Housing Market: 2000-2008 Review

During the first half of the past decade, California experienced a remarkable period in which home values began rising at incredible rates. By 2005, some markets saw home values double and triple as buyers flooded the market, enticed by easy financing and the promise that values would continue to increase in California. While there was talk of a housing bubble by some, there was an equally convincing group that suggested that California real estate values would only go up as more and more people flocked to the Golden State. However, soon cracks started appearing in the market and the boom was followed by a nationwide housing market bust of historic proportions that eventually spread fear among holders of stocks, corporate bonds, and government and municipal bonds. Credit-default swaps threatened to destroy insurance giant AIG, the company having been ultimately saved by a titanic government bailout. Mortgage giants such as Countrywide, Wachovia, and Washington Mutual, facing insolvency, were bought by stronger competitors, who were also severely weakened and ultimately bailed out by the U.S. government. Investment banks, such as Bear Stearns and Lehman Brothers, which were century-old beacons of high finance and trade, were left bankrupt. Even companies such as General Motors and Chrysler Motors, far removed from the housing market, were driven to
declare bankruptcy. Arguably further removed still, international markets all over the globe also crashed.

The history and many of the causes of the biggest housing crash since the Florida Land Crash of the 1920s are becoming well-understood. The crisis originated with the Federal Government’s Community Reinvestment Act, which encouraged home ownership and a monetary policy that kept interest rates historically very low. These policies caused real estate values to begin a steady ascent that progressively picked up steam. Wall Street was making a lot of money packaging and selling mortgage-backed securities. Credit agencies determined those investments to be very safe, and the mortgage bonds received high credit ratings. The demand for such bonds seemed endless. Banks and mortgage brokers discovered that they could make very high profits originating loans. So the competition to capture market share gave birth to creative loan products such as teaser rates (where loan rates are low for a short time and adjust to market rates at a later date), option adjustable rate mortgages (which gave the borrower the option to make less than a full payment), and Alternate-A stated income loans (where loans were underwritten based on unverified statements of income and were nicknamed “liar-loans”). Prior to 2003, those Alternate A loans, which allowed for loans to be underwritten less stringently, were a small portion of the loan market. But between the years of 2003 and 2006, those loans increased by an incredible 340%.i In higher-priced markets, such as California, Option ARM loans (those in which a borrower could pay an amount below that required to pay even the interest, and could allow the difference to be added to the loan) were also very popular. Influenced by loan brokers and reassured by climbing values, appraisers became overly-optimistic with regard to valuations. The lucre from those loans wrought fraud and misrepresentation throughout the system, since those loans were sold to Wall Street and no risk exposure remained with most lenders involved in their origination. When the demand for those products subsided and the news of the crumbling housing market spread, the value of those mortgage-backed bonds crashed. Seemingly overnight, the mortgage-origination business virtually disappeared and was irrevocably changed. Many businesses related to lending went bust. The website ml-implode.com began tracking the instances of mortgage lender failures. As of this writing, the number was 374. Nearly 300 closed during the years 2007 and 2008.

From our analysis, it is evident that the California real estate market peaked in 2005 and 2006, then started showing signs of weakness in mid-to-late 2006. In the latter months of 2006, it was evident that the housing bubble had popped. Sellers began to reduce their prices. Unsold inventory began to build. Where there was smoke in 2006, there was fire in 2007. Home buyers had vanished and sellers were unable to sell their homes at once-prevalent high prices. The inventory of unsold homes began to pile up at a rapid rate as private sellers and banks with newly acquired foreclosed homes flooded the market. Absorption rates for sales of homes plummeted. Financing began to dry up as banks reduced their exposure by withdrawing from the market and tightening lending standards. Buyers who wanted to buy were unable to act, limited by the availability of favorable financing. Throughout 2007 and 2008, the housing market seemed to be in free fall. Some parts of California saw home values decline by 75%. The declines were most evident and severe in areas where the most affordable homes could be found, and where home prices were within reach of the lower tiers of income earners and investors. The declines were also plaguing areas where developers had overbuilt small communities on the edges of cities, and prescient builders began to liquidate new tract homes. But the symptoms soon spread to the upper levels of the housing market. The market crash in 2008, and the credit crisis that erupted in the fall of that year, caused the crash to affect the wealthiest individuals. Consequently, all rungs of the housing ladder, including homes in the top tier priced at over $1 million, were negatively affected. In 2005, the number of $1 million-plus homes sold was 54,773. In 2006, it was 50,010; while in 2007, it was 42,506. Then, in 2008, it dropped 42.5% to 24,436.ii So although top-tier housing was resilient to price declines during the initial housing correction, during 2008 and 2009 significant weakness developed to cause foreclosures and price corrections to be manifested within this upper-level price market.

Published with permission from "A STATE IN TURMOIL: Why The California Residential Real Estate Market Has Just Begun To Fall" By Eli Tene, Gil Priel and Jeff Woodsworth. This text may not be redistributed or reproduced without the written consent of its authors.