American Dream for Housing at an End
The American Dream Suffers a battering
America has had its fair share of bubbles and busts. The dot com boom and bust was spectacular, if relatively short lived. The response of the Fed - cutting interest rates helped to smooth over the problem. The US avoided a serious recession and for most people (unless they had invested their life savings in dot com firms) the issue was of little importance. Furthermore the rapid response of the Fed reassured markets that the monetary authorities were eager to avoid any economic downturn. It appeared that boom and busts were not to be feared.
Against a back drop of very low interest rates, economic growth and a very competitive credit market, there was a rapid expansion in the number of mortgage advances. This enabled a new generation of Americans to buy a house (especially first generation immigrants and people with bad credit histories). Buying a house seemed to be an excellent investment. Not only did you get to own your own house, but, also could enjoy rising wealth as house prices shot up.
Between 2000 - 2006, American House prices rose by 135% encouraging even more to try buying a house.
With house prices rising so quickly, Mortgage companies were willing to lend 100% mortgages and mortgages to people with bad credit history. Mortgage salesmen were encouraged to sell mortgages with little evaluation of ability to pay. In a period of rapidly rising house prices, it was easier to mask poor mortgage decisions.
The boom in house prices also caused an unprecedented boom in building. Housing was the new gold rush. Large homes were knocked down to build several apartments. In particular there was demand for new housing in affluent suburbs, outside of central cities, but, within commuting distance.
The collapse of the housing market and credit crunch have been well documented - see credit crunch explained. In short house prices fell and banks suffered from large scale losses as people simply defaulted on rising mortgage payments.
In many cases, people are simply posting the keys in the letterbox and walking off. Unable to pay mortgage payments and left with negative equity, people prefer to have the home repossessed than struggle to fight a losing battle. The problem is that home repossessions are expensive for banks. Typically, banks may get 40% less than the original loan. It is these loan write offs which are causing the Fed to have to bail out mortgage lenders like Freddie Mae and Fannie Mac. The concern is that with house prices falling and unemployment rising, there are future waves of mortgage defaults still to come.
Sell to Lender
Rather than lose through having to repossess, many banks are encouraging struggling homeowners to transfer ownership. Basically, what this does is to wipe the slate clean. The bank bears the negative equity and takes care of the mortgage repayments. Homeowners are able to sell their house without suffering negative equity. It is also better for their credit rating. For the bank it is not good but, better than the costly drawnout process of repossession.
The housing slump is exacerbated by the number of unsold properties on the market. The boom in housing builds ended only after the market had begun to fall. The result is that even in a time of falling prices, there are still new homes coming on to the market. Faced with a slump in demand and glut in supply, it is not surprising many forecast prices to fall further. At least in the UK we do not have the same glut in supply - just a stagnant market with buyers extremely scarce.
Amidst all the statistics there are many individual cases illustrating the personal costs of the housing crisis. People who have seen the value of their homes drop by ,000. People who have lost their home, lost their credit rating and left with negative equity. It is an ugly business and the sheer scale of house price falls has taken many by surprise. The question for many Americans is when will the housing slump end? With banks still nervous about lending predicting the end may not be so easy.