The housing boom that followed the dot-com bust was not an artificial bubble created by low interest rates and speculation, but a product of increasing wealth, changing demographics, and new mortgage products that helped renters become homeowners.
That’s the conclusion of a study by two economists at the Federal Reserve Bank of Chicago. If the study’s assumptions are correct, it suggests there are solid economic fundamentals underpinning housing demand, and the current slowdown in the housing market won’t amount to a bust.
The conventional wisdom is that the Federal Reserve helped fuel demand for housing by slashing interest rates to historic lows after the stock market tanked in 2001, economists Jonas D.M. Fisher and Saad Quayyum say in their study, “The great turn-of-the-century housing boom.” (Study can be found at this link: http://www.chicagofed.org/economic_research_and_data/economic_perspectives.cfm.)
Those who subscribe to that theory say easy credit encouraged speculators to buy property, which artificially inflated home prices. Now that the Fed has restored interest rates closer to their traditional levels to keep inflation in check, credit is tighter and housing prices must fall in response — or so the theory goes.
Although Fisher and Quayyum don’t tackle the issue of housing prices directly, they conclude that the underlying demand for housing was, and remains, real.
“This is not to say the monetary policy has not been unusually loose, but that to the extent it has been loose, this is not what has been driving spending on housing,” the economists write.
That spending has been remarkable. Investment in residential property, measured as a percentage of gross domestic product, has risen to levels not seen since the 1950s, the authors note. In 1991, residential investment spending was at a near historic low of 3.5 percent of GDP. Last year, it passed 6 percent for the first time since the post-World War II housing boom.
The increase in spending on new housing is largely explained by wealth created by technological innovations over the last decade, Quayyum and Fisher claim. Using complex algorithms, they studied how not only monetary policy, but technological advances and their resulting economic impacts, affect investment in residential property.
The results suggest “the unusually high levels of residential investment in recent years may just be the direct result of the wealth accumulation from previously high rates of technological progress.” Investment in real estate, the authors conclude, appears “to have been driven mostly by fundamentals and not unusually loose monetary policy or speculative building.”
Another factor behind the high levels of residential investment is the rate of home ownership, which is at an all-time high. The rate of home ownership, which actually declined in the 1980s after four decades of growth, rebounded in the mid-1990s, reaching a record 69 percent by 2005.
About half of the increase in the home-ownership rate can be explained by changes in the demographic, income, educational and regional structure of the population, the study concluded.
In a reversal of a trend seen between 1978 and 1993 — when home-ownership rates for households headed by those under 40 declined — a growing percentage of young people are becoming homeowners. Between 1993 and 2003, the home-ownership rate for 25- to 29-year-olds grew at a faster rate than those aged 30 to 74.
Home-ownership rates are up almost across the board, regardless of race, age, gender or region. Between 1993 and 2003, home-ownership rates fell in only two types of households: those with four or more adults, or those in which the head of household has less than a high school education.
“That the increase in home ownership cuts across so many different categorizations suggests that the overall home-ownership rate is not merely reflecting changes in the distribution of the population among the categories. Something fundamental about the home-ownership process has changed,” the study theorized.
What’s changed, the economists say, is mortgages. In the last 10 to 15 years, a slew of new mortgage products aimed at first-time home buyers have been introduced. The secondary mortgage market has grown, allowing many different kinds of mortgages to be sold as securities. At the same time, technological advances have reduced the cost of approving mortgages and given lenders more precise measurements of a borrower’s credit risk. Specialized firms have sprung up to capture different segments of the market, such as origination, servicing and securitization, the authors say.
The availability of new mortgage products like combo loans, subprime mortgages and no-money-down loans — not low interest rates — has driven up home-ownership rates, Fisher and Quayyum maintain.
“Historically, we have seen large swings in mortgage rates without large changes in the home-ownership rate. So we conclude that the cost reductions and increases in the supply of capital to the mortgage market are likely to have had a relatively small impact on home ownership,” they say. “In contrast, the development and dissemination of many new mortgage products have made it possible for large numbers of people to acquire mortgages who would have been unable to previously.”
The economists backed up their case with numbers. In 1993, 7.9 percent of first-time home buyers said they made no down payment on their mortgage. That percentage had risen to 12.1 percent by 2003.
Numbers on subprime loans are harder to come by, but the authors calculated that subprime mortgages were issued for 673,000 home purchases in 2002 — nearly three times the 242,000 issued in 1994.
That increase dovetails nicely with a 1.5 percent increase in vacancy rates between 1994 and 2002, allowing Quayyum and Fisher to conclude that the 431,000 extra homes purchased using subprime loans in 2002 accounted for 76 percent of the 570,000 additional vacant rental units on the market that year.
“We conclude that substitution away from rental housing made possible by developments in the mortgage market, such as subprime lending, could account for a significant fraction of the increase in residential investment and home ownership,” the study said. “The current spending boom thus may be a temporary transition toward an era with higher home-ownership rates and spending on housing, which will ultimately move nearer to historical norms.”
