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Chapter 13

Chapter 13. The Housing Bubble. Chapter Outline. How Much Is a House Really Worth? Mortgages How to Make a Bubble Pop Goes the Bubble! The Effect on the Overall Economy. How Much is a House Really Worth?. “location, location, location” Amenities of a Community Neighboring Property

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Chapter 13

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  1. Chapter 13 The Housing Bubble

  2. Chapter Outline • How Much Is a House Really Worth? • Mortgages • How to Make a Bubble • Pop Goes the Bubble! • The Effect on the Overall Economy

  3. How Much is a House Really Worth? • “location, location, location” • Amenities of a Community • Neighboring Property • Amenities of Home • Size • Lot Size • Bedrooms • Bathrooms • Pool/Trees/Appliances • Age of Expensive replacements • Roof • Carpet • Heating & Air Conditioning

  4. Case-Shiller Index

  5. Mortgages • Traditional (Until late 80s) • 80% Loan to Value • 15, 20, & 30 Year payouts • Traditional (now) • 90%-100% Loan to Value • PMI • 15, 20, & 30 Year payouts • Interest Only • 100% Loan to Value • PMI • Interest portion of payment for first 5 to 10 years • Negative Amortization • 100% Loan to Value • PMI • About half of interest portion for first 5 to 10 years

  6. Traditional Mortgage

  7. Interest Only Mortgage

  8. Negative Amortization

  9. How to Make a Bubble • Fundamental Determinants of Housing Value • Location • Amenities • Interest rate • Non-Fundamental Determinants • Expectations that prices will rise in the future causing increased demand now. This is a prescription for a bubble.

  10. Are These Houses Affordable?

  11. Most Affordable • Elkhart-Goshen, IN • Lansing-East Lansing, MI • Kokomo, IN • Mansfield, OH • Bay City, MI

  12. Least Affordable • New York, NY • San Francisco, CA • Honolulu, HI • Los Angeles, CA • Santa Cruz, CA

  13. Vocabulary of 2008 • Securitization: The process by which mortgages are bundled into groups and sold as investment instruments. • Done by Fannie Mae and Freddie Mac • Geographically diversity • Credit Default Swap • Insurance against the loss of principal • Unregulated • ING AIG were large purveyors as were many investment banks • Goldman Sachs • Lehman Bros

  14. Vocabulary of 2008 • Subprime: A mortgage issued to • A borrower with a lower credit rating • Someone for more than a house is listed • Liar Loans • Income and assets are unverified or overstated

  15. POP Goes the Bubble! • When people cannot make payments this puts more homes on the market. • When more homes are on the market, the price falls. • When the price falls, the expectation of future increases ends. • The ability to borrow equity to make payments ends and more homes are on the market. • Repeat steps 1) through 5)

  16. The Risk to the Overall Economy • Lower aggregate demand • Less equity to buy large ticket items, vacations, etc. • Higher interest rates because of higher default rates • Tighter credit standards for all loans

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