United States housing bubble
Encyclopedia
The United States housing bubble is an economic bubble
Economic bubble
An economic bubble is "trade in high volumes at prices that are considerably at variance with intrinsic values"...

 affecting many parts of the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 housing market
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...

 in over half of American states. 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
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...

 rates in 2006–2007 among U.S. homeowners led to a crisis
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....

 in August 2008 for the subprime, Alt-A
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....

, collateralized debt obligation
Collateralized debt obligation
Collateralized debt obligations are a type of structured asset-backed security with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand...

 (CDO), mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...

, credit
Fixed income
Fixed income refers to any type of investment that is not equity, which obligates the borrower/issuer to make payments on a fixed schedule, even if the number of the payments may be variable....

, 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
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...

, home supply retail outlets, Wall Street
Wall Street
Wall Street refers to the financial district of New York City, named after and centered on the eight-block-long street running from Broadway to South Street on the East River in Lower Manhattan. Over time, the term has become a metonym for the financial markets of the United States as a whole, or...

 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
George W. Bush
George Walker Bush is an American politician who served as the 43rd President of the United States, from 2001 to 2009. Before that, he was the 46th Governor of Texas, having served from 1995 to 2000....

 and the Chairman of the Federal Reserve
Chairman of the Federal Reserve
The Chairman of the Board of Governors of the Federal Reserve System is the head of the central banking system of the United States. Known colloquially as "Chairman of the Fed," or in market circles "Fed Chairman" or "Fed Chief"...

 Ben Bernanke
Ben Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....

 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 Fannie Mae and Freddie Mac (both of which are government-sponsored enterprises
Government-sponsored enterprise
A government-sponsored enterprise is a financial services corporation created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent...

) as well as the Federal Housing Administration
Federal Housing Administration
The Federal Housing Administration is a United States government agency created as part of the National Housing Act of 1934. It insured loans made by banks and other private lenders for home building and home buying...

 (which is a United States Government agency). 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. The 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
Housing and Economic Recovery Act of 2008
The Housing and Economic Recovery Act of 2008 designed primarily to address the subprime mortgage crisis. It authorized the Federal Housing Administration to guarantee up to $300 billion in new 30-year fixed rate mortgages for subprime borrowers if lenders write-down principal loan balances to 90...

.

Background

Land prices contributed much more to the price increases than did structures. This can be seen in the building cost index in Fig. 1. An estimate of land value for a house can be derived by subtracting the replacement value of the structure, adjusted for depreciation, from the home price. Using this methodology, Davis and Palumbo calculated land values for 46 U.S. metro areas, which can be found at the website for the Lincoln Institute for Land Policy.

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
Real estate appraisal
Real estate appraisal, property valuation or land valuation is the process of valuing real property. The value usually sought is the property's Market Value. Appraisals are needed because compared to, say, corporate stock, real estate transactions occur very infrequently...

 of real property
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...

 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
Negative equity
Negative equity occurs when the value of an asset used to secure a loan is less than the outstanding balance on the loan. In the United States, assets with negative equity are often referred to as being "underwater", and loans and borrowers with negative equity are said to be "upside down".People...

—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, lax lending standards, failure of regulators to intervene, and speculative fever
Speculative fever
Speculative Fever is a term used in the housing market which represents the frequent action of buying and selling housing properties. In the case of Speculative fever, the buyer and seller has no intention of ever occupying the house, only purchasing it for the sole reason of selling it off for a...

. This bubble may be related to the stock market or dot-com bubble
Dot-com bubble
The dot-com bubble was a speculative bubble covering roughly 1995–2000 during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the more...

 of the 1990s. This bubble roughly coincides with the real estate bubble
Real estate bubble
A real estate bubble or property bubble is a type of economic bubble that occurs periodically in local or global real estate markets...

s of the United Kingdom, Hong Kong, Spain, Poland, Hungary and South Korea.

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
Alan Greenspan
Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...

 said "We had a bubble
Economic bubble
An economic bubble is "trade in high volumes at prices that are considerably at variance with intrinsic values"...

 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 mortgages reverted to regular interest rates. Freddie Mac CEO Richard Syron
Richard F. Syron
Richard F. Syron is a former chairman and chief executive officer of the Federal Home Loan Mortgage Corporation, commonly known as Freddie Mac. He previously served as chairman and CEO of Thermo Electron Corp., and as CEO of the American Stock Exchange....

 concluded, "We had a bubble", and concurred with Yale
Yale University
Yale University is a private, Ivy League university located in New Haven, Connecticut, United States. Founded in 1701 in the Colony of Connecticut, the university is the third-oldest institution of higher education in the United States...

 economist Robert Shiller
Robert Shiller
Robert James "Bob" Shiller is an American economist, academic, and best-selling author. He currently serves as the Arthur M. Okun Professor of Economics at Yale University and is a Fellow at the Yale International Center for Finance, Yale School of Management...

'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
Countrywide Financial
Bank of America Home Loans is the mortgage unit of Bank of America. Bank of America Home Loans is composed of:*Mortgage Banking, which originates purchases, securitizes, and services mortgages. In 2008, Bank of America purchased the failing Countrywide Financial for $4.1 billion...

, 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
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

." The impact of booming home valuations on the U.S. economy
Economy of the United States
The economy of the United States is the world's largest national economy. Its nominal GDP was estimated to be nearly $14.5 trillion in 2010, approximately a quarter of nominal global GDP. The European Union has a larger collective economy, but is not a single nation...

 since the 2001–2002 recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...

 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.

Identification

Although an economic bubble
Economic bubble
An economic bubble is "trade in high volumes at prices that are considerably at variance with intrinsic values"...

 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
Dean Baker
Dean Baker is an American macroeconomist and co-founder of the Center for Economic and Policy Research, with Mark Weisbrot. He previously was a senior economist at the Economic Policy Institute and an assistant professor of economics at Bucknell University. He has a Ph.D...

 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.

Congressman Ron Paul of Texas predicted the bubble and bust on 16 July 2002 with his address to the House of Representatives stating the following He even offered legislation, Free Housing Market Enhancement Act, to correct the bubble by reducing the power of Federal National Mortgage Association (Fannie), the Federal Home Loan Mortgage Corporation (Freddie), and the National Home Loan Bank Board (HLBB). These federal agencies promoted subprime interest rates and encouraged lenders to lend to people they would otherwise not approve loans for. They also subsidized subprime mortgages with $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone. This money came from American tax payers to encourage irresponsible lending and give homeloans to people that would definitely not be able to pay them back.

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:
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
The New York Times
The New York Times is an American daily newspaper founded and continuously published in New York City since 1851. The New York Times has won 106 Pulitzer Prizes, the most of any news organization...

, which reported that in mid-2004 Richard F. Syron
Richard F. Syron
Richard F. Syron is a former chairman and chief executive officer of the Federal Home Loan Mortgage Corporation, commonly known as Freddie Mac. He previously served as chairman and CEO of Thermo Electron Corp., and as CEO of the American Stock Exchange....

, the CEO of Freddie Mac, received a memo from David Andrukonis, the company's former chief risk officer
Chief risk officer
The chief risk officer or chief risk management officer of a corporation is the executive accountable for enabling the efficient and effective governance of significant risks, and related opportunities, to a business and its various segments. Risks are commonly categorized as strategic,...

, 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
Reputational risk
Reputational risk, often called reputation risk, is a type of risk related to the trustworthiness of business. Damage to a firm's reputation can result in lost revenue or destruction of shareholder value, even if the company is not found guilty of a crime...

 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
Precautionary statements
In United States safety standards, precautionary statements are sentences providing information on potential hazards, and proper procedures. They are used in situations from consumer product on labels and manuals, to descriptions of physical activities...

. Other cautions came as early as 2001, when the late Federal Reserve governor Edward Gramlich
Edward Gramlich
Edward M. Gramlich was a professor of economics at the University of Michigan and a former member of the Board of Governors of the Federal Reserve....

 warned of the risks posed by subprime mortgages. Reuters
Reuters
Reuters is a news agency headquartered in New York City. Until 2008 the Reuters news agency formed part of a British independent company, Reuters Group plc, which was also a provider of financial market data...

 reported in October 2007 that a Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...

 analyst too had warned in 2006 that companies could suffer from their subprime investment
Subprime lending
In finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...

s.

The Economist
The Economist
The Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd. and edited in offices in the City of Westminster, London, England. Continuous publication began under founder James Wilson in September 1843...

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.

On the basis of 2006 market data that were indicating a marked decline, including lower sales, rising inventories, falling median
Median
In probability theory and statistics, a median is described as the numerical value separating the higher half of a sample, a population, or a probability distribution, from the lower half. The median of a finite list of numbers can be found by arranging all the observations from lowest value to...

 prices and increased foreclosure rates, some economists have concluded that the correction in the U.S. housing market began in 2006. A May 2006 Fortune
Fortune (magazine)
Fortune is a global business magazine published by Time Inc. Founded by Henry Luce in 1930, the publishing business, consisting of Time, Life, Fortune, and Sports Illustrated, grew to become Time Warner. In turn, AOL grew as it acquired Time Warner in 2000 when Time Warner was the world's largest...

magazine report on the US housing bubble states: "The great housing bubble has finally started to deflate ... In many once-sizzling markets around the country, accounts of dropping list prices have replaced tales of waiting lists for unbuilt condos and bidding wars over humdrum three-bedroom colonials." The chief economist of Freddie Mac and the director of Joint Center for Housing Studies (JCHS) denied the existence of a national housing bubble and expressed doubt that any significant decline in home prices was possible, citing consistently rising prices since the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

, an anticipated increased demand from the Baby Boom
Baby boom
A baby boom is any period marked by a greatly increased birth rate. This demographic phenomenon is usually ascribed within certain geographical bounds and when the number of annual births exceeds 2 per 100 women...

 generation, and healthy levels of employment. However, some have suggested that the funding received by JCHS from the real estate industry may have affected their judgment. David Lereah
David Lereah
David Lereah is the President of , a real estate advisory and information company located in the Washington, DC area. Reecon Advisors is the owner and publisher of , one of the industry's leading Web sites providing intelligence and information on the residential real estate market. The Web site...

, former chief economist of the
National Association of Realtors
National Association of Realtors
The National Association of Realtors , whose members are known as Realtors, is North America's largest trade association. representing over 1.2 million members , including NAR's institutes, societies, and councils, involved in all aspects of the residential and commercial real estate industries...

 (NAR), distributed "Anti-Bubble Reports" in August 2005 to "respond to the irresponsible bubble accusations made by your local media and local academics." Among other statements, the reports stated that people "should [not] be concerned that home prices are rising faster than family income", that "there is virtually no risk of a national housing price bubble based on the fundamental demand for housing and predictable economic factors", and that "a general slowing in the rate of price growth can be expected, but in many areas inventory shortages will persist and home prices are likely to continue to rise above historic norms." Following reports of rapid sales declines and price depreciation in August 2006, Lereah admitted that he expected "home prices to come down 5% nationally, more in some markets, less in others. And a few cities in Florida and California, where home prices soared to nose-bleed
heights, could have 'hard landings'."

National home sales and prices both fell dramatically in March 2007 — the steepest plunge since the 1989 Savings and Loan crisis
Savings and Loan crisis
The savings and loan crisis of the 1980s and 1990s was the failure of about 747 out of the 3,234 savings and loan associations in the United States...

. According to NAR
National Association of Realtors
The National Association of Realtors , whose members are known as Realtors, is North America's largest trade association. representing over 1.2 million members , including NAR's institutes, societies, and councils, involved in all aspects of the residential and commercial real estate industries...

 data, sales were down 13% to 482,000 from the peak of 554,000 in March 2006, and the national median price fell nearly 6% to $217,000 from a peak of $230,200 in July 2006.

John A. Kilpatrick, of Greenfield Advisors
Greenfield Advisors
Greenfield Advisors LLC is a real estate and business consulting firm headquartered in Seattle, Washington. Originally known as Mundy Associates, it was founded in 1976 by Bill Mundy, the land economist for Weyerhaeuser Corporation...

, was cited by Bloomberg News on June 14, 2007, on the linkage between increased foreclosures and localized housing price declines: "Living in an area with multiple foreclosures can result in a 10 per cent to 20 per cent decrease in property values." He went on to say, "In some cases that can wipe out the equity of homeowners or leave them owing more on their mortgage than the house is worth. The innocent houses that just happen to be sitting next to those properties are going to take a hit."

The US Senate Banking Committee
United States Senate Committee on Banking, Housing, and Urban Affairs
The United States Senate Committee on Banking, Housing, and Urban Affairs has jurisdiction over matters related to: banks and banking, price controls, deposit insurance, export promotion and controls, federal monetary policy, financial aid to commerce and industry, issuance of redemption of notes,...

 held hearings on the housing bubble and related loan practices in 2006, titled "The Housing Bubble and its Implications for the Economy" and "Calculated Risk: Assessing Non-Traditional Mortgage Products". Following the collapse
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....

 of the subprime
Subprime lending
In finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...

 mortgage industry in March 2007, Senator Chris Dodd, Chairman of the Banking Committee
United States Senate Committee on Banking, Housing, and Urban Affairs
The United States Senate Committee on Banking, Housing, and Urban Affairs has jurisdiction over matters related to: banks and banking, price controls, deposit insurance, export promotion and controls, federal monetary policy, financial aid to commerce and industry, issuance of redemption of notes,...

 held hearings and asked executives from the top five subprime mortgage companies to testify and explain their lending practices. Dodd said that "predatory lending practices" had endangered home ownership for millions of people. In addition, Democratic senators such as Senator Charles Schumer
Charles Schumer
Charles Ellis "Chuck" Schumer is the senior United States Senator from New York and a member of the Democratic Party. First elected in 1998, he defeated three-term Republican incumbent Al D'Amato by a margin of 55%–44%. He was easily re-elected in 2004 by a margin of 71%–24% and in 2010 by a...

 of New York were already proposing a federal government bailout of subprime borrowers in order to save homeowners from losing their residences.

Extent

Home price appreciation has been non-uniform to such an extent that some economists, including former Fed
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...

 Chairman
Chairman of the Federal Reserve
The Chairman of the Board of Governors of the Federal Reserve System is the head of the central banking system of the United States. Known colloquially as "Chairman of the Fed," or in market circles "Fed Chairman" or "Fed Chief"...

 Alan Greenspan
Alan Greenspan
Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...

, 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
Robert Shiller
Robert James "Bob" Shiller is an American economist, academic, and best-selling author. He currently serves as the Arthur M. Okun Professor of Economics at Yale University and is a Fellow at the Yale International Center for Finance, Yale School of Management...

 house price index
House price index
-FHFA/OFHEO:The US Federal Housing Finance Agency publishes the HPI inx, a quarterly broad measure of the movement of single-family house prices....

, 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.

Somewhat paradoxically, as the housing bubble deflates some metropolitan areas (such as Denver and Atlanta) have been experiencing high foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...

 rates, even though they did not see much house appreciation in the first place and therefore did not appear to be contributing to the national bubble. This was also true of some cities in the Rust Belt
Rust Belt
The Rust Belt is a term that gained currency in the 1980s as the informal description of an area straddling the Midwestern and Northeastern United States, in which local economies traditionally garnered an increased manufacturing sector to add jobs and corporate profits...

 such as Detroit and Cleveland, where weak local economies had produced little house price appreciation early in the decade but still saw declining values and increased foreclosures in 2007. As of January 2009 California, Michigan, Ohio and Florida were the states with the highest foreclosure rates.

By July 2008 year-to-date prices had declined in 24 of 25 U.S. metropolitan areas, with California and the southwest experiencing the greatest price falls. According to the reports, only Milwaukee had seen an increase in house prices after July 2007.

Side effects

The unprecedented increase in house prices between 1997 and 2005 produced numerous wide-ranging effects in the economy of the United States.
  • One of the most direct effects was on the construction of new houses. In 2005, 1,283,000 new single-family houses were sold, compared with an average of 609,000 per year during 1990–1995. The largest home builders, such as D. R. Horton
    D. R. Horton
    D.R. Horton is the largest homebuilder in the United States based on its 18,839 homes closed in the 12-month period ended March 31, 2010. Founded in 1978 by Donald R. Horton in the Dallas/Fort Worth Metroplex, D.R. Horton is ranked as the largest homebuilder by units closed in the United States...

    , Pulte, and Lennar, saw their largest share prices and revenues in 2004–2005. D. R. Horton's stock went from $3 in early 1997 to all-time high of $42.82 on July 20, 2005. Pulte Corp's revenues grew from $2.33 billion in 1996 to $14.69 billion in 2005.
  • Mortgage equity withdrawal
    Mortgage equity withdrawal
    In economics, mortgage equity withdrawal is the decision of consumers to borrow money against the real value of their houses. The real value is the current value of the property less any accumulated liabilities Some authors also use equity extraction and include net payments received at time of...

    s – primarily home equity loans and cash out refinancing
    Cash out refinancing
    Cash out refinancing occurs when a loan is taken out on property already owned, and the loan amount is above and beyond the cost of transaction, payoff of existing liens, and related expenses.-Definition:...

    s – grew considerably since early 1990s. According to US Federal Reserve estimates, in 2005 homeowners extracted $750 billion of equity from their homes (up from $106 billion in 1996), spending two thirds of it on personal consumption, home improvements, and credit card debt.
  • It is widely believed that the increased degree of economic activity produced by the expanding housing bubble in 2001–2003 was partly responsible for averting a full-scale recession
    Recession
    In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...

     in the U.S. economy following the dot-com bust.
  • Rapidly growing house prices and increasing price gradients forced many residents to flee the expensive centers of many metropolitan areas, resulting in the explosive growth of exurbs in some regions. The population of Riverside County, California
    Riverside County, California
    Riverside County is a county in the U.S. state of California. One of 58 California counties, it covers in the southern part of the state, and stretches from Orange County to the Colorado River, which forms the state border with Arizona. The county derives its name from the city of Riverside,...

     almost doubled from 1,170,413 in 1990 to 2,026,803 in 2006, due to its relative proximity to San Diego and Los Angeles
    Los Ángeles
    Los Ángeles is the capital of the province of Biobío, in the commune of the same name, in Region VIII , in the center-south of Chile. It is located between the Laja and Biobío rivers. The population is 123,445 inhabitants...

    . On the East Coast, Loudoun County, Virginia
    Loudoun County, Virginia
    Loudoun County is a county located in the Commonwealth of Virginia, and is part of the Washington Metropolitan Area. As of the 2010 U.S. Census, the county is estimated to be home to 312,311 people, an 84 percent increase over the 2000 figure of 169,599. That increase makes the county the fourth...

    , near Washington, DC, saw its population triple between 1990 and 2006.
  • Extreme regional differences in land prices. The differences in housing prices are mainly due to differences in land values, which reached 85% of the total value of houses in the highest priced markets at the peak. The Wisconsin Business School publishes an on line database with building cost and land values for 46 U.S. metro areas. One of the fastest growing regions in the U.S. for the last seveal decades was the Atlanta, GA metro area, where land values are a small fraction of those in the high priced markets. High land values contribute to high cost living costs in general and are part of the reason for the decline of the old industrial centers while new automobile plants, for example, were built throughout the South, which grew in population faster than the other regions.


The real estate market correction of 2006–2007 reversed these trends. As of August 2007, D.R. Horton's and Pulte Corp's shares had fallen to 1/3 of their respective peak levels as new residential home sales fell. Some of the cities and regions that had experienced the fastest growth during 2000–2005 began to experience high foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...

 rates. It was suggested that the weakness of the housing industry and the loss of the consumption that had been driven by the withdrawal of mortgage equity could lead to a recession, but as of mid-2007 the existence of this recession had not yet been ascertained. In March 2008, Thomson Financial
Thomson Financial
Thomson Financial was an arm of The Thomson Corporation, which was one of the world's leading information companies, focused on providing integrated information solutions to business and professional customers...

 reported that the "Chicago Federal Reserve Bank's National Activity Index for February sent a signal that a recession [had] probably begun..."

The share prices of Fannie Mae and Freddie Mac plummeted in 2008 as investors worried that they lacked sufficient capital to cover the losses on their $5 trillion portfolio of loans and loan guarantees. On June 16, 2010 it was announced that Fannie Mae and Freddie Mac would be delisted from the New York Stock Exchange; shares now trade on the over-the-counter market.

Housing market correction

EWLINE

NAR
National Association of Realtors
The National Association of Realtors , whose members are known as Realtors, is North America's largest trade association. representing over 1.2 million members , including NAR's institutes, societies, and councils, involved in all aspects of the residential and commercial real estate industries...

 chief economist David Lereah's explanation, "What Happened", from the 2006 NAR Leadership Conference
  • Boom ended in 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 went to sidelines
  • First-time buyers priced out of market


Basing their statements on historic U.S. housing valuation trends, many economists and business writers predicted market corrections ranging from a few percentage points to 50% or more from peak values in some markets, and although this cooling had yet not affected all areas of the U.S., some warned that it still could, and that the correction would be "nasty" and "severe". Chief economist Mark Zandi of the economic research firm Moody's
Moody's
Moody's Corporation is the holding company for Moody's Analytics and Moody's Investors Service, a credit rating agency which performs international financial research and analysis on commercial and government entities. The company also ranks the credit-worthiness of borrowers using a standardized...

 Economy.com predicted a "crash" of double-digit depreciation in some U.S. cities by 2007–2009. In a paper he presented to a Federal Reserve Board economic symposium in August 2007, Yale University economist Robert Shiller
Robert Shiller
Robert James "Bob" Shiller is an American economist, academic, and best-selling author. He currently serves as the Arthur M. Okun Professor of Economics at Yale University and is a Fellow at the Yale International Center for Finance, Yale School of Management...


warned, "The examples we have of past cycles indicate that major declines in real home prices—even 50 per cent declines in some places—are entirely possible going forward from today or from the not-too-distant future."

Subprime mortgage industry collapse

In March 2007, the United States' subprime
Subprime lending
In finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...

 mortgage industry collapsed
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....

 due to higher-than-expected home foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...

 rates (no verifying source), 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 April 2, 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 would eventually take a toll on the economy and ultimately have an impact in the form of impaired home prices. Bill Gross, a "most reputable financial guru", sarcastically and ominously criticized the credit ratings
Moody's
Moody's Corporation is the holding company for Moody's Analytics and Moody's Investors Service, a credit rating agency which performs international financial research and analysis on commercial and government entities. The company also ranks the credit-worthiness of borrowers using a standardized...

 of the mortgage-based CDO
Collateralized debt obligation
Collateralized debt obligations are a type of structured asset-backed security with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand...

s now facing collapse:
AAA? You were wooed, Mr. Moody's
Moody's
Moody's Corporation is the holding company for Moody's Analytics and Moody's Investors Service, a credit rating agency which performs international financial research and analysis on commercial and government entities. The company also ranks the credit-worthiness of borrowers using a standardized...

 and Mr. Poor's
Standard & Poor's
Standard & Poor's is a United States-based financial services company. It is a division of The McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds. It is well known for its stock-market indices, the US-based S&P 500, the Australian S&P/ASX 200, the Canadian...

, 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... [T]he point is that there are hundreds of billions of dollars of this toxic waste... This problem [ultimately] resides in America's heartland, with millions and millions of overpriced homes".


Business Week has featured predictions by financial analysts that the subprime mortgage market meltdown would result in earnings reductions for large Wall Street
Wall Street
Wall Street refers to the financial district of New York City, named after and centered on the eight-block-long street running from Broadway to South Street on the East River in Lower Manhattan. Over time, the term has become a metonym for the financial markets of the United States as a whole, or...

 investment banks trading in mortgage-backed securities
Mortgage-backed security
A mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...

, especially Bear Stearns
Bear Stearns
The Bear Stearns Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage, until its sale to JPMorgan Chase in 2008 during the global financial crisis and recession...

, Lehman Brothers
Lehman Brothers
Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...

, Goldman Sachs
Goldman Sachs
The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...

, Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...

, and Morgan Stanley
Morgan Stanley
Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000....

. The solvency of two troubled hedge funds managed by Bear Stearns
Bear Stearns
The Bear Stearns Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage, until its sale to JPMorgan Chase in 2008 during the global financial crisis and recession...

 was imperiled in June 2007 after Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...

 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
H&R Block
H&R Block is a tax preparation company in the United States, claiming more than 22 million customers worldwide, with offices in Canada, Australia and the United Kingdom. The Kansas City-based company also offers banking, personal finance and business consulting services.Founded in 1955 by brothers...

 reported that it had made a quarterly loss of $677 million on discontinued operations, which included the subprime lender Option One, as well as writedowns, loss provisions for mortgage loans and the lower prices achievable for mortgages in the secondary market. The unit's net asset value had fallen 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
Bear Stearns
The Bear Stearns Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage, until its sale to JPMorgan Chase in 2008 during the global financial crisis and recession...

 pledged up to U.S. $3.2 billion in loans on June 22, 2007 to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages. Peter Schiff
Peter Schiff
Peter David Schiff is an American investment broker, author and financial commentator. Schiff is CEO and chief global strategist of Euro Pacific Capital Inc., a broker-dealer based in Westport, Connecticut and CEO of Euro Pacific Precious Metals, LLC, a gold and silver dealer based in New York...

, president of Euro Pacific Capital, argued that if the bonds in the Bear Stearns
Bear Stearns
The Bear Stearns Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage, until its sale to JPMorgan Chase in 2008 during the global financial crisis and recession...

 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 the 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."

On August 9, 2007, BNP Paribas
BNP Paribas
BNP Paribas S.A. is a global banking group, headquartered in Paris, with its second global headquarters in London. In October 2010 BNP Paribas was ranked by Bloomberg and Forbes as the largest bank and largest company in the world by assets with over $3.1 trillion. It was formed through the merger...

 announced that it could not fairly value the underlying assets in three funds because of its exposure to U.S. subprime
Subprime lending
In finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...

 mortgage lending markets. Faced with potentially massive (though unquantifiable) exposure, the European Central Bank
European Central Bank
The European Central Bank is the institution of the European Union that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt,...

 (ECB) immediately stepped in to ease market worries by opening lines of € 96.8 billion (U.S. $130 billion) of low-interest credit. One day after the financial panic about a credit crunch had swept through Europe, the U.S. Federal Reserve Bank conducted an "open market operation" to inject U.S. $38 billion in temporary reserves into the system to help overcome the ill effects of a spreading credit crunch, on top of a similar move the previous day. In order to further ease the credit crunch in the U.S. credit market, at 8:15 a.m. on August 17, 2007 the chairman of the Federal Reserve Bank Ben Bernanke
Ben Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....

 decided to lower the discount window
Discount window
The discount window is an instrument of monetary policy that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions...

 rate, which is the lending rate between banks and the Federal Reserve Bank, by 50 basis points to 5.75% from 6.25%. The Federal Reserve Bank stated that the recent turmoil in the U.S. financial markets had raised the risk of an economic downturn.

In the wake of the mortgage industry meltdown, Senator Chris Dodd, Chairman of the Banking Committee
United States Senate Committee on Banking, Housing, and Urban Affairs
The United States Senate Committee on Banking, Housing, and Urban Affairs has jurisdiction over matters related to: banks and banking, price controls, deposit insurance, export promotion and controls, federal monetary policy, financial aid to commerce and industry, issuance of redemption of notes,...

 held hearings in March 2007 in which he asked executives from the top five subprime mortgage companies to testify and explain their lending practices. Dodd said that "predatory lending practices" were endangering home ownership for millions of people. In addition, Democratic senators such as Senator Charles Schumer
Charles Schumer
Charles Ellis "Chuck" Schumer is the senior United States Senator from New York and a member of the Democratic Party. First elected in 1998, he defeated three-term Republican incumbent Al D'Amato by a margin of 55%–44%. He was easily re-elected in 2004 by a margin of 71%–24% and in 2010 by a...

 of New York were already proposing a federal government bailout of subprime borrowers like the bailout made in the Savings and Loan crisis, in order to save homeowners from losing their residences. Opponents of such a proposal asserted that a government bailout of subprime borrowers is not in the best interests of the U.S. economy because it would simply set a bad precedent, create a moral hazard
Moral hazard
In economic theory, moral hazard refers to a situation in which a party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party insulated from risk behaves differently from how it would if it were fully exposed to the risk.Moral hazard...

, and worsen the speculation problem in the housing market.

Lou Ranieri of Salomon Brothers
Salomon Brothers
Salomon Brothers was a bulge bracket, Wall Street investment bank. Founded in 1910 by three brothers along with a clerk named Ben Levy, it remained a partnership until the early 1980s, when it was acquired by the commodity trading firm Phibro Corporation and then became Salomon Inc. Eventually...

, creator of the mortgage-backed securities
Mortgage-backed security
A mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...

 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 seen in the subprime industry also emerge in the prime mortgage markets. Former Federal Reserve Chairman Alan Greenspan had praised the rise of the subprime mortgage industry and the tools which it uses to assess credit-worthiness in an April 2005 speech. Because of these remarks, as well as his encouragement of 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 that triggered the economic crisis of 2008. Concerning the subprime mortgage mess, Greenspan later admitted that "I really didn't get it until very late in 2005 and 2006."

On September 13, 2007, the British bank Northern Rock
Northern Rock
Northern Rock plc is a British bank, best known for becoming the first bank in 150 years to suffer a bank run after having had to approach the Bank of England for a loan facility, to replace money market funding, during the credit crisis in 2007.  Having failed to find a commercial buyer for...

 applied to the Bank of England
Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694, it is the second oldest central bank in the world...

 for emergency funds because of liquidity problems related to the subprime crisis. This precipitated a bank run
Bank run
A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent...

 at Northern Rock branches across the UK by concerned customers who took out "an estimated £2bn withdrawn in just three days".

See also

  • Real estate bubble
    Real estate bubble
    A real estate bubble or property bubble is a type of economic bubble that occurs periodically in local or global real estate markets...

  • MERS
    MERS
    Mortgage Electronic Registration Systems, Inc. is a privately held company that operates an electronic registry designed to track servicing rights and ownership of mortgage loans in the United States...

  • Australian property bubble
    Australian property bubble
    The Australian Property bubble is an observation that real estate prices in Australia are valued at more than they are worth. This is a real estate bubble....

     - 1999 - 2010
  • British property bubble
  • Financial crisis of 2007–2010
  • Indian property bubble
    Indian property bubble
    The origins of Indian Property Market Bubble can be traced to the interest rate reductions made by the NDA coalition government in the years following 2001. Home Loan Rates fell to a historical lows of 7.5% in early 2004. This prepared the basis for the increase in real estate property prices...

  • Irish property bubble
    Irish property bubble
    The property bubble in the Republic of Ireland began in 2000 and peaked in 2006, as with many other western European countries, with a combination of increased speculative construction and rapidly rising prices....

     – 2000–2006
  • Japanese asset price bubble
    Japanese asset price bubble
    The was an economic bubble in Japan from 1986 to 1991, in which real estate and stock prices were greatly inflated. The bubble's collapse lasted for more than a decade with stock prices initially bottoming in 2003, although they would descend even further amidst the global crisis in 2008. The...

     1986–1991
  • Romanian property bubble
    Romanian property bubble
    After the relative calm of the decade of the 1990s, since 2002 Romania has experienced a dramatic increase in property prices. Between 2002-2007 the median price for an old communist-era apartment rose by a factor of 10 , from around €10,000 to circa €100,000...

  • Spanish property bubble
  • Rent control
    Rent control
    Rent control refers to laws or ordinances that set price controls on the renting of residential housing. It functions as a price ceiling.Rent control exists in approximately 40 countries around the world...

  • Synthetic CDO
    Synthetic CDO
    A Synthetic CDO is a complex financial security used to speculate or manage the risk that an obligation will not be paid...


Books

  • June Fletcher
    June Fletcher
    June Fletcher is a writer for The Wall Street Journal. She is a regular contributor to the , and is the columnist for . Her beat focuses on international real estate....

     (2005), House Poor: Pumped Up Prices, Rising Rates, and Mortgages on Steroid – How to Survive the Coming Housing Crisis, New York: Collins. ISBN 0-06-087322-1.
  • Fred E. Foldvary
    Fred E. Foldvary
    Fred Emanuel Foldvary is a lecturer in economics at Santa Clara University, California, and a research fellow at The Independent Institute...

     (2007), The Depression of 2008, Berkeley: The Gutenberg Press. ISBN 0-9603872-0-X.
  • John R. Talbott (2006). Sell Now!: The End of the Housing Bubble, New York: St. Martin's Griffin. ISBN 0-312-35788-5.
  • John R. Talbott (2003). The Coming Crash in the Housing Market, New York: McGraw-Hill. ISBN 0-07-142220-X.
  • Elizabeth Warren
    Elizabeth Warren
    Elizabeth Warren is an American bankruptcy expert, policy advocate, Harvard Law School professor, and Democratic Party candidate in the 2012 United States Senate election in Massachusetts. She has written several academic and popular books concerning the American economy and personal finance. She...

     and Amelia Warren Tyagi (2003). The Two-Income Trap: Why Middle Class Mothers and Fathers are Going Broke, New York: Basic Books. ISBN 0-465-09082-6.

Articles


External links

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