Slide 1CHAPTER OUTLINEHow Much is a House Really WorthCase-Shiller IndexMortgagesTraditional MortgageInterest Only MortgageNegative AmortizationHow to Make a BubbleAre These Houses Affordable?Most AffordableLeast AffordableVocabulary of 2008Vocabulary of 2008POP Goes the Bubble!The Risk to the Overall Economy13-1©2015 McGraw-Hill Education. All Rights Reserved ©2015 McGraw-Hill Education. All Rights Reserved Chapter 13The Housing Bubble13-2©2015 McGraw-Hill Education. All Rights Reserved CHAPTER OUTLINE•How Much Is a House Really Worth? •Mortgages •How to Make a Bubble •Pop Goes the Bubble!•The Effect on the Overall Economy13-3©2015 McGraw-Hill Education. All Rights Reserved How Much is a House Really Worth•“location, location, location”•Amenities of a Community•Neighboring Property•Amenities of Home•Size•Lot Size•Bedrooms•Bathrooms•Pool/Trees/Appliances•Age of Expensive replacements•Roof•Carpet•Heating & Air Conditioning13-4©2015 McGraw-Hill Education. All Rights Reserved Case-Shiller IndexJ a n u a r y 1 9 9 7J u ly 1 9 9 7J a n u a r y 1 9 9 8J u ly 1 9 9 8J a n u a r y 1 9 9 9J u ly 1 9 9 9J a n u a r y 2 0 0 0J u ly 2 0 0 0J a n u a r y 2 0 0 1J u ly 2 0 0 1J a n u a r y 2 0 0 2J u ly 2 0 0 2J a n u a r y 2 0 0 3J u ly 2 0 0 3J a n u a r y 2 0 0 4J u ly 2 0 0 4J a n u a r y 2 0 0 5J u ly 2 0 0 5J a n u a r y 2 0 0 6J u ly 2 0 0 6J a n u a r y 2 0 0 7J u ly 2 0 0 7J a n u a r y 2 0 0 8J u ly 2 0 0 8J a n u a r y 2 0 0 9J u ly 2 0 0 9J a n u a r y 2 0 1 0J u ly 2 0 1 0J a n u a r y 2 0 1 1J u ly 2 0 1 1J a n u a r y 2 0 1 2J u ly 2 0 1 20.0050.00100.00150.00200.00250.00300.00Phoenix Los Angeles Washington Miami Las VegasCleveland Dallas Composite-10 CorePCEC a s - S h i l l e r H o m e P r i c e I n d e x ( J a n 2 0 0 0 = 1 0 0 )13-5©2015 McGraw-Hill Education. All Rights Reserved Mortgages•Traditional (Until late 80s)•80% Loan to Value•15, 20, & 30 Year payouts•Traditional (now)•90%-100% Loan to Value•PMI•15, 20, & 30 Year payouts•Interest Only•100% Loan to Value•PMI•Interest portion of payment for first 5 to 10 years•Negative Amortization•100% Loan to Value•PMI•About half of interest portion for first 5 to 10 years13-6©2015 McGraw-Hill Education. All Rights Reserved Traditional MortgagePayment NumberTraditional MortgagePayment Interest Balance0 250,0001 1,342 1,042 249,7002 1,342 1,040 249,3983 1,342 1,039 249,0954 1,342 1,038 248,791: : : :: : : :358 1,342 17 2,667359 1,342 11 1,336360 1,342 6 013-7©2015 McGraw-Hill Education. All Rights Reserved Interest Only MortgagePayment NumberInterest-Only for 5 YearsPayment Interest Balance0 250,0001 1,042 1,042 250,0002 1,042 1,042 250,000: : : :59 1,042 1,042 250,00060 1,042 1,042 250,00061 1,461 1,042 249,58062 1,461 1,040 249,159: : : :122 1,461 920 220,371123 1,461 918 219,827: : : :358 1,461 18 2,905359 1,461 12 1,455360 1,461 6 013-8©2015 McGraw-Hill Education. All Rights Reserved Negative AmortizationPayment NumberNegative Amortization 5-yearsPayment Interest Balance0 250,0001 521 1,042 250,5212 522 1,044 251,0433 523 1,046 251,5664 524 1,048 252,090: : : :59 588 1,175 282,66160 589 1,178 283,25061 1,656 1,180 282,77562 1,656 1,178 282,297: : : :358 1,656 21 3,291359 1,656 14 1,649360 1,656 7 013-9©2015 McGraw-Hill Education. All Rights Reserved How to Make a Bubble•Fundamental Determinants of Housing Value•Location•Amenities•Interest rate•Non-Fundamental Determinants•Expectations that prices will rise in the future causing increased demand now. This is a prescription for a bubble.13-10©2015 McGraw-Hill Education. All Rights Reserved Are These Houses Affordable?Median Family Income Median Sale Price of an Existing Single-Family Home Annual Mortgage Payments (30 years, 6% interest)Homeowners Insurance*Property Tax*Total Annual Housing Costs Home Costs as a Percentage of IncomePhoenix $64,200 $257,400 $18,519 $2,000 $4,000 $24,518.92 38.19%Los Angeles $59,800 $589,200 $42,391 $2,000 $4,000 $48,390.62 80.92%Washington $97,200 $430,800 $30,994 $2,000 $4,000 $36,994.36 38.06%Miami $49,200 $365,500 $26,296 $2,000 $4,000 $32,296.29 65.64%Las Vegas $63,900 $297,700 $21,418 $2,000 $4,000 $27,418.34 42.91%Cleveland $62,100 $130,000 $9,353 $2,000 $4,000 $15,352.99 24.72%Dallas $65,000 $150,900 $10,857 $2,000 $4,000 $16,856.66 25.93%13-11©2015 McGraw-Hill Education. All Rights Reserved Most Affordable•Fairbanks, AK•Cumberland, Md-WV•Springfield OH•Monroe, MI•Mansfield, OH13-12©2015 McGraw-Hill Education. All Rights Reserved Least Affordable•San Francisco, CA•New York, NY•Santa-Ana-Anaheim-Irvine, CA•Ocean City, NJ•Los Angeles, CA13-13©2015 McGraw-Hill Education. All Rights Reserved Vocabulary of 2008•Securitization: The process by which mortgages are bundled into groups and sold as investment instruments.•Done by Fannie Mae and Freddie Mac•Geographically diversity•Credit Default Swap•Insurance against the loss of principal•Unregulated•ING AIG were large purveyors as were many investment banks•Goldman Sachs•Lehman Bros13-14©2015 McGraw-Hill Education. All Rights Reserved Vocabulary of 2008•Subprime: A mortgage issued to•A borrower with a lower credit rating•Someone for more than a house is listed•Liar Loans•Income and assets are unverified or overstated13-15©2015 McGraw-Hill Education. All Rights Reserved POP Goes the Bubble!1) When people cannot make payments this puts more homes on the market.2) When more homes are on the market, the price falls.3) When the price falls, the expectation of future increases ends.4) The ability to borrow equity to make payments ends and more homes are on the market.5) Repeat steps 1) through 5)13-16©2015 McGraw-Hill Education. All Rights Reserved The Risk to the Overall Economy•Lower aggregate demand •Less equity to buy large ticket items, vacations etc.•Higher interest rates because of higher default rates•Tighter credit standards for all