It was around that time lenders started warning that rapidly rising rates were causing home sales -- and, therefore, mortgage applications -- to fall. By summer, the number of unsold houses on the market was approaching 4 million, a 40-percent increase over the inventory a year earlier. Even with the supply of houses outstripping demand, the National Association of Realtors reported that house prices were still rising.
The Realtors' chief economist, David Lereah, had been singing for years about the sunny real estate outlook. In February, he came out with a book titled, "Why the Real Estate Boom Will Not Bust -- And How You Can Profit From It: How To Build Wealth in Today's Expanding Real Estate Market."
"What you may not know is that opportunities still abound in U.S. real estate markets," Lereah wrote on the book's first page. "And those opportunities will continue to exist throughout this decade and into the next. What we are seeing today is a phenomenon that takes place only once every other generation: a long-term expansion of the real estate market. And that is why you need to take advantage of this once-every-other-generation opportunity now."
But just four months after "Why the Real Estate Boom Will Not Bust" was published, Lereah confessed to spotting some dark clouds: "a clear pattern of slower home sales activity in many higher cost markets, which are more sensitive to rises in interest rates."
Conventional wisdom held that mortgage rates would have to reach 7.5 to 8 percent and stay there for a while to cool off the hot housing market. The average rate on a 30-year fixed hadn't even reached 7 percent (It hadn't reached 7 percent since April of 2002!), yet home sales were tumbling and the inventory of unsold houses on the market was rising.
While impatient sellers and real estate agents were chewing on that development, a number of federal regulatory agencies were cooking up plans to protect consumers from the excesses of "nontraditional" home loans -- interest-only and pay-option adjustable-rate mortgages. These loans had skyrocketed in popularity in two years, largely in response to rapidly climbing house values on the east and west coasts.
As the feds saw it, nontraditional loans endangered borrowers who didn't know what they were getting into and could eventually result in hundreds of thousands of people losing their homes for inability to pay their mortgages. Regulators were especially wary of pay-option ARMs, in which the minimum monthly payment doesn't cover the interest charged, so the amount owed keeps going up. Eventually, borrowers could hit a debt ceiling, triggering a "recasting" of the loan in which the required monthly payment could more than double abruptly, in just one month.
The agencies issued a final "guidance" on nontraditional loans in early fall. In the guidance, the regulators told banks not to underwrite loans that couldn't be repaid. That's oversimplifying it, but not a lot -- which shows just what sort of Wild West atmosphere prevailed in the mortgage business during the housing boom.
At midyear came the event that home sellers and the real estate industry had hoped for: a sustained decline in mortgage rates. After that peak in late June of 6.93 percent, mortgage rates fell for three straight months, with just a couple of small weekly blips. In the last week of September, the average rate on a 30-year fixed reached 6.29 percent.
Rates went down, but home sales didn't go up, despite the conventional wisdom that falling rates would bring out the house hunters. As unsold houses started piling up, prices started going down. The median used-home price in August 2006 was 1.7 percent lower than the median price in August 2005. Half of homes cost more than the median.
By the time leaves were changing color, lenders and real estate agents were trumpeting affordability. Low rates combined with falling prices, they said, spelled great news for buyers. But buyers weren't buying it, apparently secure in the belief that house prices were destined to fall even more. Why not wait for a better deal?
And so buyers bided their time and sellers' anxiety climbed as piles of pumpkins materialized outside grocery stores and were expected to continue waiting as Thanksgiving and Christmas approach. |
