House prices are higher than before the housing market collapsed. But today “they don’t make the market vulnerable to such a downturn because these prices are mostly because of unmet demand caused by inadequate supply.” Urban Institute
TOP STORY: Lessons Learned?
It has been over 11 years since Bear Stearns and Lehman Brothers failed and this August Fannie Mae and Freddie Mac (the GSEs) observe their 11th anniversary in federal conservatorship. The collapse of the housing market was a financial debacle, a global disaster, and a personal tragedy for many individuals and households. Before it was over, 450 financial institutions had disappeared, around 8 million homes were foreclosed, millions lost their jobs, home prices dropped about 30 percent, and many homeowners were “underwater,” locked into houses they could not sell or refinance for enough to pay off the mortgage.
What was it like then? What happened? Where are we now? And were any lessons learned?
First There Was THEN
Everyone has a different theory as to what triggered the housing crash, but there is no debate about what preceded it, a three-year housing boom. Homebuilders couldn’t build fast enough, starting construction on 1.7 million homes in 2005. The size of those homes ballooned from an average of 2,266 square feet at the turn of the century to 2,521 just before the market started to crumble. And that was just the average. Remember the term “McMansion?”
And those homes sold, 1.3 million of them in 2005 (but note: that was a half million fewer than were built that year) at an average price of $297,000. New home prices didn’t speak for another two years. Existing home sales were equally frothy, exceeding 7 million units at the peak, with annual price gains topping 25% in several states including California, Florida, and Nevada.
Americans were sold on homeownership, which hit a record high of 69.2% in 2004. More than three – quarters of older adults owned a home and among even the youngest group – those we would call Millennial today – homeownership exceeded 40%. As they aged into the over 35 cohort, their homeownership rate jumped by nearly 30 points.
And if they were sold on it, so were lenders, or at least sold on a business model that assumed prices would keep rising so they could safely lend to almost anyone. They embraced the concept of the subprime loan and the theory that lending to a less than stellar credit risk was fine; they had the fallback of foreclosing and selling the house for far more than was owed. Borrowers without enough cash for a down payment might be given a quiet second mortgage to cover the gap or assured those pricy private insurance premiums were only temporary; until rising home prices would give them enough equity to refinance them away.
Still FHA, the VA and the GSEs had their rules about income, debt to income (DTI) and loan to value (LTV) ratios. That pushed a less than scrupulous subset of lenders to invent new loan products that appeared to follow the rules but bent them badly. These included no-doc loans where borrowers were encouraged to “create” an income that would qualify them, interest only and negative amortization loans where balances didn’t decline or even grew larger over time. There were also teaser loans with super low interest rates and monthly payments that quickly adjusted to levels the borrower might or might not be able to afford. These products and lenders did not survive the crash.
Real Estate is notoriously cyclical.
Prices rise, get too high for buyers to handle, and ease back. Interest rates rise and fall, markets switch regularly between favoring buyers and sellers, a market condition that can differ from one town, state, or region to the next. Historically cycles tend to be shallow and often limited geographically. Price increases slow but rarely turn negative, interest rates change slowly, buyers’ and sellers’ markets may last only a season or two.
But this time, as the cycle reversed what had been a somewhat extraordinary boom, the change was cataclysmic. It seemed sudden, but home builders had been signaling disquiet as early as 2005 through their trade organization’s Builder Confidence Survey. Existing home prices began to stall in 2005 and foreclosures started to spike late that same year. When the trend became obvious, new home builders cut production, home sales decelerated, and prices fell faster. Mortgage defaults soared and many of the lenders who had profited by ignoring risk began to fail. By mid-2008 the housing market was in full rout. And unlike many of the housing downturns, this was not a local nor a regional problem. This housing crisis verged on the global.
It is easy to forget how bad it was. When market indicators hit bottom, some in 2011, others’ in 2012, a few even later, new home sales slowed to 306,000 units although builders continued to build more houses than they were selling. There were 430,000 single family starts. At one point, more than a quarter of homes sold were bank owned and close to 30% of mortgaged home- owners owed more on their mortgage than the house was worth. In some states, like Nevada and Arizona, one in every 100 or so houses were somewhere in the foreclosure process. In California it went as high as one in 230 homes.
Stung by loan defaults, private lenders fled the market. The FHA performed as intended, as a counter-cyclical lender to provide mortgages when other lenders would not, although its mortgage insurance fund was badly damaged by defaults. The GSEs also continued lending although they needed massive government loans to do so, but it was a different world. Gone were the days of no documents, teaser rates, and the Oprah-esque “You get a loan, and you get a loan.”
COLOR ME SAFE
A fresh coat of paint is a fairly inexpensive way to freshen up a home; the average exterior paint job costs about $2,600, interior paint costs $1,660. But choose the wrong shade and you could wind up regretting it later. Paint your home with a weird color, inside or out and buyers might turn up their noses.
Fear of hurting a home’s selling price is likely one reason why many home owners play it neutral when it comes to paint colors, especially for a house’s exterior, although restrictive HOA rules might be another. Favorite exterior color combinations include white and gray, beige and taupe, and slate and black, according to the National Home Color Survey. Megan Elliott, Market Watch
In many ways the housing and mortgage markets have more than healed and in some cases, surprisingly, it didn’t take that long. In other ways things have profoundly changed, perhaps forever.
The painful mortgage default piece of the crisis is clearly over. While borrowers in some states lingered in foreclosure for up to five years after they made their last mortgage payment, those tightened lending standards along with improved household economics have returned mortgage delinquencies to decades’ long lows. The Mortgage Bankers Association’s (MBA) first quarter 2019 delinquency survey put the non-current loan rate at 4.42% compared to 10.44% at the end of 2009. More than a quarter of those risky subprime loans were delinquent at that point. But more telling, even prime loans, the supposedly solidly underwritten ones, had a delinquency rate more than three full points higher than all loans today, showing the contrast between underwriting standards then and now.
Home prices have certainly recovered. Within three years of the national trough some metro areas began seeing prices rise above their 2005 and 2006 peaks and most national home price indices had surpassed their old highs by late 2017. As of the first quarter of 2019, the Case-Shiller National Index was up 52.8% from its February 2012 low and was 10.9% higher than its 2006 record.
Rising prices have pulled the majority of homeowners above water. From more than 11 million homes with negative equity, all but about 2.5 million had recovered by the end of 2017 and few data sources bother anymore to report the numbers.
But some pieces of the housing industry, while not struggling, are not back where they were. Remember that existing home sales boiled over the seven million mark during the boom, but at last report remained off that mark by nearly two million units. New home sales are at only half their peak level. Residential construction is a particular concern; housing starts are far below the growing demand.
Homeownership is another soft spot. It fell to a record low in all age categories in 2016 and has risen only fractionally since then. There are fears that we are becoming a nation of renters.
FIRST THINGS FIRST
The housing crisis brought many changes to real estate and one was an increased buyer wariness about repeating mistakes of the past. This has led to a greater focus on financial readiness for homeownership.
A recent survey found buyers today are more likely to start their home search with a home financing consultation than by actually shopping for a house. Seventy- four percent of buyers looked into their home financing options before shopping and, among first-time buyers, that number jumps to 85%. Buyers said getting a loan preapproval before finding a real estate agent or a house gives them confidence and an understanding of what they can afford. Michele Lerner, Washington Post
Lessons of the “Cs”
Even the worst crisis can provide some good lessons and lenders, policy makers, and borrowers do seem to have learned a bit from this one. Lenders now understand why those “Cs” of underwriting – character, capacity, credit, and collateral, exist. Today they insist on verification of borrower data, collateral value is closely monitored, “creative” loans have disappeared, and subprime lending is a fringe industry.
As a result, default and foreclosure rates are largely lower than at any previous point this century. Lenders know a mortgage is not supposed to be a gamble for either borrower or bank.
Policymakers learned that it was cheaper to help a borrower keep a home than to foreclose it. They have sharpened rules to require servicers to intervene quickly, assist borrowers efficiently, and write sensible modification plans. They too absorbed the lessons of the “Cs” and have loosened crisis era underwriting standards only gradually and thoughtfully as the economy improved.
HOUSING THE HONDA
The rise of Uber, Lyft, and driverless vehicles has encouraged talk of car – free households, but Americans apparently aren’t ready yet. They love their cars, have an average of 1.95 per household, and still need a place to park them. A survey of 24,000 new home shoppers by John Burns Consulting found zero respondents who wanted a home without a garage.
Builders have figured this out and the Census Bureau says 65% of homes constructed in 2017 had two – car garages, 20% had three, while only 7% had none, down from 13% in 2013. Even buyers with only one car preferred a two-car garage for extra storage. Vincent Salandro, Builder magazine
Gain Out of Pain
And borrowers probably learned the best lessons. Number one is that credit counts. In the go-go days, a 60 – day blip on a credit report wasn’t overlooked, but it wasn’t hard to explain away. But after the bust and newly tightened rules, many borrowers found that a mediocre score or heavy debt load kept them, not only from getting a mortgage but from buying a car or getting a credit card. FICO recently announced that average scores had hit a new record – 704 points – and a fifth of its consumers are “super scorers”, with FICOs over 800. A number of studies have also found that Americans have been reducing their debt, including mortgage debt.
They also learned that their home shouldn’t be a piggy bank. Many homeowners went underwater not only because their home lost value but because it was already mortgaged to the hilt. Homeowners refinanced like mad during the boom, not to get a better rate but to cash out their equity. Over 14 quarters homeowners liberated an estimated $887 billion in equity through refinancing and another $100+ billion by way of equity loans. In 2006 almost a third of all refinances were at least 5% larger than the loan they replaced. During the recovery, when interest rates were low, few borrowers took out larger loans than they were surrendering, and many paid cash in order to reduce the balance.
Memories fade, and the crisis is receding ever further behind us. But hopefully, sufficient controls are in place, at banks, with regulators, and at the kitchen table, to ensure the lessons stick.