United States housing bubble

United States housing bubble is an economic bubble affecting many parts of the United States housing market, including areas of Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Maryland, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, Ohio, Oregon, Rhode Island, Tennessee, Utah, Virginia and Washington. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and may not yet have hit bottom as of 2011. On December 30, 2008 the Case-Shiller home price index reported its largest price drop in its history. Increased foreclosure rates in 2006–2007 among U.S. homeowners led to a crisis in August 2008 for the subprime, Alt-A, collateralized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007, the U.S. Secretary of the Treasury called the bursting housing bubble "the most significant risk to our economy.

Any collapse of the U.S. Housing Bubble has a direct impact not only on home valuations, but the nation's mortgage markets, home builders, real estate, home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks, increasing the risk of a nationwide recession. Concerns about the impact of the collapsing housing and credit markets on the larger U.S. economy caused President George W. Bush and the Chairman of the Federal Reserve Ben Bernanke to announce a limited bailout of the U.S. housing market for homeowners who were unable to pay their mortgage debts.

In 2008 alone, the United States government allocated over $900 billion to special loans and rescues related to the US housing bubble, with over half going to the quasi-government agencies of Fannie Mae, Freddie Mac, and the Federal Housing Administration. On December 24, 2009 the Treasury Department made an unprecedented announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years despite acknowledging losses in excess of $400 billion so far. Treasury has been criticized for encroaching on spending powers that are enumerated for Congress alone by the US constitution, and for violating limits imposed by the Housing and Economic Recovery Act of 2008.

Identification

Internal email from Deutsche Bank in 2005, describing a CDO trader's view of the housing bubble

Although many people claim that an economic bubble is difficult to identify except in hindsight, numerous economic and cultural factors led several economists (especially in late 2004 and early 2005) to argue that a housing bubble existed in the U.S. Dean Baker identified the bubble in August 2002, thereafter repeatedly warning of its nature and depth, and the political reasons it was being ignored. Prior to that, Robert Prechter wrote about it extensively as did Professor Shiller in his original publication of Irrational Exuberance in the year 2000.

G. Edward Griffin predicted it in his 1994 book "The Creature from Jekyll Island." So did the following author in a March 3, 2003 article:

We can profit from the collapse of the credit bubble and the subsequent stock market divestment. However, real estate has not yet joined in a decline of prices fed by selling (and foreclosing). Unless you have a very specific reason to believe that real estate will outperform all other investments for several years, you may deem this prime time to liquidate investment property (for use in more lucrative markets).

Many contested any suggestion that there could be a housing bubble, particularly at its peak from 2004 to 2006, with some rejecting the "house bubble" label in 2008. Claims that there was no warning of the crisis were further repudiated in an August 2008 article in The New York Times, which reported that in mid-2004 Richard F. Syron, the CEO of Freddie Mac, received a memo from David Andrukonis, the company's former chief risk officer, warning him that Freddie Mac was financing risk-laden loans that threatened Freddie Mac's financial stability. In his memo, Mr. Andrukonis wrote that these loans "would likely pose an enormous financial and reputational risk to the company and the country. The article revealed that more than two-dozen high-ranking executives said that Mr. Syron had simply decided to ignore the warnings. Other cautions came as early as 2001, when the late Federal Reserve governor Edward Gramlich warned of the risks posed by sub-prime mortgages. Reuters reported in October 2007 that a Merrill Lynch analyst too had warned in 2006 that companies could suffer from their subprime investments.

The Economist magazine stated, "The worldwide rise in house prices is the biggest bubble in history, so any explanation needs to consider its global causes as well as those specific to the United States. The then Federal Reserve Board Chairman Alan Greenspan said in mid-2005 that "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"; Greenspan admitted in 2007 that froth "was a euphemism for a bubble. In early 2006, President Bush said of the U.S. housing boom: "If houses get too expensive, people will stop buying them... Economies should cycle.

Throughout the bubble period there was little if any mention of the fact that housing in many areas was (and still is) selling for well above replacement cost.

Extent

Home price appreciation has been non-uniform to such an extent that some economists, including former Fed Chairman Alan Greenspan, have argued that United States was not experiencing a nationwide housing bubble per se, but a number of local bubbles. However, in 2007 Greenspan admitted that there was in fact a bubble in the US housing market, and that "all the froth bubbles add up to an aggregate bubble.Despite greatly relaxed lending standards and low interest rates, many regions of the country saw very little growth during the "bubble period". Out of 20 largest metropolitan areas tracked by the S&P/Case-Shiller house price index, six (Dallas, Cleveland, Detroit, Denver, Atlanta, and Charlotte) saw less than 10% price growth in inflation-adjusted terms in 2001–2006. During the same period, seven metropolitan areas (Tampa, Miami, San Diego, Los Angeles, Las Vegas, Phoenix, and Washington DC) appreciated by more than 80%.

However, housing bubbles did not manifest themselves in each of these areas at the same time. San Diego and Los Angeles had maintained consistently high appreciation rates since late 1990s, whereas the Las Vegas and Phoenix bubbles did not develop until 2003 and 2004 respectively.

Background

Housing bubbles may occur in local or global real estate markets. In their late stages, they are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This may be followed by decreases in home prices that result in many owners finding themselves in a position of negative equity—a mortgage debt higher than the value of the property. The underlying causes of the housing bubble are complex. Factors include tax policy (exemption of housing from capital gains), historically low interest rates, tax lending standards, failure of regulators to intervene, and speculative fever. This bubble may be related to the stock market or dot-com bubble of the 1990s. This bubble roughly coincides with the real estate bubbles of the United Kingdom, Hong Kong, Spain, Poland, Hungary and South Korea.

Robert Shiller's plot of U.S. home prices, population, building costs, and bond yields, from Irrational Exuberance, 2nd ed. Shiller shows that inflation-adjusted U.S. home prices increased 0.4% per year from 1890–2004 and 0.7% per year from 1940–2004, whereas U.S. census data from 1940–2004 shows that the self-assessed value increased 2% per year.

While bubbles may be identifiable in progress, bubbles can be definitively measured only in hindsight after a market correction,which in the U.S. housing market began in 2005–2006. Former U.S. Federal Reserve Board Chairman Alan Greenspan said "We had a bubble in housing", and also said in the wake of the subprime mortgage and credit crisis in 2007, "I really didn't get it until very late in 2005 and 2006. The mortgage and credit crisis was caused by the inability of a large number of home owners to pay their mortgages as their low introductory-rate (sub-prime) mortgages reverted to regular interest rates. Freddie Mac CEO Richard Syron concluded, "We had a bubble", and concurred with Yale economist Robert Shiller's warning that home prices appear overvalued and that the correction could last years, with trillions of dollars of home value being lost. Greenspan warned of "large double digit declines" in home values "larger than most people expect. Problems for home owners with good credit surfaced in mid-2007, causing the U.S.'s largest mortgage lender, Countrywide Financial, to warn that a recovery in the housing sector was not expected to occur at least until 2009 because home prices were falling "almost like never before, with the exception of the Great Depression. The impact of booming home valuations on the U.S. economy since the 2001–2002 recession was an important factor in the recovery, because a large component of consumer spending was fueled by the related refinancing boom, which allowed people to both reduce their monthly mortgage payments with lower interest rates and withdraw equity from their homes as their value increased.