by Calculated Risk on 2/14/2005 11:26:00 PM

The FDIC has released a new report titled "U.S. Home Prices: Does Bust Always Follow Boom?" Their analysis is based on the OFHEO House Price Index database.

Their conclusions:

1) Most booms did NOT lead to a bust.

2) Most booms ended with "stagnation in home prices".

"In these cases, nominal home prices rose by an average of 2 percent per year during the five years after the boom ended. The equivalent figure for real home prices was a modest 2 percent per year decline."

3) Busts followed booms when a local severe economic shock occurred.

"... severe economic shocks—often including a net outflow of population—appear to be a key factor in pushing nominal home prices sharply lower. Home price declines do not occur simply because home prices have boomed, and they do not occur independently of local economic conditions."

4) However, there are additional reasons for concern with the current situation:

a) Boom is almost Nationwide:

"Our count of 33 boom markets in 2003 is the highest witnessed at one time during the past 25 years—1988 ranks second, with 24 booms. Moreover, the 2003 boom markets account for roughly 40 percent of the nation's population base, contributing to the impression that this is a nationwide phenomenon."

b) Financing is in uncharted territory:

"A major financial development in the 1990s was the emergence and rapid growth of subprime mortgage lending. Subprime mortgage loan originations surged by a whopping 25 percent per year between 1994 and 2003, resulting in a nearly ten-fold increase in the volume of these loans in just nine years.12 Subprime mortgages currently account for just over 10 percent of all mortgage debt outstanding."

c) And more and more buyers are taking on high debt to equity ratio:

"Home buyers are also increasingly availing themselves of higher-leverage mortgage products. In 2003, loans exceeding 80 percent of the home purchase price accounted for 30 percent of all purchase mortgages underwritten. In a few cities, this share exceeded 50 percent.14 In addition, more borrowers are taking on second mortgages at closing. One method of doing so involves "piggyback" loans, which combine a first mortgage, usually for 80 percent of the value of the home, with a "piggyback" second mortgage amounting to 10 to 15 percent or more of the value of the home. The effect of this structure is to raise the total loan amount to a level very near the value of the home, which may make borrowers more likely to default in the event of a housing market downturn. An increased incidence of default and foreclosure could, in turn, contribute to downward pressure on home prices as distressed properties are liquidated by lenders."

I am not optimistic that we can avoid a bust ...