Real estate speculators are to blame for the intensity of the 2004-2006 housing bubble and subsequent financial crisis, as found in a study by the Federal Reserve of New York (New York Fed). Between 2000 and 2006, the share of purchase-assist financing going to people who owned more than one home — mostly real estate investors — nearly tripled in California to 20%.
Borrowers with multiple first liens flooded to the subprime mortgage market at the height of the Millennium Boom. These short-term investors — also known as speculators — took out loans with small down payments and high interest rates to buy properties and sell them quickly for a profit. At the 2006 peak, about 22% of subprime mortgage lending went to California homeowners with only one first lien while 35% went to homeowners with three or more.
Speculators seemed the more profitable bet for mortgage lenders during the first half of the decade since they were paying a higher rate of interest to cover the risk of a greater likelihood of their default. Then as prices began to fall in 2007-2009, speculators became responsible for more than 30% of seriously delinquent mortgages statewide.
first tuesday take: The Fed’s research again proves a trend first tuesday has observed in the data for years — high speculator activity hyper-inflated the 2004-2006 housing bubble, making the subsequent burst more devastating than previous booms and busts as they dumped their unprofitable holdings on the market for sale or rent. [For more information regarding speculators, see the January 2010 first tuesday article, Homebuyer beware: the real estate game lacks fair play.]
Housing prices during the Millennium Boom were initially driven up by Wall Street bankers pouring excessive money into mortgage lending with no regard for the change in value of the collateral (i.e., the real estate). Speculators then jumped into the momentum in the ever increasing over-priced market, creating artificial buying and selling activity which withdrew property from the market and in turn fueled more building, speculation and mortgage lending.
Speculators took advantage of quick and easy money leant in the form of adjustable rate mortgages (ARMs), with low teaser interest rates that wouldn’t reset to high interest rates until well after they expected the property to be flipped and sold. But when the financial crisis hit and home values plummeted, speculators were left with a glut of homes, no buyers and mortgages approaching their reset date. The resulting Lesser Depression has been longer and more devastating because of speculator activity. [For more information regarding adjustable rate mortgages, see the March 2010 first tuesday article, The danger of an ARMs build-up.]
Speculators contribute nothing of value to the real estate market. During good times, they merely purchase homes to sit on, contributing only the minimum maintenance needed to keep the property functioning, until rising market momentum increases the value and the time to sell presents itself. A speculator will then list a property for sale at a price much higher than he paid and pocket the profit on the flip. Such transactions add money to the real estate market only to withdraw it again, creating a zero-sum game (except for the lost rental value). [For more information regarding speculator activity, see the August 2010 first tuesday article, Speculations on speculator suppression.]
Owner-occupants, real estate licensees, long-term buy-to-let investors and those employed in the industries relying on a stable housing market (construction, escrow, title, home inspectors, etc.) must strive to keep the influence of the speculator at bay. This is best accomplished by demanding strict lending standards and regulation of the subprime (ARM) mortgage market. Although unqualified homeowners may not like it, lenders do them and the economy a favor by enforcing a more fundamental, documented approval process and only lending to those who can produce a minimum 20% down payment. [For more information regarding strict lending, see the July 2011 first tuesday article, Strict lending is good for you and the economy; for more information regarding 20% downpayment regulation, see the October 2011 first tuesday article, The 20% quagmire.]
Re: “Flip This House: Investor Speculation and the Housing Bubble” from the NY Fed