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Housing: a crisis with staying power

Americans just witnessed the biggest housing boom in their history. The impact of the bust that has followed looks to be wide and long-lasting. First of a three-part series.

By Staff writer of The Christian Science Monitor / December 10, 2007

Cape Coral, Fla.

The current deflation of home prices is changing America.

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It's a real estate storm that made landfall like a slow-moving Gulf Coast hurricane here in south Florida and in other once-booming housing markets last year. In recent months it has gathered momentum and spread, shaping up to become perhaps the worst home-price slump since the 1920s and '30s.

The bust promises to have lasting effects. Among them:

•It is defining the limits, for now, of what President Bush has called the "ownership society." A surging foreclosure rate means that the rate of homeownership, after a historic rise, is falling.

•It's forcing a rethink of economic policy. The Federal Reserve is expected to ease interest rates this Tuesday. Over the longer term, today's hard lessons might influence the way the Fed and the mortgage market operate.

•It affects the mood of America entering the year of an up-for-grabs presidential election.

•It marks a pocketbook shift for consumers – and perhaps even global investors – from an era of housing-fueled wealth to belt-tightening. Real estate can no longer be viewed as a surefire investment.

"We are in the aftermath of the biggest housing boom in history," says Robert Shiller, a Yale University economist. "We are in a period of exceptional uncertainty about the value of our homes."

It is that issue – how far home prices rose – that sets this bust apart from other US housing downturns in the past century. This is more than a typical cycle where the pace of home building plummets. And this goes well beyond a crisis of subprime borrowers.

That's because this housing cycle now puts the wider economy at risk through several channels. First, the dive in home sales and construction subtracts directly from economic growth. Second, the erosion of property values is beginning to affect consumer confidence and spending. Perhaps more serious, write-downs of bad loans are crimping the health of banks, raising concerns that the flow of credit could be choked off despite Federal Reserve efforts to keep interest rates low.

In the boom, prices up 90 percent

What caused US home prices, as tracked by the Standard & Poor's Case-Shiller index, to shoot up nearly 90 percent in the first six years of this decade?

Easy credit laid the foundation for the run-up. But it also gathered a momentum of its own. As people saw the annual gains in home values outstrip the interest on a loan, they piled into the market.

Some worried that if they didn't scramble to buy, they'd never get another chance. Others were investors eager to "flip" homes for quick profits.

When home values finally maxed out in 2006 – not because of any general trouble in the economy but because asking prices outstripped the means of new buyers – the stage was set for a reversal. Speculators backed out of the market and defaults began to rise for subprime borrowers, who face higher interest rates because they present a higher risk to lenders. When adjusted for inflation, housing prices have fallen an average of 8.9 percent this year, according to Mr. Shiller (see chart below). Most economists expect them to fall further.

Economists differ on whether this housing slump is tipping the nation into its first recession since 2001. It is certainly a big drag on growth.

Recession or no, it appears clear that some of the repercussions will be long-lasting.

Start with a historic surge in foreclosures that has made some neighborhoods look like disaster zones. The problem may not crest for several years.

Here in Florida, many of the buyers who got burned were investors who expected to buy and then quickly resell homes in a rising market.

"There's a lot of people that stuck their neck out," says Richard Ray, a longtime resident who works at a marina in Cape Coral, with a rate of foreclosures in process – 5.4 percent of all mortgages – that leads the nation.