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Anatomy of the Housing Market Boom and Correction

Working paper #617
Kenneth T. Rosen

The housing boom of 2002 to 2006 was caused by access to the easiest credit in fifty years and poor lending practices, rather than demographics and income. The financial incentives initially expanded home ownership, but also encouraged speculation, estimated to be 20 percent to 30 percent of all sales in the “hot” housing markets. A shift in the price of credit produced massive cancellations of these earlier sales, and a skyrocketing inventory of homes and condominiums. The capital markets seized-up as investors tried to unload leveraged positions in structured investment vehicles containing the riskiest of these mortgage loans. Buyers of these structured products didn’t understand that valuations were based on the risks of a traditional housing cycle rather than on this speculative one. If the economy were to go into recession the current problems would become overwhelming and could very well create a deep and long downturn. Only a loan modification and forbearance plan might forestall a foreclosure onslaught by allowing a transition period to tighter and more sound lending practices.

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