United States housing prices experienced a major market correction after the housing bubble that peaked in early 2006. Prices of real estate then adjusted downwards in late 2006, causing a loss of market liquidity and subprime defaults.
A real estate bubble is a type of economic bubble that occurs periodically in local, regional, national or global real estate markets. A housing bubble is characterized by rapid and sustained increases in the price of real property, such as housing' usually due to some combination of over-confidence and emotion, fraud, the synthetic offloading of risk using mortgage-backed securities, the ability to repackage conforming debt via government-sponsored enterprises, public and central bank policy availability of credit, and speculation. Housing bubbles tend to distort valuations upward relative to historic, sustainable, and statistical norms as described by economists Karl Case and Robert Shiller in their book, Irrational Exuberance. As early as 2003 Shiller questioned whether or not there was, "a bubble in the housing market" that might in the near future correct.
Timeline
Market correction predictions
Based on the historic trends in valuations of U.S. housing, many economists and business writers predicted a market correction, ranging from a few percentage points, to 50% or more from peak values in some markets, and, although this cooling did not affect all areas of the United States, some warned that the correction could and 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. Dean Baker of the Center for Economic and Policy Research was the first economist to identify the housing bubble, in a report in the summer of 2002. Investor Peter Schiff acquired fame in a series of TV appearances where he opposed a multitude of financial experts and claimed that a bust was to come."
The housing bubble was partly subsidized by government-sponsored entities like Fannie Mae and Freddie Mac and federal policies intended to make housing affordable for all.
Market weakness, 2005–06 National Association of Realtors (NAR) chief economist David Lereah's Explanation of "What Happened" from the 2006 NAR Leadership Conference NAR plot of Condominium Price Appreciation (percentages) in the south and west United States, 2002–2006: 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
The booming housing market halted abruptly in many parts of the United States in the late summer of 2005, and as of summer 2006, several markets faced 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 had dropped almost 3% since January 2006, that new-home inventories hit a record in April and remained near all-time highs, that existing-home inventories were 39% higher than they were just one year earlier, and that sales were down more than 10%, and predicted that "the national median price of housing will probably fall by close to 30% in the next three years ... simple reversion to the mean."
In Boston, year-over-year prices dropped, sales fell, inventory increased, foreclosures were up, and the correction in Massachusetts was called a "hard landing" in 2005. The previously booming Plot of inflation-adjusted home price appreciation in several U.S. cities, 1990–2005: housing markets in Washington, D.C., San Diego, California, Phoenix, Arizona, and other cities stalled as well in 2005.
Fortune magazine in May 2006 labeled many previously strong housing markets as "Dead Zones";This article classified several U.S. real-estate regions as "Dead Zones", "Danger Zones", and "Safe Havens." + Fortune magazine Housing Bubble "Dead Zones" "Dead Zones" "Danger Zones" "Safe Havens" Boston Chicago Cleveland Las Vegas Los Angeles Columbus Miami New York Dallas Washington, D.C. / Northern Virginia San Francisco / Oakland Houston Phoenix Seattle Kansas City Sacramento Omaha San Diego Pittsburgh other areas were classified as "Danger Zones" and "Safe Havens". Fortune in August 2005 also dispelled "four myths about the future of home prices".
The Arizona Regional Multiple Listing Service (ARMLS) showed that in summer 2006, the for-sale housing inventory in Phoenix had grown to over 50,000 homes, of which nearly half were vacant (see graphic). Plot of Phoenix inventory: Several home builders revised their forecasts sharply downward during the summer of 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 buyers are canceling contracts for homes already being built". Homebuilder Kara Homes announced on 13 September 2006 the "two most profitable quarters in the history of our company", yet the company 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 $100,000 (~$ in ).
As the housing market began to soften from 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 was not comfortable with the mild term "soft landing" to describe what was 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 I. 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."
The World Bank lowered the global economic growth rate due to a housing slowdown in the United States, but it did not believe that the U.S. housing malaise would further spread to the rest of the world. The Fed chairman Benjamin Bernanke said in October 2006 that there was currently a "substantial correction" going on in the housing market and that the decline of residential housing construction was one of the "major drags that is causing the economy to slow"; he predicted that the correcting market would decrease U.S. economic growth by about one percent in the second half of 2006 and remain a drag on expansion into 2007.
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 was the steepest since 1989. The new home market also suffered. The biggest year over year drop in median home prices since 1970 occurred in April 2007. Median prices for new homes fell 10.9 percent according to the U.S. Department of Commerce.
Others speculated 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 was 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.
Predictions of housing bubble bursting
In 2005, economist Robert Shiller gave talks warning about a housing bubble to the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. He was ignored, and later called it an incidence of Groupthink. That same year, his second edition of Irrational Exuberance warned that the housing bubble might lead to a worldwide recession.Challenging the Crowd in Whispers, Not Shouts, Robert J Shiller, New York Times, 2008 Nov 1. As mentioned in Econned, by Yves Smith Also in 2005, economist Fred Harrison commented: "The next property market tipping point is due at end of 2007 or early 2008... The only way prices can be brought back to affordable levels is a slump or recession."Bezemer, Dirk J, 16 June 2009. "“No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models" In January 2006, financial analyst Gary Shilling wrote an article entitled: "The Housing Bubble Will Probably Burst".How To Prosper In The Changing Real Estate Market In May 2006, JPMorgan's Christopher Flanagan, director of global structured finance research, warned clients of a coming housing downturn. In August 2006, economist Nouriel Roubini similarly warned that the housing sector was in "free fall" and would derail the rest of the economy, causing a recession in 2007. Joseph Stiglitz, winner of the 2001 Nobel Prize in Economics, also said that the U.S. might enter a recession as house prices declined.
Major downturn and subprime mortgage collapse, 2007
The White House Council of Economic Advisers lowered its forecast for U.S. economic growth in 2008 from 3.1 per cent to 2.7 per cent and forecast higher unemployment, reflecting the turmoil in the credit and residential real-estate markets. The Bush administration economic advisers also revised their unemployment outlook and predicted the unemployment rate could rise slightly above 5 per cent, up from the prevailing unemployment rate of 4.6 per cent.
The appreciation of home values far exceeded the income growth of many of these homebuyers, pushing them to leverage themselves beyond their means. They borrowed even more money in order to purchase homes whose cost was much greater than their ability to meet their mortgage obligations. Many of these homebuyers took out adjustable-rate mortgages during the period of low interest rates in order to purchase the home of their dreams. Initially, they were able to meet their mortgage obligations thanks to the low "teaser" rates being charged in the early years of the mortgage.
As the Federal Reserve Bank applied its monetary contraction policy in 2005, many homeowners were stunned when their adjustable-rate mortgages began to reset to much higher rates in mid-2007 and their monthly payments jumped far above their ability to meet the monthly mortgage payments. Some homeowners began defaulting on their mortgages in mid-2007, and the cracks in the U.S. housing foundation became apparent.
Subprime mortgage industry collapse