Academic journal article Chicago Fed Letter

Developments and Innovations in Real Estate Markets: A Conference Summary

Academic journal article Chicago Fed Letter

Developments and Innovations in Real Estate Markets: A Conference Summary

Article excerpt

During the last few years, activity in the U.S. housing market has been brisk, and mortgage credit has reached an ever wider circle of borrowers. A recent conference at the Chicago Fed assembled researchers, regulators, and practitioners to discuss the implications of these developments, both for the housing finance system and for the economy as a whole.

Residential real estate in the U.S. has performed extremely well in recent years. Home prices have appreciated rapidly, sales and construction have been robust, and investors have reaped profits by flipping properties. Helping to spur this growth have been historically low mortgage rates and innovative mortgage products-such as interest only loans and option adjustable rate mortgages-that let borrowers minimize monthly payments during the early years of a loan. These changes have enabled many Americans to afford homes that otherwise might have been out of reach.

Meanwhile, homeowners have taken advantage of their rising property values by extracting equity from their homes, often to fuel spending. Consumer spending, in turn, has helped keep the national economy growing despite corporate frugality and mounting energy prices.

However, the blistering pace of price appreciation and mortgage originations has raised concerns about the possibility of a housing "bubble." Have prices gotten too high to be sustainable? Have too many consumers stretched too far to purchase homes? If such a bubble exists and then "pops," the consequences for financial institutions and for overall economic growth could be serious.

Accordingly, the Chicago Feel's 42nd Annual Conference on Bank Structure & Competition addressed these and other issues. The conference, tided "Innovations in Real Estate Markets: Risks, Rewards, and the Role of Regulation," was held on May 17-19, 2006, and brought together bankers, academics, regulators, and other professionals to discuss the current housing situation and its implications for the financial system. This Chicago Fed Letter provides a summary of the relevant research and commentary presented.1

Changing landscape of the housing market

Douglas Duncan, Mortgage Bankers Association, kicked off the conference theme panel with an overview of current market trends. Duncan clarified what is unique about recent developments and where potential risks lie. Housing price appreciation has indeed been unusual in recent years, he said. Normally, home prices are rising in some local markets while falling in others. Over the past few years, however, prices have essentially been rising across the board-a situation that is unlikely to be sustained and already appears to be shifting.

Duncan pointed out that the recent high demand for adjustable rate mortgages (ARMs) is not new. The attraction of adjustable rate loans when interest rates are low-an "affordability play"fits with historical patterns of borrower behavior. However, fostered by continued innovations in mortgage products, the current upswing has lasted longer than in the past. At the same time, innovations have allowed for a significant expansion of mortgage financing to "credit-blemished" borrowers. Unfortunately, there is little historical experience with how such a large and broad pool of these non traditional loans will perform over time.

Lender insight on recent innovations

John McMurray of "mortgage supermarket" Countrywide Financial highlighted a recent internal study of mortgage performance. Covering approximately ten million mortgages and examining a wide array of variables, the study focused on pinpointing where lenders' risks are concentrated, given the rapidly evolving mortgage market. Which types of borrowers and which types of loans are more likely to become seriously delinquent? How might lenders want to change their practices in light of these results?

Much of the study's findings were not surprising. For instance, larger loan amounts, lower credit scores, and higher loan-to-value ratios were associated with a greater probability of delinquency, all else being equal. …

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