When Dr. Stanley D. Smith, a finance professor at the University of Central Florida, recently examined the rise and fall of housing prices for the Orlando metropolitan market, his research brought up a somewhat surprising conclusion: By removing the effects of the housing bubble from the economic equation, it appeared that prices for the Orlando area would have been close to where they are today.
‘If you bought in 2005 or 2006, you were hurt,’ says Smith, who also publishes a quarterly report on house prices for the Mortgage Bankers Association of Central Florida.
Smith notes that Orlando prices shot up 20% in 2005 and 32% in 2006 – prior to the bubble, they were growing at approximately 5% a year. According to his research for the Orlando market, Smith determined that the actual housing price index (HPI) for 2009 (222) was 6% higher than the estimated HPI for 2009 without the 2005 housing bubble (210). He adds that this bubble-free scenario could also apply to other markets around the country.
‘We wouldn't have been as far off as we could've been,’ he says.
While ‘What if?’ scenarios can easily be spun in a variety of ways, Smith's research raises a curious question: What would have happened to the housing market, the mortgage banking industry and, by extension, the national economy if there had not been a housing bubble?
For David Oser, executive vice president, chief investment officer and treasurer at ShoreBank in Chicago, the concept of this ‘What if?’ scenario is extraordinary.
‘It is almost an impossible question – it is almost cosmic,’ he says. ‘The entire financial system, the entire U.S. and perhaps the entire world economy would be so different.’
Dr. Anthony Sanders, professor of finance at George Mason University in Fairfax, Va., observes that the concept of a bubble-free economy is difficult to accept, considering that the bubble played a central role in shaping the U.S. socioeconomic policy.
‘The point that many people miss is that the economy in the 2000s was listless,’ says Sanders. ‘The rate cuts and lack of oversight by the Fed had the temporary advantage of stimulating housing construction and employment.’
Of course, the housing bubble was the decade's second economic roller coaster: The collapse of the dot-com industry at the start of the decade and the recession, triggered by its downfall, started the new millennium's economy on shaky ground. Having two dramatic bubbles in a row came as no surprise to Sam Khater, senior economist with First American CoreLogic, based in Santa Ana, Calif.
‘When the technology bubble exploded, there was an excess of money in market looking for yield,’ he says. ‘The money that was in technology rolled into real estate. When you whacked out the technology bubble, out popped the housing bubble.’
So why didn't anyone learn the still-fresh lessons from the dot-com fiasco?
‘Blame it on human fallibility and the casino mentality,’ says Dr. Gregory Price, chairman of the Department of Economics at Morehouse College in Atlanta. ‘You hope you don't get caught.’
The bubble's expansion was tooled, in large part, by a proliferation of loan products that have since been discredited as dangerous. But Frank T. Pallotta, executive vice president and principal at Loan Value Group LLC, Rumson, N.J., notes that without the frenzy and tumult created by the bubble, these products might still be with us.
‘No-doc and low-doc were good loans, up until 2004,’ he says. ‘But in order to grab volume, originators lowered all of the bars.’
Pallotta adds that the significantly lowered standards in the secondary marketing process aggravated the problems. ‘If someone raised their hand and said, 'There is no way that I'm buying these loans,' then no one would have been originating them,’ he comments.
Khater concurs, noting that without the bubble mania, the government-sponsored enterprises (GSEs) would be maintaining a greater degree of control and order – and, ultimately, retain the sovereignty they lost in 2008.
‘One reason for the bubble was that the private-label market exploded,’ he says. ‘A lot of business that would have gone to Fannie Mae and Freddie Mac went to the other market. If the market didn't get out of control, Fannie and Freddie would've set standards for the market – they would have served as gatekeeper. But they got sucked into this like everyone else – they looked around, saw they were losing market share and said, 'We've got to get into this' – and then it was a race to the bottom.’
However, Bill Bradway, managing director of Bradway Research LLC in Boston, questions whether the GSEs would have been able to escape the decade unscathed.
‘They had separate problems, including the accounting fiascos they experienced when they were trying to manage their earnings,’ he says. ‘Those statistics plagued both firms. Without that, they wouldn't have been tempted to jump into the housing bubble.’
Oser also considers the GSEs' political power, which might have remained intact without the bubble.
‘Unlike most huge corporations, they were completely focused on Washington, D.C.,’ he says. ‘There was a real anger at their lobbying clout. But the Bush administration took advantage of that situation to use Fannie and Freddie to bolster a lot of programs they put in place to help homeownership.’
Dr. Daniel W. Immergluck, associate professor in the City and Regional Planning Program at Georgia Institute of Technology in Atlanta, agrees with Oser. ‘They were primarily companies with a monopoly and lots of lobbying power,’ he says. ‘They followed the market into all kinds of bad things.’
However, at least one sector of the financial services world would have remained untouched in a bubble-free decade: credit unions, which have traditionally not occupied a major slice of the home loan market.
‘We'd still be at two percent to three percent market share,’ says American Credit Union Mortgage Association President Bob Dorsa, who points out that credit union activity in the sector has slowly expanded in the aftermath of the bubble's bursting. ‘Credit unions would have otherwise been plodding along and focusing on the easy stuff.’
Khater acknowledges that there was another factor that would have remained a key problem in a bubble-free decade: affordability.
‘The boom really began in 1997, when the tax law changed on capital gains for homeowners,’ he explains. ‘If the housing market behaved, home appreciation levels would be at one percent above inflation. But affordability became an issue, because incomes were not keeping up with home prices.’
Cliff Rosenthal, president of the Federation of Community Development Credit Unions, believes the question of affordability – especially in regard to encouraging homeownership among lower-income borrowers – would have been better in a bubble-free decade.
‘Without the bubble, community development would be better than it is now,’ he says. ‘We would have seen a more incremental and more responsible increase.’
Rosenthal argues that without the bubble, the federal government would not have pushed the economy into an overdrive that it ultimately could not handle.
‘The bubble was fed by subprime lenders and a convergence of a lot of political, social and economic strains that said homeownership was the way to go,’ he continues. ‘It became the national goal – the way for people to improve the economy was through homeownership, homeownership, homeownership.’
Sanders theorizes that without the bubble, the federal government would have kept an unusual hands-off approach to this sector of the economy.
‘The housing bubble was, in part, fueled by a Federal Reserve monetary policy of keeping rates too low for too long and a lack of oversight for the banking industry,’ he says. ‘Hence, the bubble resulted in massive housing construction, particularly on the rural/urban fringe and traditionally vacation/retirement areas. Without the bubble, we would have seen considerably less growth in California, Arizona, Nevada and Florida.’
‘There are areas of the country that will never come back, because the boom created neighborhoods that would never have been there without the housing boom,’ says Pallotta.
But for many surviving neighborhoods, Pallotta believes that Smith's research on bubble-free housing prices is on target.
‘We are where we should be on homeownership levels – in the low 50s,’ he says.
And in other markets, it seems the industry's odyssey of the past few years was, ultimately, a round-trip excursion. Andrew DeJoseph, assistant professor of business and economics at the College of Mount Saint Vincent in the Bronx, N.Y., points to the Case-Shiller Index for the New York metropolitan area to show that Smith's observations are on target.
‘In May 2009, the Case-Shiller Index found the average home price in New York at about $170,000,’ he says. ‘The last time it was that low was in May 2004. We're back to where we started!’
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