Portfolios and leverage the gses continued to lower

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portfolios and leverage), the GSEs continued to lower their underwriting standards to try to keep pace with the PLS market. While we argued in Chapter 2 that even without this “race to the bottom”, the GSEs would most likely have failed, it is certainly true that it would not have happened in such spectacular fashion and on such a scale. This chapter lays out the case. 3.1 Gold Rush The housing boom that ended in the worst financial crisis since the Great Depression was a nationwide phenomenon. It started as far back as the mid-1990s. While local housing downturns (in Boston, New York, and Los Angeles, among others) led the national house price
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35 index to decline modestly between 1990 and 1995, since then house prices recorded an unprecedented run-up. The Case-Shiller 10-city index almost tripled from 77 in June 1996 to a high of 226 in June 2006 -- an increase of 11.3% per year. House price increases in some markets in Florida, Arizona, Nevada, and California were higher still. This period was also one of fast-rising income and financial wealth inequality. Incomes of the middle class hardly increased, after controlling for the increase in the cost of living. Because house prices rose much faster than did median income, houses became much less affordable during the boom. Relative to the cost of renting, national house prices also increased substantially: by 31-43% from 2000 to the middle of 2006, depending on the data source. Households resorted to taking on more debt to afford their homes, and they also borrowed more against the rising value of their homes. Household mortgage debt increased from 54% of gross domestic product (GDP) at the end of 1996 to 89% of GDP at the end of 2006. This ten-year increase in household leverage was bigger than the entire increase from 1951 to 1996! What caused this unprecedented boom in house prices? We believe various factors conspired, with no one single cause. The run-up took place in a favorable macro-economic environment with low (real) interest rates (especially before 2005), low volatility, high economic growth (3.1% per year real GDP growth in 1985-2007), and low unemployment (especially after 2003). GDP growth was fueled by massive residential investment: Construction grew by 225% from 2002 until 2005, as 2 million new houses came online each year. Short-term interest rates were kept low by the Federal Reserve through monetary stimulus that was aimed to fight the jobless recovery after the 2001 recession. An additional force that kept (long-term) interest rates low was the massive purchase spree of U.S. Treasuries and Agencies by foreign investors -- something that Ben Bernanke dubbed the “global savings glut.” Low mortgage interest rates induced households to refinance their homes and to take out home equity lines of credit to tap into their home equity.
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