JULY 2008 PUBLICATION 1871
ATV shows began to reflect the popularity of investing in
homes. Investors could tune in to “Flip This House,” then
switch channels and watch “Flip That House.”
In post-World War II U.S. history, there have been three barriers
to buying a first home: a down payment, a job and good
But early in this decade, the desperate search for yield
prompted investors to buy riskier mortgages. Lenders had a
new way of doing business. No job? No credit? No cash? No
problem! They began making 100 percent loans without documenting
borrower financials. Traditional risk management
and mortgage underwriting standards that had served well for
decades were swept aside.
This new type of mortgage lender went by the name of Wall
Street. Mr. Street did not need Fannie Mae and Freddie Mac
After the Fallout
By Mark G. Dotzour
A year has gone by since the real estate mortgage markets
experienced the first day of “nuclear winter.”
For three or four years prior to July 2007, the credit markets
for real estate lending were on fire. The thinking among the
“smart money” on Wall Street was that under modern central
bank policies, risk was a thing of the past. The economy would
still move up and down, but in much gentler waves, and when
things got rough, the Fed could fix it.
Remember the Y2K crisis? The Fed fixed it. Remember
the stock market difficulties after 9/11? The Fed fixed them.
Remember the 1998 Russian ruble crisis and the ensuing credit
market turmoil it caused? The Fed fixed it. Even when the
stock market crashed in October 1987, the Fed fixed it.
These examples prove the Fed will not tolerate more than
minimal corrections in the U.S. economy. Investors have
now succumbed to the notion of “The Greenspan Put.”
This catchy little phrase essentially means there is
no longer any risk in the markets that the Fed cannot
fix by lowering interest rates.
When global investors perceive no risk,
investment capital flows everywhere. Investment
prices go up and yields go down. Cap
rates on real estate hit record lows. In this
kind of environment, how do investors
find higher yield? The answer
is that they take on more risk. They
make home loans to people who cannot
afford to pay them back. Then they
sell those loans to investors who do not
know what they are buying. The profits
Housing Wheel of Good Fortune
This new “no risk” era has had a remarkable
impact on the housing market. Prices
started rising and suddenly homes were
no longer just places to live — they became
investments as well. As prices continued to
escalate, investors figured if one house
was a good investment,
why not buy more?
underwriting guidelines because he did not sell his loans to
Fannie and Freddie. He sold them to all kinds of investors all
over the world. These loans were supposed to be virtually riskfree,
rated AAA by the most reputable ratings agencies.
In 2006, prices stopped going up. Then they started to decline.
Some people stopped paying their mortgages. Suddenly,
investors decided not to buy more U.S. residential mortgages
from Mr. Street. At this writing, those investors still are not
interested in buying new mortgages.
So guess who is left to make the loans? The traditional lenders
who made them back in the good old days. Even an old
friend — FHA — is looking dapper again and is quickly evolving
into the subprime lender of the 21st century.
Where’s the Bottom?
Two major events have to occur before the housing market
will begin to bottom out. First, home prices have
to stop falling, and second, investor confidence in the
traditional U.S. residential mortgage must be restored.
What must happen for home prices to stop falling? The
answer is a painful process. Prices fall when there are more
houses for sale than there are buyers who want to buy (or can
afford to buy).
The abrupt “nuclear
event” that occurred
in July 2007 shut off a
substantial amount of
demand for new homes
almost overnight. The
large group of lowincome
that was active in the
market in June 2007 was
gone completely the
next month. Meanwhile,
new homes were still
piling into the market.
The excess supply has
continued to grow as foreclosed homes are put on the market.
This overwhelming imbalance of supply and demand caused
prices to fall. Prices will stop falling when the excess supply
is eliminated from each local market. This can happen in only
First, new construction must be reduced to virtually nothing.
The relentless population growth in most of America will
ultimately absorb the excess inventory. The inventory of unsold
homes will decline until selections get too limited to meet
the needs of picky homebuyers. At this point the market will
begin to shift from a buyer’s market to a seller’s market. Prices
will stabilize, and the market will begin to heal itself.
How Long to Heal?
The pace of this turnaround will vary from city to city. If
home builders cut back dramatically on new supply, the recovery
will occur faster. Communities with fewer foreclosures
will work through the excess supply more quickly. Communities
with strong job and population growth will create demand
that will absorb the excess units faster. Conversely, communities
with slow job growth could take years to bounce back from
the excess supply.
The “no-risk” environment of the past few years spurred
lenders to make risky loans and investors to buy those
loans. Before the U.S. housing market can begin to bottom
out, prices have to stop falling and investor confidence in
traditional mortgages must be restored.
Political action could change the timeline as well. If the
Federal government were to offer tax credits for people to buy
homes, the excess inventory could be soaked up even faster.
This would cause the housing market to bottom and turn
around much faster.
Another stimulus that would speed the recovery is gently
rising mortgage rates. Typically, when mortgage rates are
falling, homebuyers postpone buying. But when they see that
mortgage rates have stopped declining and may rise, they hop
off the fence and buy.
As the economy begins to rebound in 2009, look for mortgage
rates to take an upward turn. As long as rates do not increase
dramatically enough to impact affordability, this should
stimulate housing demand.
The long-term outlook for the Texas housing market is
clearly strong. In the 1970s and 1990s, house prices in Texas
rose in nine out of ten years. And even in the 1980s — the
most challenging decade for Texas in the past 38 years — house
prices increased eight out of ten years.
Job growth in Texas has doubled the national average for
most of the past ten years. Demographic experts estimate another
13 million people will live in Texas by 2030. Many Texas
cities still have tight
inventories of homes for
sale with prices continuing
The state’s metropolitan
areas have strengths
and weaknesses in their
local markets. Attractive
in older neighborhoods
close to downtown are
still performing well and
will continue to do so.
The challenges in big
city housing markets
will be in select sections
of the suburban perimeter. In the short term, these markets
will struggle because too many new homes have been built.
But even in these areas, supply is being quickly withdrawn as
new home starts plummet. It may take a few years for these
areas to return to a balanced supply.
For now, builders are accepting substantial concessions to
make a sale. If you plan to buy a house to live in for a number
of years, this would be a great time to buy. If you think you
may not live in a house for two years before you move again,
you might be better off to rent.
Dr. Dotzour (firstname.lastname@example.org) is chief economist with the Real Estate
Center at Texas A&M University.
An overwhelming imbalance
of supply and demand caused
prices to fall. Prices will stop
falling when the excess supply
is eliminated from each
MAYS BUSINESS SCHOOL
Texas A&M University
College Station, TX 77843-2115
Director,Gary W. Maler; Chief Economist, Dr. Mark G. Dotzour; Communications Director, David S. Jones; Associate Editor, Nancy McQuistion; Associate Editor,
Bryan Pope;Assistant Editor, Kammy Baumann; Art Director, Robert P. Beals II; Graphic Designer, JP Beato III; Circulation Manager, Mark Baumann; Typography,
Real Estate Center.
D. Marc McDougal, Lubbock, chairman; Ronald C. Wakefield, San Antonio, vice chairman; James Michael Boyd, Houston; Catarina Gonzales Cron, Houston;
David E. Dalzell, Abilene; Tom H. Gann, Lufkin; Jacquelyn K. Hawkins, Austin; Barbara A. Russell, Denton; Douglas A. Schwartz, El Paso;
and John D. Eckstrum, Conroe, ex-officio representing the Texas Real Estate Commission.
Tierra Grande(ISSN 1070-0234) is published quarterly by the Real Estate Center at Texas A&M University, College Station, Texas 77843-2115. Subscriptions
are free to Texas real estate licensees. Other subscribers, $20 per year. Views expressed are those of the authors and do not imply endorsement by the
Real Estate Center, Mays Business School or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of
socioeconomic level, race, color, sex, religion, disability or national origin. Photography/Illustrations: Real Estate Center files, p. 1.