There’s been much debate over the root causes of the housing meltdown that catapulted the nation into the worst financial crisis in 80 years – from lax lending and subprime loans to over-leveraging in the secondary market.
A new report from researchers at the Federal Reserve Bank of New York focuses on the sharp run-up and subsequent collapse in housing prices during the 2000s.
It concludes that real estate investors who used mortgage credit to purchase multiple residential properties with the intent of flipping, or reselling them within a short period of time, played a larger role in fueling the housing bubble than previously recognized.
These investors, the Fed researchers say, helped push prices up during 2004-2006, but when prices began to head south, they defaulted in large numbers, which served to intensify the housing cycle’s downward leg.
Fed officials point out in their report that investors are more likely than owner-occupants to walk away from an underwater property. As such, lenders typically factor in that higher default risk by requiring larger down payments from buyers who acknowledge that they won’t be living in the house.
The expansion of the nonprime mortgage market during the 2000s, however, provided the perfect opportunity for optimistic investors to get low-down-payment credit, according to the report. “Buy-and-flip” investors, in particular, were able to make higher bids on houses, even if they had relatively little cash.
At the peak of the boom in 2006, the New York Fed’s researchers found that over a third of all U.S. home purchase lending was made to people who already owned at least one house.
In the four states with the most pronounced boom-and-bust cycles – Arizona, California, Florida, and Nevada – the investor share was as high as 45 percent.
Overall, the investor share of mortgage-financed home purchases roughly doubled between 2000 and 2006, with the largest increases seen among those owning three or more properties, according to Fed data.
In 2006, Arizona, California, Florida, and Nevada investors owning three or more properties were responsible for nearly 20 percent of originations, almost triple their share in 2000, Fed officials report.
“Longstanding tradition in the mortgage lending business and the predictions of economic models hold that investors will quickly default if prices begin a persistent fall. This is what happened starting in 2006,” according to the Fed researchers.
From 2007 to 2009, they found that investors were responsible for more than a quarter of seriously delinquent mortgage balances nationwide, and more than a third in Arizona, California, Florida, and Nevada.
“We conclude that investors were much more important in the housing boom and bust during the 2000s than previously thought,” the researchers wrote in a blog post explaining their findings.
They stress that the availability of low- and no-down-payment mortgages in the nonprime sector enabled investors to make highly leveraged bets on house prices, which likely allowed the bubble to inflate further and caused millions of owner-occupants to pay more for their homes.
“In the end, even the value of the 20 percent down-payments made by responsible, prime borrowers was wiped out — leaving the housing market, and the economy, in the vulnerable state we find them in today,” according to the researchers at the New York Federal Reserve.