You know that thing that happened back in 2006 and 2007 where increasingly predatory loans were going to low income households that couldn't begin to make the payments, and when the Ponzi scheme inevitably came to its end, those low income households started defaulting?
And, then, a domino effect happened, where low income neighborhoods were full of foreclosures that undermined the market, and just made home prices in those neighborhoods collapse even more? So, the mortgage brokers got out of town with their fees and their bonuses and left lower income households holding the bag?
Remember when that happened?
I do too.
Except, it kind of didn't happen. (You knew I was going to say that, didn't you?)
Here are scatterplots of zip codes in Los Angeles. The x-axis is the log median home price in the zip code. (12 ~ $160k, 13 ~ $440k, etc.) The y-axis is how the median home price changed in a year. The scatterplots contain the years 2005-2009.
In 2005, we see the rising prices we all remember.* But, note what happens in 2006. Prices start to moderate, but that moderation isn't led by a collapse in low priced homes. It is high priced homes that were declining first.
By 2007, prices were widely in decline. But, even by then, homes at the high end were leading the trend. Remember, by the middle of 2007 the private mortgage market was gone. Not diminished, basically just gone. There was no source of credit for unconventional mortgages by then.
It was only in 2008 that low priced homes really dropped. And, boy did they drop. Notice that high priced homes were still declining, but the decline was about where it had been in 2007. Then, high priced homes stabilized in 2009, but low priced homes continued to collapse wildly.
You know what has a stronger influence on high priced homes than low priced homes? High interest rates. Because the implied net return (net rent/price) is lower on high priced homes than it is on low priced homes, so the risk free rate effects them more. There is basically a spread on home equity returns that gets larger as you move to lower priced homes. In other words, if interest rates cause required returns in housing to go up 1%, high priced homes where the returns go from 3% to 4% will be effect more than low priced homes where returns go from 7% to 8%. Interest rate policy creamed the high end housing market, and only later, as a lagging effect, did low priced homes collapse.
Of the 22 MSAs I have been looking at (the largest 20, minus Houston, plus San Jose, Portland, and Las Vegas) where Zillow has zip code level data on the trailing 12 month rate of existing home sales and on price levels, in 20 of 22 cities, existing home sales started drying up in high priced homes before low priced homes. And in 15 of 22 cities prices of high end homes started to fall before prices of low end homes.
This was not a subprime crisis. It is a misnomer. It was a moral panic. What those neighborhoods in 2008 and 2009 needed was a government that would allow banks to sell mortgages to them. It's 2016, and we still won't let them.
I have included Phoenix and Dallas here too. It's a common pattern in all city types.
In Phoenix, of course, there was the big price jump in 2005, although there wasn't much difference between high priced and low priced homes. But, even in Phoenix, high priced homes led the collapse and low priced homes had their crisis well after the collapse of subprime.
In Dallas, there was just 5%, + or -, regular price appreciation, but a lot of low priced zip codes there got to see a couple years worth of 5-20% price drops, too. Because they needed to learn a lesson. If we had supported the housing market in 2006 and 2007**, those low income zip codes in Dallas would be full of people who think a house is a safe investment. That'd be a pretty stupid thing to encourage, wouldn't it? They are wiser now. You're welcome, poor Texans. Job well done, everybody.
*In 2005, LA did see low priced home values rise more quickly than high priced homes, which I think I have gone over here. I expand on it more in the book. This only happened in the Closed Access cities (coastal California, etc.). It didn't happen in the Contagion cities (Phoenix, Miami, etc.) The reason it happened is because Price/Rent ratios naturally increase as home prices rise, up to about $500,000. So, this effect was not pushing the high end of Closed Access home prices up, but it was still in effect for most other homes.
** Some will probably react to that by saying, "Oh, so now, the Fed is in charge of making sure nobody ever loses on a real estate speculation?" No. It's not. There is a long distance between micromanaging an asset market and engaging in a multi-year attack on the mortgage market that first exogenously cuts 10% market share from conventional mortgage originators and then creates a liquidity crisis in the mortgage markets that rise up to replace them.***
*** Some will probably react to that by saying, "Oh, so now, the Fed is in charge of making sure nobody ever loses on a reckless MBS with rigged credit ratings?" No. It's not....Ah, heck. It's turtles all the way down, isn't it?****
****As I think through the book, it really is amazing how deeply the premises determine the conclusions throughout this topic.