Between 1975 and 1995, real single-family house prices in America grew every year with an of 0,5 percent, equal to 10 percent over that 20 years. From 1995 to 2004, the national real house prices increased with 3.6 percent per year on every, a more than seven-fold increase in the annual rate of real appreciation, equal to a total of nearly 40 percent in ten years. There are several causes for this. There are several causes for this strong upsweep in the United States housing market.
After 9/11 in 2001, a recession was threatening the United States, what for the Federal Reserve, the U.S. system of central banks, was a reason to drastically reduce the official interest rate in a number of steps, to a level of 0.25 percent. Consequently, loans (including mortgages) were clearly cheaper, mainly for mortgages with variable interest rates (Mah-Hui Lim, 2008). A second factor was formed by an increase in the amount of liquidity in the financial system, on the one hand caused by injections by central banks and on the other hand by an influx of capital available for investment, particularly from Asia (Mah-Hui Lim, 2008). A third factor was formed by the development of a large number of new mortgages in the United States like Low-doc or No-doc loans, Piggyback loans, Step up loans and Negative amortization loans, which were very risky (Mayer et al, 2009).
The securitization of housing mortgages into mortgage-backed securities (MBS) has enabled banks and mortgage companies to increase the velocity and turnover of loans as banks and mortgage companies securitized and sold off these loans. This is known as the "originationdistribution" model. The volume of MBS originated and traded reached $3 trillion in 2005 in a U.S. housing mortgage industry of $10 trillion (Farzad et al., 2007). Securitization enabled banks and mortgage companies, the originators of these loans, to take on more loans as they moved the securitized loans off their books. It was, significantly more than before, usual to choose a variable rate mortgage, the adjustable rate mortgage. This means that the interest for a few years was fixed and after that determined period the interest became.
All this resulted in the fact that it was easier to get a mortgage. Hence, the house prices increased enormous and above their fundamentals. According to Rosser definition of a bubble, a bubble exists when: "the price of something does not equal its market fundamentals for some period of time for reasons other than random shocks." The figure 5.3.1 compares the Actual House Prices to the Fundamental House Prices. The Fundamental House Price followed from the adaptation of the vector autoregressive (VAR) methodology initiated by Campbell and Shiller (1987, 1988a, 1988b). In this methodology the key determents are real income, and interest rates, proxies for affordability. That is because: "the real value of residential property is the expected value of future real disposable income discounted at the real discount rate." (Black et. Al, 2005). From the equation 1 follows the Fundamental House price:
(1)
Derivation of this equation 1 can be found in Appendix 1.1.
Plotting the actual price and the rent model prices in one chart, gives the following figure:
Figure 5.3.1 Actual (real) House Prices () and Fundamental House Prices () in USA
Source: Black, A., Fraser, P. & Hoesli, M. (2005). House prices Fundamentals and Inflation.
The figure plots the (log of) actual and computed fundamental residential house prices over the full sample period, where fundamental residential house prices is calculated by Black et al. (2006). Overvaluation is noticeable from 2001. By the end of the time period, what is September 2004, there is a 25 percent gap between the actual price and the fundamental price.
Hott and Monnin (2007) have another interesting approach with respect to fundamentals and actual house prices. They state that: "according to the no-arbitrage view, agents have to choose whether to buy or to rent a house. In equilibrium, agents are indifferent between these two options and the imputed rents are equal to the actual rents ()." Following the Hott and Monnin Rent model, the fundamental house price is given by equation 2:
(2)
Derivation of this equation 2 can be found in Appendix 1.2.
Plotting the actual price and the rent model prices in one chart, gives the following figure:
5.3.2 Observed price versus rent model price in USA.
Source: Hott, C. & Monnins, P. (2007). Fundamental Real Estate Prices: An Empirical Estimation with International Data.
Looking at this figure, we can observe that in 2005 there was a gap of more than twenty percent between the fundamental price and the actual price. Based on Figure 5.3.1 and 5.3.2 and Rosser definition of a bubble, it can be concluded that there was a housing bubble in the United Stated.
Despite of the reckless provision of mortgages everything would go well when the house prices kept increasing. By rising house prices homeowners could make a profit by selling the house. Also speculators allowed themselves to these activities so that led the house prices rose again. But like the Tulipmania and The Florida Landboom, also the US Housing bubble could not last forever.
By a number of reasons the process of increasing house prices stagnated since mid 2006. Arrears of the mortgage applicants were increasing, especially the subprime mortgages could not pay the monthly charges. The negative features of the above mentioned mortgages emerged. Also a growing number of loans reached the end of the fixed rate period, whereby the homeowners were faced to a significant higher interest rate (Belke & Wiedman, 2007).
By these reasons the interest to speculate in houses and real estate in the United States decreased. This resulted in a decrease of the number of newly built houses and a decrease in the number of sales of existing homes, what the house prices led collapse. The bubble has burst (Belke & Wiedman, 2007).
