Understanding the Housing Market Crash and Its Recovery

Most of the general public realizes by now that the recession was caused by the collapse of the nation’s financial system. That is, the system whose sole purpose was supposed to facilitate the exchange of goods and services in the U.S. economy, seems to have had just the opposite effect stemming from the creation and sale of high risk of collateralized debt obligations (CDOs) to investors who thought they were purchasing relatively safe financial instruments. The questionable CDOs were based on packaging and reselling home mortgages, many of which were approved for a segment of home-buyers classified as the sub-prime market (i.e., home buyers with anticipated high default rates due to one or more aspects of the buyers’ credit histories, income and/or down payments). As of 2005, historical data reveals that an unusually large percentage of homes had been approved for the subprime market. Moreover, many of these mortgages were creatively financed as adjustable rate mortgages and ‘interest only’ mortgages for limited periods of time in order to make them initially affordable for buyers.
By 2008, large numbers of homeowners who were primarily members of sub-prime market started to default on their mortgage payments and financial markets stated to disintegrate. The rest is history. For all of 2009 and the first quarter of 2010, Congress and the Federal Reserve Board of Governors have tried to stabilize the economy and restore credibility to the financial markets. The housing market, however, that is best described as an assortment of regional and local markets, will need a stable growing economy before it will function normally again. Therefore, according Standard and Poor’s report on the Case-Shiller (C-S) Home Price Indices ‘…From their peak in June/July of 2006 through the trough in April 2009,the 10-City C-S Composite was down 33.5% and the 20-City Composite is down 32.6%.... The 20-City Composite is [was] up 0.6% [ in February 2010] versus the same time last year. However, 11 of 20 cities saw year-over-year declines. The cities of Seattle and Portland are 2 of the 20 cities included in the 20-City C-S Composite. (Source: http://www.standardandpoors.com/spf/...ce_Release.pdf.
The Case-Shiller indices rely on data from as many as 20 cities in order to generate a national estimate of the price of home values that have been resold over time. The most recent S&P-C-S report did not predict future changes in the housing market; but it did refer to the negative impact that home foreclosures had on the historical price of homes. According to this report, foreclosures rates have reached their highest level in the last five years.

Focusing on the Pacific and Northwestern coastal states, there are notable differences in the housing markets due to differences in the impacts of the pre-recession housing boom on home values, the financial profile of homeowners; and the strength or stability of the underlying state economies when they were subjected to the impact of the forces that created the national recession that bean in late 2007. Therefore, the remainder of this paper focuses on the housing markets in Alaska and Oregon. An article that will cover Washington’s and CA’s housing markets will be published in the future along with updates on all 4 states.

Oregon- The median price of housing rose significantly in Oregon between 2004 and 2007 due to a decline in the credit/eligibility requirements for purchasing homes, speculation; and the in-migration of CA natives who purchased retirement or second homes in Oregon. The median value of owner-occupied mortgaged homes that was $211,400 in 2005 grew annually by 16.4 percent, 11.2 percent and 3.6 percent in 2006, 2007 and 2008 Absent the speculation and liberal lending practices that created the inflated home values, a reasonable growth rate for home values in Oregon might have been roughly 4 percent per year in keeping with Oregon’s average annualized 4.2 percent growth rate for the median value of family income between 2005 and 2008. Applying a 4.2 percent annual growth rate to the $211,400, the value of owner-occupied, mortgaged homes in 2005 implies a value of $250,000 in 2009 and $259,000 in 2010. However the actual median value in 2008 was $283,500. Therefore, a downward adjustment is expected to occur between 2008 and the end of 2010 on the order of 8.6 percent to 10 percent in Oregon. As stated above, this reduction in value will be attributable to excess demand attributable to in-migration, speculation; and liberal financing granted to the subprime housing market that ultimately contributed to Oregon’s historically high home foreclosure rates (see Table 1).

Table 1- Foreclosures of Single Family Homes
Source: reatytrac


Alaska- Noticeable differences exist for the housing markets among several Western coastal states. For example, the median value of owner-occupied, mortgaged homes located in Alaska was roughly $211,000 in 2005, similar to the median value in Oregon. Economically, both Oregon and Alaska are in their early stages of economic development. Both states have enormous areas of natural beauty and vast sources of yet untapped natural resources. The median value of homes in Alaska, however, grew more conservatively than it did in Oregon, suggesting that homes in Alaska were far more insulated from the factors that caused home values to appreciate in Oregon. The median value of owner-occupied mortgaged Alaskan homes by 7.1 percent, 8.3 percent and 3.0 percent in 2006, 2007 and 2008, respectively for an average annualized rate of 6.9 percent. Unlike Oregon, Alaska’s home owners were better insulated against changes in lending rates that caused foreclosures rates to rise in Oregon for several reasons, the most important of which was probably the fact that Alaska’s median family income in 2005 of $67,084 was also higher than Oregon’s family median income of $52,698. Both states had an annualized average annual growth rate in family income between 2005 and 2008 of roughly 4.1 percent. Given the higher levels of family income, Alaskan homebuyers were relatively less receptive to the liberal credit practices that attracted Oregonians because between 2005 and 2008 a smaller share of Alaskan homeowners had first mortgages. In addition, a smaller share of the owners of mortgaged homes had second mortgages or equity loans that were secured by their homes.. Given the stronger financial positions of Alaskan homeowners, in the third quarter of 2008 there were 30 foreclosures in Oregon for every 1 foreclosure in Alaska. Stated differently, the foreclosure rate on homes for the 3rd quarter of 2008Q was 0.1 percent in Alaska relative to 0.6 percent in Oregon These factors suggest that the valuation of homes in Alaska will continue to be less volatile than home values in Oregon. Based on its 2005 value of $211,000 and a 4.1% annualized growth rate, owner-occupied mortgaged home values in Alaska should approach $259,000 by the end of 2010. However, since the actual median value of owner-occupied mortgaged homes was $252,100 in 2008, the median value of these homes should increase by 8 percent between 2008 and 2010. In other words,, the valuation of the homes in Oregon and Alaska will converge to roughly $259,000 in 2009; however, these values will from opposite directions (see Figure 3).

There is really no practical way to estimate the adjustment process that took place in the housing market in 2009 because so much of the process depended on the successful implementation of federal programs that have been designed to create jobs and stabilize the financial markets. However, assuming that economies of Alaska and Oregon will begin to show signs of economic recovery in 2010, the housing market will begin to show signs of improvement.An economic recovery anticipated in 2010-2011 will create a natural increase in the demand for homes if unemployment rates approach pre-recession levels and families are comfortable again with their permanent incomes will increase as well. Needless to say,however, depending on the duration and severity of the current recession, it may take period of time during which home values consistently increase and after-tax family income consistently increases before households reach the same comfort levels about purchasing homes that they had prior to 2005 because many families realize today that home-ownership is no longer be the perfect hedge against inflation.