Background – 3Q 2007. Looking back, August 2007 was a memorable month, filled with good news and bad. Based upon RMLS™ numbers, it was a statistically impressive month for closed residential transactions in the Portland Metro area. The bad news was that it was the last such month we were to see. From that point forward, in almost every meaningful category, the local housing stats just kept getting worse.
The Credit Crisis – 3Q 2007. Quietly, and with little public fanfare, in the third quarter of 2007, worrisome cracks began to appear in the country’s financial system. They were first noticed by those who monitor these things, such as the Federal Reserve. They were also noticed by some who actually had a hand in causing the cracks to occur.
In short, the credit markets began seizing up; access to short term borrowing engaged in by companies was drying up. Normally, large businesses financed their daily operations through the sale of commercial paper, i.e. secured and unsecured short term loans. The Federal Reserve recognized the crunch, and in September 2007, cut interest rates by 50-basis points, or one-half of one percent. The purpose in so doing was to provide liquidity for financial institutions and investment houses so they could continue to survive. Bloomberg explained it well in its September 27, 2007 article titled “U.S. Commercial Paper Drop Slows After Fed Cuts Rates (Update5)”:
Commercial paper is bought by money market funds and mutual funds that invest in short-term debt securities. In asset-backed commercial paper, the cash is used to buy mortgages, bonds, credit card and trade receivables, as well as car loans. Some of the programs are backed by subprime loans, issued to borrowers with poor credit or high debt.
Yields of asset-backed commercial paper soared to six-year highs for overnight borrowing on Aug. 9 after BNP Paribas SA froze withdrawals from three investment funds that held subprime bonds. Three U.S. commercial paper issuers, units of American Home Mortgage Investment Corp., Luminent Mortgage Capital Inc., and Aladdin Capital Management LLC, exercised an option to delay repaying the debt, casting a pall over a market that’s been considered almost risk free.
Because some of the programs are backed by subprime loans, where defaults had reached a five-year high, investors refused to buy the debt.
The 2007 Bloomberg article quotes a Fed official making a statement that today we would regard as prescient, but wholly understated, in light of what was to soon occur: “…tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally….”
Once it became clear to investors in 3Q 2007 that what the credit ratings agencies had been touting as “investment-grade” securities were actually poorly underwritten subprime mortgages, they began to re-evaluate the wisdom of purchasing more commercial paper. In a “king has no clothes” moment, commercial paper was seen for what it really was – a high risk investment. Demand for the paper plummeted. But since this over-the-counter marketplace – unlike the stock market – was opaque, investors did not know which banks and investment houses owned these toxic assets. Moreover, the OTC market was essentially unregulated, so it was unknown – or at least never fully understood – just how highly leveraged many of the issuers of this paper had become.
Tremors then began to be felt in the national real estate market, as institutional lenders tightened their underwriting rules, causing sales of new homes to contract. What Fed Chairman Alan Greenspan had mistakenly identified in 2005 as “froth” in the housing market, was actually smoke from an approaching fire. Why he did nothing at the time remains a mystery. But, looking back, one thing is certain: What was initially described as a “subprime crisis” failed to adequately describe what was to ensue over the following five years. Once credit tightened, housing prices dropped as borrowers sought to re-sell their homes and escape loans they could not afford. Foreclosures climbed and buyers remained on the sidelines, unsure when prices would level out. Banks, now chastened for their risky or non-existent underwriting, began making home loans only to their most creditworthy borrowers. Communities that had been built during the years of easy credit and poor underwriting – circa 2004 to 2007 – began to witness a tsunami of residential foreclosures engulfing entire neighborhoods. Foreclosure and short sale prices became the new “comps” for appraisers; buyers and investors, who were accustomed to seeing Neiman Marcus level real estate prices, now figured they could pick up homes at Filene’s Basement prices. Market values plummeted.
In short order, all of the subprimers were gone, having lost the homes they acquired with easy money and sketchy credit. But the side effects wicked up the economic food-chain, affecting borrowers who had not bitten off more than they could chew. They had good credit going into their loans. How could that be? Simple: If you were prudent and creditworthy in 2004-2006 and had 5%, 10%, or even 20%+ equity in your new home, it was not enough to weather the drop in market values that was to come. As a result of the housing crisis over the past five years, values have dropped 40% or more in value. Conscientious borrowers needing to move, but wanting to maintain their good credit ratings were faced with a Hobbesian choice: Either refinance or sell, and bring money to the closing table.
3Q 2007 Housing Prices. According to the RMLS™, in August, 2007, the average price of a home was $355,000. The median price was $302,000. For a good discussion of the difference between “average” [or “mean”] and median, go to the Realtor.com website here.
Briefly, the average price is obtained by totaling all of the closed sales prices for a specific period and dividing the gross figure by the number of homes sold. The downside in relying too heavily on this statistic is that it can be skewed by a few “outliers,” that is, extremely high or low home sale figures. The median [or “mean”] price is arrived at by tallying the number of closed sales and then finding the statistical middle, where there are the same number of transactions above, as below, the midpoint.
In August 2007, Portland Metro home prices reached their statistical highpoint – numbers that have not been seen since. From that month forward, the real estate market pulled into a nose dive from which it has never fully recovered. The stats for the next five years became more sobering:
- August 2008, the average sale price was $331,000 and the median price was $280,000;
- August 2009, the average sale price was $296,000 and the median price was $249,000;
- August 2010, the average sale price was $299,300 and the median price was $250,000;
- August 2011, the average sale price was $271,800 and the median price was $225,000;
- August 2012, the average sale price was $281,700 and the median price was $241,000.
The Good News. The August 2012 average and median housing prices have experienced significant improvements from the death spiral of the prior four years, 2008 – 2011. Comparing August 2012 to August 2011 [which appears to represent the statistical “floor” where home prices hit their lowest level], average prices have improved by 3.64% and median prices by 7.10%. These improving prices are reflected in the RMLS’s™ October 2012 statistics:
“The average sale price so far in 2012 is $273,400, 3.7% higher than the average price of $263,700 in the same period last year, while the 2012 year-to-date median of $232,500 is 5.2% higher than the median of $221,000 last year. Total market time has dropped 21.0% from 144 days last year to 102 days for the first ten months of 2012.”
To be continued…
 In explaining the housing crisis that we’ve witnessed for the past five years, it is essential to understand the causes. This is especially true because some blame our economy’s downturn on the “housing bubble” which misses the mark. The truth is that the housing crisis was the result of the “credit bubble.”
 In the fall of 2006, Angelo Mozilo, the head of Countrywide, began quietly adjusting his company policy on stock options that controlled the number of shares he was permitted to sell. Between January and August 2007, he had reportedly sold over $200 Million of Countrywide stock. And then there’s the case of the WAMU executives and their wives, who allegedly began shifting their assets in 2008 to avoid the onslaught of lawsuits they saw coming as a result of the bank’s collapse. It became the largest bank failure in U.S. history. According to a 2011 Wall Street Journal article reporting on a lawsuit filed against them personally by the FDIC, “The three executives allegedly gambled billions of dollars on high-risk home loans, a strategy that maximized their own compensation….” The case settled before the end of the year with the execs denying any wrongdoing.
 When yields “soar,” it is because those investors buying the paper are demanding higher returns to compensate for the perceived higher risk.
 The slight uptick from 2009 may have resulted from the somewhat artificial stimulus of the first time homeowner tax credit, which expired in April 2010 and required that purchases be closed by June 30, 2010. Unless I’m incorrectly remembering, I recall some Realtors® complaining during the summer months of 2010 that sales were slower than normal, because those buyers who would normally have purchased homes at the time, had already closed their transactions to meet the June 30 deadline.
 The latest available statistics from RMLS™.