Problems in the US and Global Housing Market

Problems Encountered in the US and Global Housing Market

The U.S. Housing market slump has a long and inter-related history. Policies, financial packages and expectations during a housing market bubble, peaking between 2002 and 2006, accumulated a backlog of market forces ready to burst. The crashing housing market is a knock on from this unsustainable boom period, which we need to take a closer look at to find answers as to the crash has occurred to such an extent.

Reasons for U.S. Housing market slump

The housing boom, roughly starting in 2002, itself has the background of the U.S. recession in 2001. Following booms of the late 90s, with dot com and stock market increases, The Federal Reserve tightened credit in the U.S economy in an attempt to control inflation and achieve sustainable growth. This lead to short term interest rate hikes, which briefly lowered borrowing and consumer spending whilst stock prices began to fall sharply, and unemployment rose, the U.S economy, entered a slump.

2002

Following the recession of 2001, the housing market held strong in 2002 and increased in sales to hit a record of $5.3 million (Joint Center for Housing Studies of Harvard University, 2002). Much of the increased demand is attributed to changes in demographics as immigration and ethnic minorities joined the share of homeowners, enabled by subprime, low-deposit mortgages fuelled by the Federal Reserve expansionary monetary policy during the recession.

2003

Following the record year of 2002, a housing market bubble began to grow as purchases increased for investment purposes from speculators that jumped on the increasing house prices. Borrowers began to borrow higher amounts, despite the general increase in unemployment above averages (see table 1), to capture more valuable properties with the expectation that house prices will continue to appreciate rapidly in value following the market trend and a lagging quantity of builds. Increased capital for purchases, despite a difficult labour market was enabled by ever loosening mortgages from the lenders with lower interest rates making monthly payments affordable.

Table 1. U.S. Unemployment Since 2001 Recession

Source: Bureau of Labor Statistics – Employment status of the civilian non-institutional population

2004

In 2004, demand for housing continued to increase unnaturally, breaking records by reaching 69% homeownership (Joint Center for Housing Studies of Harvard University, 2005), despite continued above average job losses, as further risky sub prime, higher interest rate (but relatively low) loans, government backed larger prime loans and new adjustable rate loans (at the low interest rate, tracking if rates increase) from banks continued fuelling purchases and increased property prices beyond natural affordable levels. Single family home sales rose to 6.1 million units (Joint Center for Housing Studies of Harvard University, 2004).

2005

In 2005, adjustable rate mortgages continued to rise in popularity to make up one third of mortgage share (Joint Center for Housing Studies of Harvard University, 2005), as the banking industry further financed increased purchases and debts rose. Housing prices continued to rise beyond the natural affordability of potential owners, however financial institutions range of loose loan conditions enabled more and more buyers to make their purchase.

2006

Following more records in 2005, with falls in unemployment toward average rates (see table 1), higher interest rates and further increasing prices did not slow the housing boom greatly as flexible mortgages continued to subsidise financing for lower earners who would have been priced out of the market. The debts are accumulating year on year, with the expectation that equity in property with high prices can provide the bailouts for defaults on loans.

2007

The end of 2006 and 2007 begins to see the dramatic effects of high housing production from years prior to 2006 and surpassing the quantity of houses demanded to create a surplus inventory of houses vacant. Houses prices suddenly house prices began to fall nationwide (see figure 1). New houses and sales had fallen, as production was then sharply cut back, reducing national growth by a more than 1% and signalling a decline in the appreciative potential of properties (Schifferes, 2007). The chain reaction was in full swing, as this was causing an increase in the risk felt by potential low-income would-be buyers to take out recently hiked interest rate and stricter mortgages, making these them opt to wait and thus spiralling down the quantity of demand for housing and deflating prices throughout 2007. Some houses were repossessed, as adjustable interest rates were reset and increased beyond affordability for sub-prime owners and the debt collections began to mount.

Figure 1. Source: Schifferes, 2007

2008

Wider implications of U.S housing bubble burst

The cumulative effect of several years of debt for properties expected to continue to gain equity, has left a hitherto $4 trillion leverage that banks could not balance in foreclosures or sell to the Federal National Mortgage Association (Fannie Mae), causing wide-spread problems across the financial industry. Several major U.S. Banks, such as JP Morgan and Merill Lynch have suffered liquidity restrictions as inter-institution lending across the whole banking system became untenable beyond just days (US bail-out of banks is under way, October 2008). Businesses have has been affected by difficulty to secure capital from financial institutions as the banks continue to tighten credit standards. This has reduced their investment and growth possibilities, causing a further blow to GDP (GovernorRandall S. Kroszner, November 2008).

The U.S. Treasury and Congress have since agreed to $700 billion bailout plan to provide liquidity to U.S. banks through purchasing equity the banks. The hope is that the banks will be able to relax credit standards and fuel more capital in the economy with this stimulus package.

During 2008, other world banks, such as the European Central Bank, Bank of England and the Bank of Japan, began to feel the stresses in the U.S. banking system, struggling to obtain dollar funding from U.S. banks, due to the same tightening policy by U.S. financial institutions. As a result, the Federal Open Market Committee (FOMC) has authorized a total $330 billion increase in temporary purchases of reciprocal currencies to total $620 billion (until April 30, 2009), in order to provide U.S dollars to other central banks around the world and increase global U.S dollar liquidity. (Monetary Policy Press Release, September 2008).

Further planned building cuts with a 27.3% fall in projects between October 2007 to October 2008, and decreasing completed homes with a 25.6% fall between the same period (U.S Department of Commerce, November 2008), is set to impact the growth in production, GDP.

All in all, the fall in the housing market, has affected GDP, with the two being historically linked (Is The Housing Bubble Fuelling GDP Growth? nd) and thus the decline in productivity reacting to reductions in general consumption by homeowners to adjust to the housing market crash is due to show up in GDP decreases. Three month GDP analysis show a 0.3% decline, with consumer spending falling 3.1% (US economy officially shrinking, October 2008).

The decline in the U.S. economy has a knock on affect to world economy as several countries depend on the U.S. for the trade exports, as demonstrated by the U.S huge trade deficits. The strength of the dollar in foreign exchange market fell up to August 2008, increasing the cost of imports to the U.S whilst wide spread spending decreases meant cut backs in U.S. demand for goods for many of the words economies.

The UK housing market is also experiencing a slump, with property values falling since the middle of 2007 after large rises for 2 years, very similar to the trend in the U.S market, falling by over around 15% in value on average between 2007 and 2008 according to two Halifax and Nationwide mortgage lenders (Housepricecrash.co.uk, Dec 2008). The Bank of England have, like the Federal Reserve, implemented an expansionary policy, through cutting interest rates, in a bid to stimulate the financial institutions to relax credit standards, and re-fuel consumer spending to boost demand in the housing market. UK business investments also fell throughout 2008, as well as the strength of the UK Sterling for international trade, as imports became more expensive and international investors discouraged.

Across Europe, several central banks and government budgets are attempting to stimulate their economies with loosening policies. The German government have planned a €50 billion stimulus package to support the banking system in the face of domestic credit liquidity problems (Robert Winnett and Nick Allen, October 2008). The Spanish government has also planned a 20-40 billion fiscal stimulus package, focusing on tax cuts to for workers and non-workers and relaxing credit standards by financial institutions in order to boost their consumption (Spain pledges economic stimulus, August 2008).

The global “Credit Crunch”, has been affected greatly by the world’s largest economy having huge financial difficulties, as GDP growth begins to slow. The correctional attempts by governmental policies and central banks worldwide require a period before their implementations can have a local market and macroeconomic impacts necessary to recover target productivity and consumption levels. The U.S. government bailing out the major banks it seems may just have slowed down worse global economic chaos that would have ensued, however a lot of damage has already been done by the U.S housing market stresses. Whilst production on houses has slowed in the U.S., the number of vacant properties for sale should continue to decrease and once equilibrium is reached between the current oversupply the demand, the U.S. should be on the road to economic recovery.

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