Threats chill home security
The old adage that “a man's home is his castle” was based on the belief that if anything was secure in life, it was that each person's home was free from threat or invasion.
Indeed, for most homeowners in the United States, their home has been their single most important asset. The real estate crisis has proved that very few homes are safe from economic invasion.
In 2007, real estate prices began to collapse. Soon, home values in many parts of the nation became top heavy as mortgage debt exceeded their owners' equity. In addition, many homeowners borrowed with adjustable rate mortgages, or ARMs. Under the terms of an ARM, low initial “teaser” rates adjusted over time to higher rates. The combination of lower value and higher interest rates drove many into foreclosure.
Recently, the Federal Reserve's efforts to stimulate the economy, known as quantitative easing or QE, has lowered interest rates, curing the problem for some. Economic conditions this summer brought evidence of an improvement in home prices. The combination may restore confidence in homeownership and boost consumer demand generally.
How did the real estate crisis come about? Before 2007, then-Fed Chairman Alan Greenspan, along with Ben Bernanke (a Fed board member from 2002 to 2005), dramatically increased the money supply with stimulus efforts. In response, home prices rose in an unprecedented manner. According the Standard & Poors/Case-Shiller Index, by 2007, average home prices exceeded, by 50 percent, their established, 100-year-old trend of increasing at 3 percent a year.
This gave homeowners an almost euphoric feeling of wealth. Homeowners became aggressive consumers, boosting growth, particularly in the United States. This unleashed a speculative fever that tempted banks to make increasingly imprudent and liberal mortgage loans and to pass on those loans — by packaging them into securities — to unwitting investors, such as institutions and other banks.
This bubble burst in 2007, a major price correction occurred, and almost all favorable financing conditions reversed. Regulators allowed banks to hide these mortgage assets, now toxic, on their books at full value. As prices fell, the Fed created trillions of dollars with which to buy these toxic assets from banks. Future generations were left to salvage the liabilities.
The Fed's quantitative easing has enabled many consumers to deleverage and even to accumulate cash. Some families are tempted to buy, but lending restrictions have tightened, making mortgages difficult to obtain.
Recession threatens still. Professor Robert J. Shiller cautioned against concluding that home price increases have signaled a convincing market turn.
When the economy recovers once more, the vast cash deposits held at banks — created by the Fed and its quantitative easing — will be leveraged up as loans, increasing the money supply even more and igniting inflation.
Increased investing in housing is likely to return. But the safety and security of homeownership is not in the offing anytime soon.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at firstname.lastname@example.org.