This chapter is from the book
This chapter is from the book
This chapter is from the book
Housing Boom
Global investors were particularly enamored of securities backed by U.S. residential mortgage loans. American homeowners were historically reliable, paying on their mortgages even in tough economic times. Certainly, some cities or regions had seen falling house prices and rising mortgage defaults, but these were rare. Indeed, since the Great Depression, house prices nationwide had not declined in a single year. And U.S. housing produced trillions of dollars in mortgage loans, a huge source of assets to securitize.
With funds pouring into mortgage-related securities, mortgage lenders avidly courted home buyers. Borrowing costs plunged and mortgage credit was ample. Housing was as affordable as it had been since just after World War II, particularly in areas such as California and the Northeast, where homeownership had long been a stretch for most renters. First-time home buyers also benefited as the Internet transformed the mortgage industry, cutting transaction costs and boosting competition. New loan products were invented for households that had historically had little access to standard forms of credit, such as mortgages. Borrowers with less than perfect credit history—or no credit history—could now get a loan. Of course, a subprime borrower needed a sizable down payment and a sturdy income, but even that changed quickly.
Home buying took on an added sheen after 9/11, as Americans grew wary of travel, with the hassles of air passenger screening and code-orange alerts. Tourist destinations struggled. Americans were staying home more, and they wanted those homes to be bigger and nicer. Many traded up.
As home sales took off, prices began to rise more quickly, particularly in highly regulated areas of the country. Builders couldn’t put up houses quickly enough in California, Florida, and other coastal areas, which had tough zoning restrictions, environmental requirements, and a long and costly permitting process.
The house price gains were modest at first, but they appeared very attractive compared with a still-lagging stock market and the rock-bottom interest rates banks were offering on savings accounts. Home buyers saw a chance to make outsized returns on homes by taking on big mortgages. Besides, interest payments on mortgage loans were tax deductible, and since the mid-1990s, even capital gains on most home sales haven’t been taxed.
It didn’t take long for speculation to infect housing markets. Flippers—housing speculators looking to buy and sell quickly at a large profit—grew active. Churning was especially rampant in condominium, second-home, and vacation-home markets, where a flipper could always rent a unit if it didn’t sell quickly. Some of these investors were disingenuous or even fraudulent when applying for loans, telling lenders they planned to live in the units so they could obtain better mortgage terms. Flippers were often facilitated by home builders who turned a blind eye in the rush to meet ever-rising home sales projections.
Speculation extended beyond flippers, however. Nearly all homeowners were caught up in the idea that housing was a great investment, possibly the best they could make. The logic was simple: House prices had risen strongly in the recent past, so they would continue to rise strongly in the future.
Remodeling and renovations surged. By mid-decade, housing markets across much of the country were in a frenzied boom. House sales, construction, and prices were all shattering records. Prices more than doubled in such far-flung places as Providence, Rhode Island; Naples, Florida; Minneapolis, Minnesota; Tucson, Arizona; Salt Lake City, Utah; and Sacramento, California.
The housing boom did bring an important benefit: It jump-started the broader economy out of its early-decade malaise. Not only were millions of jobs created to build, sell, and finance homes, but homeowners were also measurably wealthier. Indeed, the seeming financial windfall for lower- and middle- American homeowners was arguably unprecedented. The home was by far the largest asset on most households’ balance sheet.
Moreover, all this newfound wealth could be readily and cheaply converted into cash. Homeowners became adept at borrowing against the increased equity in their homes, refinancing into larger mortgages, and taking on big home equity lines. This gave the housing boom even more economic importance as the extra cash financed a spending splurge.
Extra spending was precisely what the central bankers at the Federal Reserve had in mind when they were slashing interest rates. After all, the point of adjusting monetary policy is to raise or lower the economy’s speed by regulating the flow of credit through the financial system and economy. Nevertheless, by mid-2004, the booming housing market and strong economy convinced policymakers it was time to throttle back by raising rates.