Lax proof-of-income requirements (like no documentation of income or employment) during the housing bubble resulted in exaggerated incomes on loan applications. Nothing surprising there, but now new research and analysis from CoreLogic directly connects 2002-2007 inflated housing prices with insufficiently documented loans.
Borrowers’ incomes have historically dictated the loan amount limits of their eligibility for a purchase-assist home loan. Compiling records of sale prices, buyer income levels and loan origination practices from the last 30 years, analysts have confirmed the relationship between changes in income and changes in housing prices. This relationship was consistent from the 1970s to early 2000s, during which both income and housing prices rose steadily and simultaneously. Between the two rates of increase, no greater disparity than 16% was ever present from 1970 to the early 2000s.
However, in 2005 (the peak of the housing bubble), an unparalleled gap had been created; housing prices rose at a rate 50% higher than buyers’ incomes justified.
Home prices for mortgage collateral ballooned during the housing bubble as lenders allowed borrowers to exaggerate their incomes by providing “alternative forms of income documentation.” It is estimated that 20% of borrowers placed in these liar loans exaggerated their incomes, resulting in the grossly inflated loan amounts that fueled the momentum market.
Data shows the actual income received by low-doc and no-doc loan borrowers was consistently lower than the actual income of borrowers with fully documented loans. According to CoreLogic calculations, this difference in borrower income reached a peak in November 2006 for no-doc loans and January 2007 for low-doc loans.
In November 2006, actual incomes for no-doc loan borrowers were 66% lower than verified incomes recorded on fully documented loans in the same month. In January 2007, actual incomes for low-doc loans were found to be 41% lower than verified incomes for borrowers on fully documented loans in the same month. Low-doc loans later defaulted at over twice the rate of fully documented loans.
An analysis of income amounts independent of loan agreements during the early 2000s reveals only a slight influence on housing prices during that time. However, when incomes reported on low-doc loans were used to represent the general population during those years, the influence of these exaggerated incomes was undeniable:
general population data explained only 50% of price levels;
exaggerated incomes explained 80% of price levels.
Housing prices had been inflated by exaggerated incomes and had little relation to borrowers’ actual incomes.
first tuesday take: No surprise: corruption by any provider in a real estate transaction always leads in an unstable real estate market. No surprise again: sellers will exact as high a price for their property as demanding buyers are willing and able to pay. That is how the market works. Today, demand is lacking (to be polite) and will not materialize to meet an excessive supply of available housing until jobs pick up dramatically for a couple of years.
The correlation between a seller’s price and the buyer’s income sets conditions for sales volume. But if fraudulent loan practices offer buyers the opportunity to pay inflated prices for property, boom-time prices will instantly result. The likely culprit: deregulation of the mortgage market, which always goes up in flames. [For more information on factors contributing to the housing bubble, see October 2011 first tuesday article, The equilibrium trendline: the mean-price anchor.]
Alternative loans, such as adjustable rate mortgages (ARMs), have historically contributed to unsteady real estate markets since they allow borrowers to assume greater financial responsibility than their incomes justify. [For more information on the impact of ARM financing on the real estate market, see January 2012 first tuesday market chart The iron grip of ARMs on California real estate.]
California’s ailing real estate market is the result of the lack of accountability and the resulting greed from the bottom up. Lenders are just the current high visibility object of scorn. Home builders and title companies are also contributors, as every provider furthered the inflation of housing prices, choosing immediate profit over long-term stability. [For more information on reliable financing practices, see November 2011 first tuesday market chart, The 20% solution: personal savings rates and homeownership.]