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Mark’s Perspective

It was frightening enough, however, that I wrote about it in the March 2006 issue of The Navigator. “In the next five years, house values are going to return to their 1997 levels plus inflation,” I wrote. “Inflation since 1997 is roughly 21 percent. That means to calculate the value of your house in 2011, take the 1997 value and add 21 percent.  For most of us, that is quite an adjustment from 2006 values.”

I remember the morning of March 9, 2006, as if it were yesterday—because my first thought of the day was that if I lost my home, I couldn’t afford to buy it back. 

By now, many U.S. homeowners have experienced that fear and seen it become a reality. The number of “underwater” homeowners grew by about 400,000 during the fourth quarter of 2011, to 11.1 million, as home prices fell as a result of seasonal declines and a slowdown in processing homes through the foreclosure process.  According to data aggregator CoreLogic, 22.8 percent of all residential properties with a mortgage had negative equity.

Back in 2006, however, the U.S. housing market was on a tear. President George W. Bush’s 2004 campaign slogan “the ownership society” encouraged Americans to own homes. That became easier in the wake of the recession caused by the dot-come bubble bursting in 2000.  The U.S. Federal Reserve Board (Fed) dramatically lowered the federal funds rate, from about 6.5 percent to 1 percent over a three-year period, spurring easy credit for banks and low interest mortgage rates.  

As more and more Americans entered the housing market, home prices skyrocketed, peaking in March of 2006. Americans, meanwhile, just couldn’t conceive of the possibility that the housing market would not continue its rally. As a result, Americans lined up for loans at any cost, even those they could not afford.  Beyond the rush to buy, the number of suspicious activity reports (SARs) filed by depository institutions indicating the level of mortgage loan fraud increased by 1411 percent between 1997 and 2005 as reported by the U.S. Treasury.

Then the Fed stepped in. Between 2004 and 2006, the policymakers raised interest rates 17 times, ultimately stopping when the federal funds rate hit 5.25 percent in 2006. That increased the monthly payments for adjustable rate mortgages and lowered demand for homes. As a result, homeowners who had adjustable-rate mortgages could no longer make their payments.  At the same time, they couldn’t sell their homes, because the housing market had stalled. Most home buyers had been told not to worry about the affordability of a home as the value of the home would continue to increase.  That was false, and the housing crash started.

In March of 2006, of course, that process had only just begun, so my fear that morning of March 9 was speculative.

We can’t change what has happened in the past, but we can learn from our mistakes in order to hopefully avoid making similar ones in the future. In that vein, this chapter is not an economist’s guide to the housing-market meltdown; it is intended to explain how the housing market declined, how we could have foreseen it, what we can learn from it, and if we can take advantage of it now.

In early August 2007, the Dow Jones Industrial Average enjoyed its biggest one-day point gain in four years, rising by 286 points to 13468. Just a year later, the U.S. economy was shaken to its core by a credit crunch stemming from a lack of confidence in subprime mortgages, leading the U.S. government to implement a sweeping bailout package unlike anything seen since the Great Depression. At the time, trying to pinpoint the significance of a world-shattering event such as this was tricky.