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Monday, May 02, 2005

FDIC Update: U.S. Home Prices: Does Bust Always Follow Boom?

by Calculated Risk on 5/02/2005 10:19:00 PM

The FDIC today released an update to their February report that shows the boom is even more widespread.

"... the number of boom markets according to our definitions increased by 72 percent last year, and now includes some 55 metropolitan areas."

They also express concern about excessive leverage and speculation:
"... there have been a number of changes in mortgage markets that could have an influence on home prices, including the emergence of high loan-to-value lending and subprime lending ...

In addition to increased leverage and subprime lending activity, use of adjustable-rate mortgages, or ARMs, remains high. According to the Mortgage Bankers Association, ARMs accounted for almost 46 percent of the value of new mortgages in 2004 and 32 percent of all applications. Both figures were up sharply from their 2003 levels of 29 percent and 19 percent, respectively. It is noteworthy that this development occurred despite the fact that the average annual fixed rate for a 30-year mortgage remained virtually unchanged from 2003.

Furthermore, data from the Federal Housing Finance Board indicate that the ARM share is high and rising in several of our boom markets. Taken together, these trends suggest that highly-leveraged borrowers are increasingly taking on interest-rate risk as they stretch to afford high-cost housing. ...

Another evolving trend that has not been tested in a housing market downturn is the increasing market penetration of innovative mortgage products, such as interest-only (I/O) and option ARMs. These mortgages are specifically designed to minimize initial mortgage payments by eliminating principal repayment; but these also can increase leverage and expose owners to large jumps in monthly payments as interest rates rise. According to Inside MBS and ABS, interest-only mortgages accounted for 23 percent of the value of non-agency mortgage securitizations in 2004. ...

Finally, although this factor is not directly related to credit conditions, heightened investor purchases of homes could also be signaling a higher degree of speculative activity in housing markets during 2004. Data from Loan Performance indicate that 9 percent of U.S. mortgages in 2004 were taken out by investors, up from just under 6 percent in 2000. Furthermore, this share is significantly higher in local markets that are experiencing the strongest home price appreciation. In some of these markets, it is estimated that the investor share of new mortgage originations is as high as 19 percent. Academic studies show that residential property investors are less loss-averse than owner-occupants and thus more likely to sell precipitously in a declining market, thereby aggravating any existing downtrend in home prices."