[embedyt] https://www.youtube.com/watch?v=XwDrVZBzI6Y%5B/embedyt%5DBesides the current economic concerns, the house price boom has also created worries about future market stability. The Economist recently explained how this housing bubble could wipe out $8 trillion in American household wealth over the next decade – more than the country’s GDP. It’s impossible to predict when this will happen, but economists are certain that it is coming. This post discusses how there might be a near-term collapse of the US mortgage market over fears that few homes are being bought with cash anymore – particularly by young Americans with little or no credit history. This development could lead to a major economic crisis in America.
A bit from the history of the Mortgage bubble
First, let’s look at the data. The following graph from the Economist compares the median house price to earnings. In 1985, a house was 3.9 times more expensive than the average income in a major city ($70,000 divided by $20,000). By 2006, this had risen to 6.5 ($210,000 divided by $45,000).
Update: Median US house prices increased from $219k in October 2005 to $265k in March 2008 – representing annual growth of 5%. This is close to the 5-year moving average of annual growth rates – which is currently 4.8%.
What is causing the house price growth?
The Economist points out that it is mainly coming from low interest rates, tax breaks for first-time buyers, lax credit standards, and foreign investors. Low interest rates have boosted the demand for housing, particularly as inflation rates are close to zero. Tax breaks have helped boost supply by more than 100,000 units a month. Lax credit standards have allowed people with bad credit to buy homes. Foreign investment has increased because of the hype about real estate on TV shows like “Flip This House.” This explains why 65% of all mortgage originations last year were refinanced loans. Only 8% were purchase loans – which was down from 20% in 2000.
Where will the housing market collapse?
The Economist suggests that it will come from three different directions. First, there is a lack of demand for houses – especially from young people. US mortgage rates are low, and most older couples have enough equity to buy homes without paying high interest rates. This means there is plenty of supply and, as a result, prices can’t be expected to rise much more.
Second, the American economy has been growing at a slow 3% rate – well below potential growth levels, which indicates that this could lead to slower economic expansion. Lastly, the ratio of debt to GDP for American households is quite high (around 280%). This is well above 300% in Sweden, which suggests that American households are vulnerable to a crash.
What can be done?
At this point, it appears that there is very little the Federal Reserve can do by increasing interest rates. It has already raised them to 5% over the past few years – but house prices have continued to rise. If this trend continues, then it suggests that prices have nowhere to go but down – since interest rates are now reaching zero. Raising them again could just lead to another bubble. Since credit standards are still easy, it doesn’t seem likely that government-sponsored loans will be able to stop the bubble from bursting soon.
The plausibilities
It seems that the only thing the Federal Reserve can do is make a strong statement about future interest rates. They can’t really do anything about low-interest rates on first mortgages since those tend to be governed by the market. However, if they start raising interest rates on home loans with $250,000 mortgage limits, they could start impacting large numbers of people who may not even realize that their credit has got worse. While the Fed cannot stop the housing bubble from bursting – it can cause a major economic crisis when it does.
The only problem with this is that the Fed’s move will hurt many people. There are many Americans who have almost no assets other than their homes. Already, there are around 7 million American households with no other assets – so anything that hurts their ability to buy houses will hurt them badly.
It’s also important to note that many people won’t understand how dramatic the Fed’s announcement was. If they feel nervous about interest rates, then they may take out loans that are not really necessary. This could lead to an economic crash if the housing market continues to weaken.
This is not a situation where you can just sit back and wait until it blows over. It could happen at any time, and moving too soon could cause the situation to worsen. The Fed will likely make an announcement about raising interest rates next summer – at which point there may be little that average Americans can do to protect themselves.
Risk factors
The risks of not doing anything are also quite large. The economy is growing at a very slow rate, contributing to stress in the housing market. This suggests that if the Fed does nothing, then there might be a major economic crisis on its hands sooner than expected. What will happen when people start filing for bankruptcy after it becomes clear that they cannot repay their mortgages?
Housing bubbles are the easiest way to cause major economic crises in countries around the world. It is generally much easier to stop these than it is to stop any other economic event – because they are rarely based on sound economic principles. Instead, they tend to focus on short-term factors like political leverage, media attention, and government interest rate policy. This makes them much more unpredictable than other types of bubbles.
The US Mortgage Market is Recovering
Economists were expecting a recession sometime in the third quarter of 2008, but this has not happened. In fact, from one perspective, things are starting to pick up a bit.
Total mortgage applications were up 10% from the previous month through June. This is a preliminary estimate, and there’s still no official data yet for July – but it suggests the end of the housing recession in some parts of the country.
The median house price was down 1% from last year in June, indicating that prices are starting to stabilize. However, this is a measure that takes into account seasonal variation in spring and summer home sales. In other words, it actually shows that house prices dropped 1% over the past 12 months – not 1% over six months or 12 months.
Despite this, there are signs that the housing market is improving from a long-term perspective. The US Census Bureau reports that the national homeownership rate rose to a new 12 year high of 70%. This includes people who don’t own their home outright – but rather have a mortgage on it.
The possible suggestions to the Mortgage market
This suggests that homeownership is going up, even though it has fallen back from its peak in 2004. This suggests that much of the angst which drove people to buy houses when they really shouldn’t have – like impulse purchases, bad credit, and overinflated assessments – has been eliminated. Americans no longer feel like they need to make such large down payments on houses in order to get good deals.
The combination of this, the recent increase in mortgage interest rates, and an improving economy should improve housing markets eventually. The problem is that much of the US mortgage market was affected by bad credit – much more than in other countries like Canada. For example, one in four mortgages in Canada is for people with bad credit – less than 1% in the US (and even this figure has fallen steadily). As a result, Americans who want to buy homes may need to take on much more debt than Canadians. That makes it harder for them to get good interest rates on mortgages – which means that stock prices are likely to stay low until things resolve.
Watch video to learn more…….
[embedyt] https://www.youtube.com/watch?v=XwDrVZBzI6Y%5B/embedyt%5D
