The housing bubble: Perceptions and reality
By Scott Sumner
Kevin Erdmann has an excellent post that discusses what really happened in the famous housing bubble and bust. It’s fairly long, so I’ll just excerpt a few highlights–but read the whole thing:
As far as I can tell, just about everyone agrees on the following series of events:
1) House prices driven up by predatory lenders, or public pressure to expand home ownership, or both, pushed low income households in homes they couldn’t afford.
2) As rates rose, low income households with unsustainable ARM mortgages couldn’t afford their mortgage payments. Delinquencies started to pile up. Home prices started to collapse as a result of families losing their homes in foreclosures, and the wider economy and labor market finally collapsed under the weight of it.
. . .
Short term rates began to rise in 2Q 2004, topped out in 3Q 2006, and remained there until 2Q 2007. In 2Q 2007, the single family home delinquency rate was at 2.3%. Please note how starkly the consensus narrative differs from reality.
In 2Q 2007, at 2.3%, single family home delinquency rates were still at the level we saw throughout the 1990’s, which ranged between 2% and 3.4%. Short term interest rates had been rising for 3 years and had been at this level for 1 year, so rate resets would have been well-baked in by this time.
. . .
So, the consensus narrative is that loose money, greedy bankers, and enthusiastic bureaucrats combined to create a housing bubble. Despite these policies, the unsustainability of dicey mortgages caused millions of households to default because they couldn’t keep up with rising rates, and this led to the crash of the bubble, despite efforts by the Fed to prop up this pretend economy.
The actual order of events is quite the opposite. (1) Tight monetary policy. (2) Rising Unemployment & Collapsing prices. (3) Delinquencies.
In the 18 months after 2Q 2007, to 4Q 2008, home prices dropped by 25%! In those 18 months, delinquencies rose from 2.3% to 6.9%. Unemployment also rose to 6.9%. In the following year, while home prices would find their bottom, unemployment would top out at about 10%. Soon after, delinquencies on single family homes would top out at 11.3%
Here is one last graph, comparing delinquencies on single family homes, all real estate loans, and all loans at commercial banks. We don’t see delinquencies on single family homes rising, leading to problems in other areas. We see all three measures rising at once, as if moved by some singular exterior force. The only difference in behavior is after 2010, when policies regarding bank regulation, foreclosure processes, continued timid monetary policy, and persistent unemployment continue to create frictions in the owner-occupier home market.
. . .
Even in early 2008, after 2 years of liquidity starvation and home prices down 15%, delinquencies were under 4%. Yet, after all of this, in the infamous September 2008 FOMC meeting, the Fed held rates steady to signal that inflation was their primary concern. They soon dropped rates to the zero lower bound. Delinquencies in 3Q 2008 were still at 5.2%. Two-thirds of the rise in delinquencies happened after that meeting, with short term rates (presumably including ARM rates) near their lower bound. However, equity as a proportion of real estate began rising again in 1Q 2009, when the Fed finally reversed course and implemented QE1.
I’ve argued that the housing bust was misdiagnosed. The original weakness in housing prices and output (in late 2006) was an exogenous shock, perhaps triggered by the crackdown in immigration, which reduced the expected growth in population in the subprime states. But the biggest part of the financial crisis was an endogenous reaction to tight money—which sharply slowed NGDP growth.