Explaining the US Housing Market – Cole Kendall
Cole Kendall has created a very well-researched series of articles on the US Housing Market on his blog Understanding the Market.
As an introduction, he asks How Many Houses are there in the US?:
- The US has around 125 million houses. Of these, around 109 million houses are occupied year-round, 75 million by owners and 34 million by renters.
- Half of the houses were built before 1973; 32 million are in central cities and 52 million in suburbs.
- 76 million are single family and 6 million condominiums.
- Approximately 2 million houses were built in 2005 and 2006 and about 1.5 million in 2007
He continues with an article on how US Homes are financed:
- 75 million private houses in the U.S.
- Value of household real estate was $20,150 billion dollars in 2007 financed with $10,500 billion mortgages – owners’ equity is around 48% of the total value
- In 2005 about 25 million of the 75 million homes have no mortgage at all.
- The approximately 50 million mortgages have a median principle amount of $92,000 (55% loan to value), interest rate of 6%, with 24 years of payments remaining. The median mortgage was made in 2002 for 29 years.
- in 2005, about 10 million mortgages have a loan to value ratio greater than 80%, of which 2.5 million mortgages have a loan to value greater than 100%.
- In 2005, 18 million of the mortgages had been refinanced at some point, 15 million to receive a lower rate. Only 2.5 million mortgages had been refinanced to receive cash, that is paying off a smaller mortgage by taking out a larger mortgage and receiving cash as a result.
- The typical US mortgage is a 30-year, fixed rate loan for less than $417,000, a so-called “conforming” loan.
In another article he asks Are there too many houses in the US?:
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- Due to low-interest rates in the US and worldwide, Americans invested in housing. As home buyers started to buy larger houses, prices for existing homes started to rise, and home builders tried to meet the new demand.
- The Median Price rose from US-$ 175,000 in 2001 to US-$ 262,000 in March 2007.
- From 2001 to 2006, the yearly sum of new houses rose from 1,57 million to 1,98 million houses.
- Given the rate of population growth, the average size of households and the desired number of homes per household, the demand for homes would be around 1.5 million homes per year in the current decade.
- Roughly 2 million “extra” houses built between 2001 and 2006; to return to equilibrium, home building must remain under 1.5 million per year for several years.
Then he explains the origins of Subprime-Loans:
- The mortgage rate that you pay depends, among other factors, upon your credit score. Credit scores range from 300 to 850; the higher your score, the lower the interest rate you will pay on your mortgage.
- As of April 2008, a borrower with a credit score of 760-850 would pay 5.5% for a 30-year fixed rate mortgage, 700-760 5.7%, 660-700 6.0%, 620-660 6.8% and 560-620 9.2%. Below 620 is considered subprime.
- People with poor credit histories had to make a 20% down payment which was difficult for most of them to save such a large amount.
- Financial innovation such as “piggyback mortgages” made it easier to take out loans and avoid making down-payments.
- With the official government policy of increasing homeownership rates, there was pressure on lenders not to refuse mortgages to borrowers with imperfect credit.
- By creating adjustable rate mortgages (ARMs), subprime borrowers were allowed to pay low rates for a few years and purchase a larger house than they would otherwise be able to afford. The advantage for the borrower is that they can buy a bigger (more expensive) house right away, pay the low rate for a few years and then refinance to a lower rate with a better credit history.
- Some lenders added prepayment penalties to the deal, meaning that if the borrower repaid the mortgage (refinancing the loan) in the first five years the borrower would have to pay an additional fee.
- During the 2004-2006 housing bubble it seemed like home prices were rising rapidly, so that even if a borrower would not be able to repay the loan he probably thought that he could sell the house at a profit as a last resort. When housing prices stopped rising, the number of defaults on subprime loans started to rise sharply.
Finally, he discusses the origin of the housing bubble:
- The traditional model of the mortgage business was transformed during housing boom into a credit bubble by a disintermediation in the credit markets. Low long-term interest rates worldwide and the securitization of subprime loans created a housing credit bubble.
- From 1955 to 1975, the largest source of mortgage finance was the banking system. By the 1980s a greater fraction of loans were held outside the banking system, as more mortgages were sold to Fannie Mae and other GSEs.
- GSEs such as Fannie Mae (the Federal National Mortgage Association or FNMA) purchase mortgages from mortgage issuers and then resell them in the form of Mortgage Backed Securities (MBS) that are packaged in ways attractive to institutional investors.
- In recent years the ABS (Asset Backed Securities) issuers became a more important source for home mortgages. Asset Backed Securities (ABS) are pools of securities whose credit rating often exceeds that of the underlying securities by “packaging” them produce a security with fairly low risk. This is usually done by providing a credit enhancement or dividing a pool of risky debt into various tranches.
- Typically, mortgage brokers would make a risky loan, sell it to a SIV (Structured Investment Vehicle) which packaged the mortgages and then the SIV would create new securities that represent claims on the mortgages. Some of these securities get AAA ratings since they are overcollateralized and have a positive yield spread.
- Because of this credit rating, these new securities were popular among institutional investors. Buyers asked the SIVs for more securities, so the SIVs asked the mortgage brokers for more mortgages. Mortgage brokers faced little risk if they could sell any mortgage immediately so they did not carefully examine the mortgage borrower.
- Housing prices stopped rising, borrowers started to default on their mortgages, investors stopped buying mortgage products from SIVs and SIVs stopped buying mortgages from mortgage brokers and people with poor credit got fewer mortgages.
Most likely, there will be another essay on how the Subprime crisis unfolded and the role of the Credit-Rating-Agencies. Meanwhile, this article by paul Jackson at Netnewspublisher discussed how the rating of GSEs is affected by burst of the housing bubble.
Topics of this post: abs, definition, Discussions, goverment-sponsored-mortgage-lenders, gse, housing bubble, mbs, siv, usa