Dr. Austin J. Jaffe: PAR Consulting Economist, Penn State University, University Park, PA

Introduction

For the past several months, there has been consistently bad news about housing as a consumer good, housing as a household asset, or housing as a healthy industry whether the construction or brokerage sides. It is true, however, that in most recent weeks, there is a glimmer of hope that the bottom of the decline might be in sight: the reductions in home values have continued but at a smaller pace than in previous periods. In some cases, there are indications of sales figures picking up which suggests that prices might have fallen sufficiently for that interest among buyers to be growing once again.

Housing markets have always been relatively complex compared to markets for other goods, although we likely didn’t appreciate the complexity until this downturn. It was easier to assume that everything worked well and things just went along nicely. Some convinced themselves that the Federal Reserve would solve any potential problems when they arose as the Fed came to the rescue of borrowers, consumers and investors many times in the past. The decline in property values came as a shock to many, since the mantra in some circles was that property prices always rose over time due to some unstated fundamental relationships. Some acknowledged that it was conceivable during brief periods for prices to stagnant or even decline a bit, but this view, could not imagine a world where prices truly declined. Other commodities declined in price; land and buildings would not.

Since mid-2006, such talk has ceased and a new reality is upon us. For the first time since the 1930s, housing markets are now working through substantial price declines not witnessed in this country in living memory. In addition, home sales have slowed significantly and credit availability has tightened. With declining prices, household equity evaporates, especially for highly-levered purchases in recent years. With the use of home equity loans and home credit lines, access to housing equity had become easier than ever and this resulted in even greater mortgage finance opportunities. Millions of homeowners are suddenly out of the money as their mortgage situation is now upside-down (i.e., the amount of the mortgage(s) exceeds the market value of their homes).

The procedure of mortgage foreclosure is the traditional legal remedy for enforcing the lender’s secured mortgage financing claims against borrowers who have defaulted. While costly to implement, foreclosure is often the last resort lenders are forced to use in order to recover their resources. In this market environment, foreclosure rates have swelled and are expected to exceed 2.5 million homes this year.