Nomura | JPNRichard Koo February 21, 2012
An effective 40% fall in house prices after 70 years of steady increases exploded the myth that houses were always a goodinvestment—much as Japan’s land myth collapsed in the 1990s—and prompted those who were buying in anticipation of speculative demand to leave the market.Until 2007 in the US (and until 1990 in Japan), home buyers were encouraged by the belief that prices would always go higher no matter how much they paid. As long as this myth persisted, houses were considered a safe asset as attractive as—if notmore attractive than—bank deposits.But the collapse of this view after 70 years and an effective decline in prices of almost 40% prompted homebuyers to becomemuch more cautious. Like their Japanese counterparts in the 1990s, they began using a very different yardstick to examinepotential purchases.Demand plummeted as a result, and US housing starts have averaged less than 500,000 units a year since 2009 after a 15-year period when they never once slipped below 1mn units.
More than half of homeowners’ equity has vanished
Mr. Bernanke also said the drop in house prices has caused more than half of homeowners’ equity to disappear, with lossesamounting to $7trn.He estimated that some 12mn homeowners—representing one in five mortgages—are now underwater as a result.The Fed chairman cited several studies estimating that a $100 drop in housing value depresses annual consumption by $3 to$5 and concluded that the fall in house prices thus far had reduced private consumption by $200bn to $375bn.
Reaction to excessive mortgage securitization
From a financial perspective, the outstanding value of home mortgages has fallen 13% from the 2007 peak in response to a risein defaults, a decline in new purchases, and banks’ unwillingness to lend. Regarding the final factor, Mr. Bernanke argued thecurrent credit crunch is attributable in some measure to past excesses in the securitization of home mortgages.The GSEs (government sponsored entities like Fannie Mae and Freddie Mac) demand insurance when purchasing homemortgages from financial institutions for securitization purposes, but the sharp increase in defaults over the last few years hasleft many of the providers of this insurance struggling to survive.The surviving insurers have become far more cautious as a result, and that has forced banks to become more cautious as well,since uninsured home mortgages cannot be sold to the GSEs.
GSEs and FHA only functioning cogs in US mortgage market
A second issue is that the dramatic increase in defaults has prompted the GSEs and other investors who purchased these loansto seek restitution from the originating banks.This is a reaction to the excessive availability of credit and securitization of home loans in the past, and the securitization marketis unlikely to revive until the extent of legal liability at the originating banks is clarified.New home mortgage securitizations by private entities remain extremely rare. The GSEs and the Federal HousingAdministration are essentially the only players still active in the securitization market.The issues of mortgage insurance availability and the legal responsibility of loan originators need to be resolved if this market isto regain its earlier vitality. Even if these questions are resolved, I do not think we will ever again see home loans being offeredwith the same kind of perfunctory credit checks witnessed during the housing boom.
End to US housing myth could have greater impact than in Japan
The issues facing the US housing market are numerous, ranging from the breakdown of the housing myth to the need to rebuilda securitization infrastructure. In a sense, I think the US may be worse off than Japan.The US economy, after all, is far more dependent on the housing market than Japan’s ever was, with a slump in the housingmarket having a correspondingly large impact on the broader economy. Housing was reportedly responsible for most of thegrowth in the US economy in the five years leading up to the market peak in 2007.The externalities in the US housing market are also far larger than those in Japan, where no one would expect a foreclosedhome to reduce the value of other properties in the neighborhood.The asset value of US housing, meanwhile, is influenced by the surrounding environment as well as the house itself. Neighborsoften complain if a resident lets the grass in his lawn grow a bit longer than usual. As many foreclosed homes are a mess bothinside and outside, the appearance of even one in a neighborhood can lower the value of nearby homes.
Extension of ultra-low rates reflects time needed to resolve problems
Mr. Bernanke said that 1mn foreclosed properties could be added to the housing supply in each of the next few years.Such properties are referred to in the industry as real estate owned, or REO. The Fed chairman said houses currently inforeclosure are more than four times as numerous as the entire existing inventory of REO.