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Lecture

W9 HousingPriceConundrum.docx

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Department
Economics
Course
ECON 255
Professor
Ashok Kotwal
Semester
Winter

Description
Video 1: The Housing Price Conundrum − Regardless of any event, housing price always goes up  but its rate is escalating − What is causing the escalating rate?  for price to increase, the demand has to increase faster than the rate of supply − Demand drivers:  Population increases  Incomes − Supply drivers:  New houses are built − Ultimately: the jump in the rate of the rate of housing can be explained by the rate of demand drivers > supply drivers − Attempt to Explain:  Decreasing Income (recession) and stagnating total population  data pulled between 2000 – 2004 shows that: 1) income decreases and 2) population increases  Calculation: in 2000, number of house is 115mil.  1.8mil houses built per year x 4 years (2000-2004) = 7.2mil  7.2mil/115mil(the number of house in 2000) = 6% of the housing supply  Bizarre result: naturally, when income decrease and at the same time the housing supply increases, the price of the house should go down. But this didn’t happen. − So, what’s causing the rapid price increase? Video 2: Housing Price Conundrum (Part 2) − Why housing prices skyrocketed between 2000 – 2006? − Calculation for Example 1:  mid 1970s, house priced $60K  downpayment (deposit) is 25% = $15K  so, mortgage will be = $45K. Assume that the interest is 9%  so, interest rate per year = $4050. For each month, will have to pay approx. $340  then, the family moved out and rented the house for $900 because they need the money − Rent versus buy argument: why would you pay $900 per month when having your own house means only having roughly $400? Possible explanations:  What factors will allow you to buy a house or in other words, to get a mortgage? 1) need a $15K down payment. So, maybe these people didn’t save their money enough to cover for the down payment. 2) Also need a steady job. So, maybe the people who were renting were doing odd jobs. So, the job wasn’t steady or maybe they don’t have steady income, 3) need good credit − For the purpose of explanation, the possible circumstances then: possibly the renter just don’t have the discipline to make $15K downpayment and the need to pay $900 make it even harder for them to save enough money. − But, the requirement to own a house changes in the early 2000: the standard was lowered to make it easier for people to own a house − Calculation for Example 2:  Between 1980-200, to own a house you need: 1) 25% downpayment, 2) steady job, 3) 700 credit score  But in 2001, the standards were lowered by possible circumstances such as: 1) the downpayment might have been lowered to only 10%, 2) can have a not so steady job, 3) 600 credit rating  Q: What happens when the mortgage standard was lowered? Ultimately: more people will qualify to buy the house  resulting in the shift of Aggregate Demand for house even if income didn’t increase, even if population didn’t increase  In 2003: the regulation loosen even more: 1) no downpayment, 2) not so steady job, 3) 500 credit. Ultimately, without creating more jobs, without any income increase, without having any population increase  there were more people who qualify for financing  In 2004 afterwards, the regulation loosen even more and there was no strict background checking on your income and worse, you can state whatever you like as your income as there’s no need for proofing for your salary and no credit checking  Ultimately: credit gets easier and easier over the years  when credit gets easier, more people qualify for financing even though they don’t make more income or satisfy any of the 3 requirements  since there is more people qualify for financing, demand for house increase higher and higher  when demand increases faster than the supply of house  housing price increases which leads to the Housing Bubble − Why did it get easier from 2000 to 2004?: Some people who can own a house only make $40K per month, migrant labors and they buy a house worth $1 mil − Next video: Why were people willing to give their cash to people to buy a house that had a very low likelihood of getting paid back, and for a house that had a very low likelihood of being able to retain its value Video 3: Housing Price Conundrum (Part 3) − Housing Bubble from 2000 – 2006: it began when financing got easier (by lowering standard)  so, more people can demand for the house  this is also called, increasing the demand for the house artificially  artificially because: 1) populations didn’t increase, 2) income didn’t increase − Why did financing get easier and easier?  Explanation using the traditional model: people go to bank to get money  bank gives money and in return, we give back bank the money+interest  from the officer’s perspective, he wants to be able to get the money regardless of whether you lose your job etc  that’s why need the 3 factors crucial before you can qualify for the housing  the higher your ability to repay, the higher will the bonus (incentive) be for the officer  But, this situation changes starting in the 90s in California  in 2002: securitization of the mortgage market was introduced and this happens before Fannie Mae and Freddie Mac  Government Sponsored Entities (GSE): Fannie
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