After the Fall by Steve Bergsman

Author:Steve Bergsman
Language: eng
Format: epub, mobi
Publisher: John Wiley & Sons, Ltd.
Published: 2010-05-11T04:00:00+00:00

Where We Were

There are probably 50 reasons why the country fell into a profound real estate downturn and credit crisis, but if we isolate just a small group of interrelated factors, we can more easily understand what happened to the country’s residential real estate markets.

After the tech bubble burst at the end of the last decade and then the terrorist strikes in 2001, the country entered into a mild recession. Meanwhile, the housing industry, which had been strongly pummeled in the late 1980s, began a decade-long upswing. From a cyclical standpoint, the single-family housing market probably would have started to swoon at the start of this decade, but the Federal Reserve decided to help the economy out of the recession by keeping interest rates low. This had the two-pronged ancillary effect of prolonging the upswing in the housing cycle and pumping up single-family residential market performance with steroid-like enhancements much above and beyond normality.

The housing market was able to keep going strong because of what was happening on Wall Street. Investment banks had been buying mortgages, packaging them into large pools, slicing and dicing the pools into traunches based on risk, and selling them as investment vehicles called mortgage-backed securities. By this new decade, Wall Street had refined and overengineered the process so they could, in fact, sell securities reformulated from other securities. This was all great for Wall Street because every time they sold a mortgage-backed security, the investment banks booked gobs of fees.

Obviously, there had to be a market for mortgage-backed securities. And there was—everywhere around the world. Unlike in the United States, where people spend all they earn, in many developing countries, such as China, citizens save. Cumulatively this saved money doesn’t have an investment outlet big enough in the home-land, so the financial infrastructure of countries in Europe and Asia invests elsewhere around the world, such as in mortgage-backed securities designed and constructed in the United States.

So, let’s work backward along this chain. Global investors need investments, so they turn to Wall Street; Wall Street creates mortgage-based investments; it turns to mortgage originators for more product. Mortgage originators create more types of mortgages; they turn to home builders to build more homes so they can sell more mortgages. Home builders construct more and more residences.

The end of this daisy chain came in two phases. The first was slow and easy, the second was a free fall.

“The precipitating factor was affordability,” explains Richard DeKaser, chief economist at National City Corporation. “If you look at the basic affordability calculation, how much a typical family’s money is required in order to buy the typical home, 1998 was the best year and things didn’t get any worse until early in the decade because the Federal Reserve was cutting interest rates. But, by 2005, interest rates were no longer falling and that, combined with rising home prices, increased the pain on homebuyers to the point where demand began to back off.”

At this juncture, the housing market made a smooth cyclical adjustment: demand diminished, sales declined, and price appreciation began to fade.

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