treasury secretary calls the "ongoing housing correction" "the most significant risk to our economy."
    • February–ongoing: 2007 Subprime mortgage financial crisis Subprime industry collapse; more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale.
    • April 2: New Century Financial, largest U.S. subprime lender, files for chapter 11 bankruptcy.
    • August: worldwide "credit crunch" as subprime mortgage backed securities are discovered in portfolios of banks and hedge funds around the world, from BNP Paribas to Bank of China. Many lenders stop offering home equity loans and "stated income" loans. Federal Reserve injects about $100B into the money supply for banks to borrow at a low rate.
    • August 6: American Home Mortgage files for chapter 11 bankruptcy.
    • August 7: Democratic presidential front-runner Hillary Clinton proposes a $1 billion bailout fund to help homeowners at risk for foreclosure.
    • August 16: Countrywide Financial Corporation, the biggest U.S. mortgage lender, narrowly avoids bankruptcy by taking out an emergency loan of $11 billion from a group of banks.
    • August 17: Federal Reserve lowers the discount rate by 50 basis points to 5.75% from 6.25%.
    • August 31: President Bush announces a limited bailout of U.S. homeowners unable to pay the rising costs of their debts.Ameriquest, once the largest subprime lender in the U.S., goes out of business;
    • September 1–3: Fed Economic Symposium in Jackson Hole, WY addressed the housing recession that jeopardizes U.S. growth. Several critics argued that the Fed should use regulation and interest rates to prevent asset-price bubbles, blamed former Fed-chairman Alan Greenspan's low interest rate policies for stoking the U.S. housing boom and subsequent bust,, and Yale University economist Robert Shiller warned of possible home price declines of 50 percent.
    • September 17: Former Fed Chairman Alan Greenspan said "we had a bubble in housing" and warns of "large double digit declines" in home values "larger than most people expect."
    • September 18: The Fed lowers interest rates by half a percent (50 basis points) to 4.75% in an attempt to limit damage to the economy from the housing and credit crises.
    • September 28: Television finance personality Jim Cramer warns Americans on The Today Show, "don't you dare buy a home—you'll lose money," causing a furor among realtors.
    • September 30: Affected by the spiraling mortgage and credit crises, Internet banking pioneer NetBank goes bankrupt, the first FDIC-insured bank to fail since the savings and loan crisis,, and the Swiss bank UBS announced that it lost US$690 million in the third quarter.
    • September 30:Prices fell 4.9 percent from September 2006 in 20 large metropolitan areas, according to Standard & Poor’s/Case-Shiller indexes. This is the 9th straight month priced have fallen.
    • October 10: US Government and private industry created Hope Now Alliance to help some sub-prime borrowers.
    • October 15–17: A consortium of U.S. banks backed by the U.S. government announced a "super fund" or super-SIV" of $100 billion to purchase mortgage backed securities whose mark-to-market value plummeted in the subprime collapse. Fed chairman Ben Bernanke expressed alarm about the dangers posed by the bursting housing bubble;) Secretary of the Treasury Paulson said "the housing decline is still unfolding and I view it as the most significant risk to our economy. … The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth."
    • October 31: Federal Reserve lowers the federal funds rate by 25 basis points to 4.5 percent and the discount window rate by 25 basis points to 5 percent.
    • October 31: Prices fell 6.1 percent from October 2006 in 20 large metropolitan areas, according to Standard & Poor’s/Case-Shiller indexes. This is the 10th straight month priced have fallen.
    • October 31: The Department of Housing and Urban Development adopted new regulations banning so-called "seller-funded" downpayment programs.
    • November 1: Federal Reserve injects $41B into the money supply for banks to borrow at a low rate. The largest single expansion by the Fed since $50.35B on September 19, 2001.
    • December 6: President Bush announced a plan to voluntarily freeze the mortgages of a limited number of mortgage debtors holding ARMs for 5 years. The plan run by the Hope Now Alliance. Its phone number is 1-888-995-HOPE. Some experts criticized the plan as "a Band-Aid when the patient needs major surgery", a "teaser-freezer", and a "bail-out".
    • December 11: Federal Reserve lowers the federal funds rate by 25 basis points to 4.25 percent and the discount window rate by 25 basis points to 4.75 percent.
    • December 12: Federal Reserve injects $40B into the money supply for banks to borrow at a low rate and coordinates such efforts with central banks from Canada, United Kingdom, Switzerland and European Union.
    • December 24: A consortium of banks officially abandons the U.S. government-supported "super-SIV" mortgage crisis bail-out plan announced in mid-October, citing a lack of demand for the risky mortgage products on which the plan was based, and widespread criticism that the fund was a flawed idea that would have been difficult to execute.
    • December 26: Standard & Poor’s/Case-Shiller indexes of housing prices in 20 large metropolitan areas for October 2007 is released showing that for the 10th straight month priced have fallen, but most worrying is that the decline in home prices accelerated and spread to more regions of the country in October. "Since their peak in July 2006, home prices in the 20 regions have dropped 6.6 percent. Economists' predictions of the total amount of home price declines from the bubble's peak range from moderate 10–15 percent to larger 30–50 percent price declines in some areas.
    • December 28: The U.S. Commerce Department reported that November 2007 new home sales were down 9 pct to a seasonally-adjusted annual rate of 647,000 the lowest sales rate since April 1995.

Market correction predictions

File:WaPo Bubble Bench.png The Washington DC "bubble bench" made famous by the Washington Post; the 49 lockboxes hold keys to unsold units of a 200 unit condominium complex in Fairfax County, Virginia.

Comparison the percentage change of the Case-Shiller Home Price Index for the housing correction beginning in 2005 (red) and the 1980s–1990s correction (blue), comparing monthly CSI values to the peak value seen just prior to the first declining month all the way through the downturn and the full recovery of home prices.

NAR chief economist David Lereah's Explanation of "What Happened" from the 2006 NAR Leadership Conference Boom ended August 2005 Mortgage rates rose almost one point Affordability conditions deteriorated Speculative investors pulled out Homebuyer confidence plunged Resort buyers went to sidelines Trade-up buyers to sidelines First-time buyers priced out of market

Based on the historic trends in valuations of U.S. housing, many economists and business writers have predicted a market correction, ranging from a few percentage points, to 50% or more from peak values in some markets, and, in spite of the fact that this cooling has not affected all areas of the U.S., some have warned that it could and that the correction would be "nasty" and "severe". Chief economist Mark Zandi of the research firm Moody's Economy.com predicted a "crash" of double-digit depreciation in some U.S. cities by 2007–2009.

Bubble bursts

The booming housing market appears to have halted abruptly for many parts of the U.S. in late summer of 2005, and as of summer 2006, several markets are facing the issues of ballooning inventories, falling prices, and sharply reduced sales volumes. In August 2006, Barron's magazine warned, "a housing crisis approaches", and noted that the median price of new homes has dropped almost 3% since January 2006, that new-home inventories hit a record in April and remain near all-time highs, that existing-home inventories are 39% higher than they were just one year ago, and that sales are down more than 10%, and predicts that "the national median price of housing will probably fall by close to 30% in the next three years … simple reversion to the mean." Fortune magazine labelled many previously strong housing markets as "Dead Zones;" other areas are classified as "Danger Zones" and "Safe Havens." Fortune also dispelled "four myths about the future of home prices." In Boston, year-over-year prices are dropping, sales are falling, inventory is increasing, foreclosures are up, and the correction in Massachusetts has been called a "hard landing". The previously booming housing markets in Washington DC, San Diego CA, Phoenix AZ, and other cities have stalled as well. Searching the Arizona Regional Multiple Listing Service (ARMLS) shows that in summer 2006, the for-sale housing inventory in Phoenix has grown to over 50,000 homes, of which nearly half are vacant (see graphic). Several home builders have revised their forecasts sharply downward during summer 2006, e.g., D.R. Horton cut its yearly earnings forecast by one-third in July 2006, the value of luxury home builder Toll Brothers' stock fell 50% between August 2005 and August 2006, and the Dow Jones U.S. Home Construction Index was down over 40% as of mid-August 2006. CEO Robert Toll of Toll Brothers explained, "builders that built speculative homes are trying to move them by offering large incentives and discounts; and some anxious buyers are canceling contracts for homes already being built." Homebuilder Kara Homes, known for their construction of "McMansions", announced on 13 September 2006 the "two most profitable quarters in the history of our company", yet filed for bankruptcy protection less than one month later on 6 October. Six months later on 10  April 2007, Kara Homes sold unfinished developments, causing prospective buyers from the previous year to lose deposits, some of whom put down more than $100,000.

As the housing market began to soften in winter 2005 through summer 2006, NAR chief economist David Lereah predicted a "soft landing" for the market. However, based on unprecedented rises in inventory and a sharply slowing market throughout 2006, Leslie Appleton-Young, the chief economist of the California Association of Realtors, said that she is not comfortable with the mild term "soft landing" to describe what is actually happening in California's real estate market. The Financial Times warned of the impact on the U.S. economy of the "hard edge" in the "soft landing" scenario, saying "A slowdown in these red-hot markets is inevitable. It may be gentle, but it is impossible to rule out a collapse of sentiment and of prices. … If housing wealth stops rising … the effect on the world's economy could be depressing indeed." "It would be difficult to characterize the position of home builders as other than in a hard landing", said Robert Toll, CEO of Toll Brothers. Angelo Mozilo, CEO of Countrywide Financial, said "I've never seen a soft-landing in 53 years, so we have a ways to go before this levels out. I have to prepare the company for the worst that can happen." Following these reports, Lereah admitted that "he expects home prices to come down 5% nationally", and said that some cities in Florida and California could have "hard landings." National home sales and prices both fell dramatically again in March 2007 according to NAR data, with sales down 13% to 482,000 from the peak of 554,000 in March 2006 and the national median price falling nearly 6% to $217,000 from the peak of $230,200 in July 2006 . The plunge in existing-home sales is the steepest since 1989 . The new home market is also suffering. The biggest year over year drop in median home prices since 1970 occurred in April of 2007. Median prices for new homes fell 10.9 percent according to the Commerce Department.

Based on slumping sales and prices in August 2006, economist Nouriel Roubini warned that the housing sector is in "free fall" and will derail the rest of the economy, causing a recession in 2007. Joseph Stiglitz, winner of the Nobel Prize in economics in 2001, agreed, saying that the U.S. may enter a recession as house prices decline. The extent to which the economic slowdown, or possible recession, will last depends in large part on the resiliency of the U.S. consumer spending, which now makes up approximately 70% of the US$13.7 trillion economy. The evaporation of the wealth effect amid the current housing downturn could negatively affect the consumer confidence and provide further headwind for the U.S. economy and that of the rest of the world. The World Bank recently lowered the global economic growth rate due to a housing slowdown in the United States, but it does not believe that the U.S. housing malaise will further spread to the rest of the world. The Fed chairman Benjamin Bernanke said in October 2006 that there is currently a "substantial correction" going on in the housing market and that the decline of residential housing construction is one of the "major drags that is causing the economy to slow"; he predicted that the correcting market will decrease U.S. economic growth by about one percent in the second half of 2006 and remain a drag on expansion into 2007.

Others speculate on the negative impact of the retirement of the Baby Boom generation and the relative cost to rent on the declining housing market. In many parts of the United States, it is significantly cheaper to rent the same property than to purchase it; the national median mortgage payment is $1,687 per month, nearly twice the median rent payment of $868 per month.

Subprime mortgage industry collapse

Main article: 2007 Subprime mortgage financial crisis

In March 2007, the United States' subprime mortgage industry collapsed due to higher-than-expected home foreclosure rates, with more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale. The stock of the country's largest subprime lender, New Century Financial, plunged 84% amid Justice Department investigations, before ultimately filing for Chapter 11 bankruptcy on 2 April 2007 with liabilities exceeding $100 million. 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. Bill Gross, "a most reputable financial guru", sarcastically and ominously criticized the credit ratings of the mortgage-based CDOs now facing collapse:

AAA? You were wooed Mr. Moody’s and Mr. Poor’s, by the makeup, those six-inch hooker heels, and a “tramp stamp.” Many of these good looking girls are not high-class assets worth 100 cents on the dollar. … And sorry Ben, but derivatives are a two-edged sword. Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain. When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of that leverage ultimately reduces the price of assets. Houses anyone? … AAAs? [T]he point is that there are hundreds of billions of dollars of this toxic waste and whether or not they’re in CDOs or Bear Stearns hedge funds matters only to the extent of the timing of the unwind. [T]he subprime crisis is not an isolated event and it won’t be contained by a few days of headlines in The New York Times … The flaw lies in the homes that were financed with cheap and in some cases gratuitous money in 2004, 2005, and 2006. Because while the Bear hedge funds are now primarily history, those millions and millions of homes are not. They’re not going anywhere … except for their mortgages that is. Mortgage payments are going up, up, and up … and so are delinquencies and defaults. A recent research piece by Bank of America estimates that approximately $500 billion of adjustable rate mortgages are scheduled to reset skyward in 2007 by an average of over 200 basis points. 2008 holds even more surprises with nearly $700 billion ARMS subject to reset, nearly ¾ of which are subprimes … This problem—aided and abetted by Wall Street—ultimately resides in America’s heartland, with millions and millions of overpriced homes and asset-backed collateral with a different address—Main Street.

Financial analysts predict that the subprime mortgage collapse will result in earnings reductions for large Wall Street investment banks trading in mortgage-backed securities, especially Bear Stearns, Lehman Brothers, Goldman Sachs, Merrill Lynch, and Morgan Stanley. The solvency of two troubled hedge funds managed by Bear Stearns was imperliled in June 2007 after Merrill Lynch sold off assets seized from the funds and three other banks closed out their positions with them. The Bear Stearns funds once had over $20 billion of assets, but lost billions of dollars on securities backed by subprime mortgages. H&R Block reported that it made a quarterly loss of $677 million on discontinued operations, which included subprime lender Option One, as well as writedowns, loss provisions on mortgage loans and the lower prices available for mortgages in the secondary market for mortgages. The units net asset value fell 21% to $1.1 billion as of April 30 2007. The head of the mortgage industry consulting firm Wakefield Co. warned, "This is going to be a meltdown of unparalleled proportions. Billions will be lost." Bear Stearns pledged up to US$3.2 billion in loans on 22 June 2007 to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages. Peter Schiff, president of Euro Pacific Capital, argued that if the bonds in the Bear Stearns funds were auctioned on the open market, much weaker values would be plainly revealed. Schiff added, "This would force other hedge funds to similarly mark down the value of their holdings. Is it any wonder that Wall street is pulling out the stops to avoid such a catastrophe? … Their true weakness will finally reveal the abyss into which the housing market is about to plummet." The New York Times report connects this hedge fund crisis with lax lending standards: "The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them struggling to stay in their homes."

In the wake of the mortgage industry meltdown, Senator Chris Dodd, Chairman of the Banking Committee held hearings in March 2007 and asked executives from the top five subprime mortgage companies to testify and explain their lending practices; Dodd said, "predatory lending practices" endangered the home ownership for millions of people. Moreover, Democratic senators such as Senator Charles Schumer of New York are already proposing a federal government bailout of subprime borrowers in order to save homeowners from losing their residences. Opponents of such proposal assert that government bailout of subprime borrowers is not in the best interests of the U.S. economy because it will simply set a bad precedent, create a moral hazard, and worsen the speculation problem in the housing market. Lou Ranieri of Salomon Brothers, inventor the mortgage-backed securities market in the 1970s, warned of the future impact of mortgage defaults: "This is the leading edge of the storm. … If you think this is bad, imagine what it's going to be like in the middle of the crisis." In his opinion, more than $100 billion of home loans are likely to default when the problems in the subprime industry appear in the prime mortgage markets. Fed Chairman Alan Greenspan praised the rise of the subprime mortgage industry and the tools with which it uses to assess credit-worthiness in an April 2005 speech:

Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country … With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. … Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s.

Because of these remarks, along with his encouragement for the use of adjustable-rate mortgages, Greenspan has been criticized for his role in the rise of the housing bubble and the subsequent problems in the mortgage industry.

Alt-A mortgage problems

Subprime and Alt-A (including "stated income" or "liar's loans" which are basically loans made to home buyers without the verification of borrowers' incomes; home buyers tend to overstate their incomes in order to get the loan amounts they desire to purchase their dream homes, thus called the "liar's loans") loans account for about 21 percent of loans outstanding and 39 percent of mortgages made in 2006. 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. American Home Mortgage said that it would earn less and pay out a smaller dividend to its shareholders because it was being asked to buy back and write down the value of Alt-A loans made to borrowers with decent credit; causing company stocks to tumble 15.2 percent. The delinquency rate for Alt-A mortgages has been rising in 2007. In June 2007, Standard & Poor's warned that U.S. homeowners with good credit are increasingly falling behind on mortgage payments, an indication that lenders have been offering higher risk loans outside the subprime market; they said that rising late payments and defaults on Alt-A mortgages made in 2006 are "disconcerting" and delinquent borrowers appear to be "finding it increasingly difficult to refinance" or catch up on their payments. Late payments of at least 90 days and defaults on 2006 Alt-A mortgages have increased to 4.21 percent, up from 1.59 percent for 2005 mortgages and 0.81 percent for 2004, indicating that "subprime carnage is now spreading to near prime mortgages."

Foreclosure rates increase

The 30-year mortgage rates increased by more than a half a percentage point to 6.74 percent during May–June 2007 , affecting borrowers with the best credit just as a crackdown in subprime lending standards limits the pool of qualified buyers. The national median home price is poised for its first annual decline since the Great Depression, and the NAR reported that supply of unsold homes is at a record 4.2 million. Goldman Sachs and Bear Stearns, respectively the world's largest securities firm and largest underwriter of mortgage-backed securities in 2006, said in June 2007 that rising foreclosures reduced their earnings and the loss of billions from bad investments in the subprime market imperiled the solvency of several hedge funds. Mark Kiesel, executive vice president of a California-based Pacific Investment Management Co. said,

It's a blood bath. … We're talking about a two- to three-year downturn that will take a whole host of characters with it, from job creation to consumer confidence. Eventually it will take the stock market and corporate profit.

According to Donald Burnette of Knight Mortgage Company in Florida, one of the states hit hardest by the bursting housing bubble, the corresponding loss in equity from the drop in housing values has caused new problems. "It is keeping even borrowers with good credit and solid resourses from refinancing to better terms. Even with tighter restrictions on ALT A and the disappearance of most subprime programs, there are many borrowers who would qualify as "A" borrowers who can't qualify to refinance as they no longer have the equity in their homes that they had in 2005 or 2006. They will have to wait for the market to recover to refinance to the terms they deserve."

See also

• 2007 Subprime mortgage financial crisis
• Subprime lending
• Mortgage loan
• Real estate bubble
• List of entities involved in 2007 finance crises
• The world housing bubble
  • British property bubble
  • Chinese property bubble
  • Indian property bubble
  • Irish property bubble
  • Japanese asset price bubble
  • Russian property bubble
  • Spanish property bubble
• Economic bubble
• dot-com bubble
• Real estate pricing
• Real estate appraisal
• Real estate economics
• Real estate trends
• Creative Real Estate Investing
• Deed in lieu of foreclosure
• Foreclosure consultant

References and notes

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