Chain Reactions of Bursing the Housing Bubble

 Chain Reactions of Bursting the Housing Bubble

Facing  the unprecedented housing crisis in U.S history along with the credit crisis, thousands of Americans face the foreclosure

of their home and the county economy slide into serious recession. On July 23, 2008, Congress passed Housing and Economic

Recovery Act of 2008.

As part of the bill, Congress has created a new, temporary tax credit to provide an incentive for first-time homebuyers.

Why the housing tax credit now? We have to look at what had happened to the greatest housing bubble in U.S history.

Subprime mortgage crisis

The last bull market of 90s had cultured three great bubbles: Stocks, Real estate, and Commodities.

Unprecedented dramatic appreciation in house prices between 1997 and 2005 had inflated greatest housing bubble in U.S history. The one of big effects of housing

bubble is the Mortgage equity withdrawals or primarily home equity loans and cash out refinancing grew considerably since early 1990s.

By definition, the home equity loan is the qualified residence interest. These loans utilize the personal residence of the taxpayer as security. Because the funds from home equity loans can be used for personal purposes, what would otherwise have been nondeductible consumer interest becomes deductible qualified residence interest. 

Estimated by US Federal Reserve, in 2005, homeowners extracted $750 billion from equity of their homes (up from $106 billion in 1996), spending two thirds of it on personal consumption, home improvements, and credit card debt.

Construction of new single-family houses sold were 1,283,000 compared with an average of 609,000 per year during 1990-1995.

As Robert Shiller, a professor of Economics at Yale had warned the ongoing housing bust in 2005, “Many places around the world have been in a housing boom since the late 1990s. …the boom is rooted in speculative investment by ordinary homebuyers, fueled substantially by the world wide perception that capitalism has triumphed. Convinced that private ownership has become essential to smart living, buyers bid up home prices, moreover, the fear that one must get in on the boom before it is too late often drives people to bid up home prices faster now. But the boom generated by such beliefs cannot go on forever, because prices can’t go up forever, and there are already signs of a hard landing.” In August 2007, he warned again, “ the examples we have of past cycles indicate the major declines in real home prices—even 50% declines in some places –are entirely possible going forward from today or from the not too distant future.

Just as professor predicted, in early 2006, American housing market started show the sign of aging.The psychology has suddenly changed, creating widespread fear of sharp drops in U.S. home prices.

National home sales and prices both fell dramatically in March 2007—according to NAR data, with sales down 13% to 482,000 from the peak of 554,000 in March 2006 and the national median price falling nearly 6% to $217,000 from the peak of $230,200 in July 2006.

In August 2006, Barron’s magazine warned, “ a housing crisis approaches”, and noted that the median price of new homes has dropped almost 3% since January 2006, that new-home inventories hit a record in April and remain near all-time highs, that existing-home inventories are 39% higher than they were just one year ago, and that sales are down more than 10%, and predicts that “ the national median price of housing will probably fall by close to 30% in the next three years.

The greatest housing boom in U.S history has finally come to the end.

Following the housing bubble bursting, is the horrible Subprime mortgage crisis. It is an ongoing financial crisis characterized by contracted liquidity in global credit markets and banking systems. Subprime and Alt-A loans are loans made to home buyers without the verification of their incomes. Account for about 21 % of loans outstanding and 69 % of mortgages made in 2006. The crisis eventually forced New Century Financial; the largest subprime lender’s stock plunged more than 90 % and filed Chapter 11 bankruptcy on April 2, 2007.

National foreclosure rates reached 56% in March 2007. In April 2008 survey sees more than 243,000 filings, up 65% from a year earlier. A downturn in the housing market of the United States, risky practices in lending and borrowing, and excessive individual and corporate debt levels have caused multiple adverse effects on the U.S economy.

Housing Bubble did not exist alone

As the subprime crisis continue unfold, several biggest U.S investment banks that had involved subprime landing practice had faced an unprecedented loss due to result of having held on to large positions in subprime and other lower-rated mortgage trenches when securitizing the underlying mortgages. In August 2007, Lehman brothers, the one of the largest investment bank in U.S closed its subprime lender. In 2008, lehman faced an unprecedented loss due to the result of having held on to large positions in subprime and other lower-rated tranches when securitizing the underlying mortgages. in the second fiscal quarter, Lehman reported losses of $2.8 billion. It’s stock lost 73% of its value as the credit market continued to tighten. On September 15, 2008 as opposite of broad market view, government did not bailed out Lehman brothers and it could not sell itself to other financial institutions, and Lehman brothers, the one of largest investment filed for Chapter 11 bankruptcy protection.  

The impact of Lehman bankruptcy filing was devastating.  On the same day of filing the Dow Jones closed down over 500 points, at the time the largest drop by points in a single day since the days following the attacks on September 11, 2001, Followed by wave of wave selling off of U.S and world stock markets.

Recovery Act of 2008 and rejuvenate the housing market

The housing and credit crisis had been so dramatic affected thousands of Americans and our financial system. The credits of Housing and Economic Recovery Act will provide $7500 credit for first time home buyers, the credit:

·          Applies to purchase of a principal residence on or after April 8, 2008 and before July 1, 2009.

·          Reduces a taxpayer’s tax bill or increases his or her refund, dollar for dollar.

·          Is fully refundable, meaning that the credit will be paid out to eligible taxpayers, even if they owe no tax or the credit is more than the tax that they owe.

Hopefully that the credits will be able to stable and rejuvenate the housing market and prevent the crisis get worse and save country economy.