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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. research.stlouisfed.org