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Economic SYNOPSES
short essays and reports on the economic issues of the day
2008 ■ Number 12

Boom and Gloom in Housing Markets: The Sequel
Carlos Garriga

T

However, the homeownership rate differs substantially across
he effect that housing has on the economy has received
periods. Innovations in housing finance after the Great Depression
increased attention in recent years—first for the recordreduced the barriers to homeownership for many middle-income
high boom in house prices and homeownership and then
households. These individuals had at least 20 percent of equity
for the decline in house prices and the subprime market meltdown.
in the house to buffer a large decline in the price. That, combined
Part of the boom was fostered by important developments in
with some legal restrictions to “walk away” from the house, kept
housing finance such as the introduction of new mortgage prodthe foreclosure rates at historically low levels.
ucts, a reduction in the cost of providing mortgage services, and
By contrast, the innovations in the past decade allowed firstthe expansion of subprime lending and private securitization of
time
(young and low-income households) and repeat buyers to
mortgages. For example, instruments such as “piggyback” loans
purchase
or refinance a house with a very low or even no downand option adjustable-rate mortgages accounted for 12.5 percent
payment.
These low levels of equity have increased homeowners’
of the originations in 2004 and 32.1 percent in 2006.
exposure
to
the widespread decline in house prices and have
Mortgage market innovations and their importance in increastriggered
the
current higher level of foreclosures. The Housing
ing house prices and homeownership have a historical preceand Vacancies Survey (HVS/CPS) reports that the largest drop
dent: After the collapse of mortgage markets during the Great
in homeownership in the period 2004-07 involves individuals
Depression, policymakers’ goal was to increase owner-occupied
between age 45 and 54; in fact, most of this group’s increase in
housing. In the late 1930s, the creation of the Federal Housing
participation since the early 1990s has been completely wiped
Administration (FHA) led to changes in the terms of existing
out. Moreover, the decline for individuals age 44 and younger
mortgage contracts. Prior to the Great Depression, the typical
has been around 50 percent.
mortgage contract had a maturity of less than ten years, a 50
Thus, this experience shows that homeownership is not necpercent downpayment, no amortization, and a balloon payment
essarily the best housing option for highly leveraged households
at expiration. The FHA sponsored the use of a new mortgage
more prone to foreclosure. ■
with a longer duration, lower downpayment requirement, and self-amortizing structure. Government
intervention provided uniform lending throughout
Percent Growth
Percent Growth
the country that resulted in low and stable mortgage
1.8
1.8
Real Housing Appreciation
Real Housing
rates. Between 1942 and 1947, house prices and home(1942:1948) = 6.7%
Appreciation
(1998:2007) = 6.3%
1.7
1.7
ownership attained historical heights with an annual
inflation-adjusted appreciation of 6.5 percent and a
1.6
1.6
total increase in owner-occupied housing of 20 perCase-Shiller Index
cent. Shortages of building materials and delays in
Case-Shiller Index
1.5
1.5
construction of housing for low-income families
fueled the house price boom, followed by a bust
OFHEO Index
1.4
1.4
once the supply of new construction caught up.
The similarities between these time periods
1.3
1.3
become clear by plotting inflation-adjusted U.S.
house prices (see the chart), which suggests that
1.2
1.2
periods following innovations in housing finance
also include high appreciation. The magnitudes of
1.1
1.1
Homeownership Rate
the house price increases from both periods are
Homeownership Rate
qualitatively the same when the OFHEO index is
1.0
1.0
1942 1943 1944 1945 1946 1947 1948
1998
2002
2006
2004
2000
2008
used, and the most recent period is slightly higher
(10 percent) according to the Case-Shiller index.
Views expressed do not necessarily reflect official positions of the Federal Reserve System.

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