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Call it a recession or the collapse of a bubble. Or a meltdown.
Whatever you call it, global financial markets are being racked by turmoil of a magnitude that hasn't been seen in decades. Texas, however, seems to be faring relatively well.
Throughout 2008, seismic shocks prompted by declining house prices and record foreclosure rates shook the national economy. The pace of events quickened in September with the federal takeover of Fannie Mae and Freddie Mac, the government-sponsored mortgage brokers, and AIG, the nation's largest insurance company; the failure of Lehman Brothers; and the bankruptcy of Washington Mutual Inc., the largest bank failure in U.S. history.
Thus far, Texas' housing market is relatively healthy, and the state has a good chance of avoiding the worst effects of the meltdown. But the landscape of corporate America has been altered in unprecedented ways.
And it all started at home, quite literally.
End of the dream?
About a decade ago, U.S. home prices entered a period of dramatic growth. Rising prices, low interest rates and a plentiful money supply made real estate an increasingly attractive investment, particularly after the collapse of the tech bubble in 2000.
Between 1999 and 2005, the median U.S. home sale price rose from $174,510 to $234,736, a 34.5 percent increase. But much larger rises were seen in some states, particularly in the Sun Belt. The median home price in Phoenix, Ariz., for instance, rose by 46 percent between August 2004 and August 2005 alone.
Lenders chasing lucrative mortgage business further increased the demand for homes by offering reduced income requirements and lower down payments. Many of these mortgages were subprime -- that is, they were made to buyers who presented too great a risk of default to receive regular loans. These subprime loans were made at interest rates above the prime rate offered to more credit-worthy buyers. Higher interest rates made these loans desirable to lenders despite the greater risk of default.
"In many cases, these loans were made with no money down," said John Heleman, chief revenue estimator for the Texas Comptrollers office. "The days of 20 percent down were so far in the rearview mirror that no one could even recall them. Some borrowers had no proof of income or even of having any job at all."
The industry described these as NINJA loans -- no income, no job, no assets.
Selling debt
Banks were able to make such risky loans due in part to a relatively new class of financial transactions called collateralized debt obligations. They can be used to bundle mortgage debt into instruments that can be bought and sold, just as municipal bonds are.
Clinton and Bush administration policies intended to expand homeownership boosted the market for CDOs. The government-supported institutions Fannie Mae and Freddie Mac purchased large numbers of these instruments to ensure that relatively risky mortgages remained attractive to lending institutions.
"Many mortgages were immediately sold and then packaged, or pooled, into mortgage-backed securities," Heleman said. "In many cases, the people making the mortgage loans didn't want to hold onto them.
"But as time went on, as we're now finding out, the loans Fannie Mae and Freddie Mac were purchasing became lower quality," he said. "As this situation continued, Fannie and Freddie got to a point where they did not want to purchase more of these loans." But private investment firms picked up the slack, buying up debt and packaging it into mortgage-backed securities.
What goes up...
In 2005, the real estate boom began grinding to a halt. Since then, housing prices have declined steadily in many areas. According to First American CoreLogic, the nation's largest property information service, national housing prices declined by an average of 11.3 percent between August 2007 and August 2008.
But some areas were hit much harder. Housing prices in the greater Los Angeles area were 28.6 percent lower in August 2008; Phoenix-area prices were nearly 23.6 percent lower. By contrast, the Dallas, San Antonio, Houston and Austin areas all posted price increases.
Unfortunately, the plunge in prices means many Americans are saddled with mortgages that no longer reflect the current value of their homes.
CoreLogic recently analyzed data for about 42 million properties accounting for more than 80 percent of the nation's mortgages. The company found that as of Sept. 30, more than 7.5 million mortgages -- nearly one in five of the total examined -- were in a "negative equity position," meaning that the property owners owed more on their mortgages than their houses were worth. (In common real estate parlance, these folks are "under water.") In Texas, 16.5 percent of mortgages are under water.
Bubbles, human nature
The first rule of economic bubbles is that they always burst. The second rule seems to be that no one believes that they'll burst until they do.
"Why people thought that home prices would go up forever is a behavioral and psychological question," said Bruce Kellison, associate director of the University of Texas Bureau of Business Research. "But as in any bubble, people convince themselves that we're in a new period where old rules don't apply.
"People were in denial that this could ever end," Kellison said. "But it ended, just like lots of other bubbles. And now we're in a recession where people are losing their jobs, have huge credit card bills, can't afford the mortgages on their homes -- and their homes themselves have lost value or have stopped rising in value."
By 2007, plunging home values and the generally risky nature of many subprime loans prompted a serious wave of mortgage defaults across the nation. According to RealtyTrac, a property information service, U.S. foreclosure activity rose by 75 percent in 2007.
Over the top
"The tipping point came when people started defaulting on their mortgages just as property values started going down," said Heleman. "That's the part that invalidated the investors' whole assumption about how the world was going to work. I think we'll be reading books about this for a good many years to come."
The wave of defaults meant that CDOs held by investors around the world suddenly offered little hope of any return. And many financial institutions had borrowed huge sums to invest in CDOs, essentially betting on the continuing rise in home values.
And so the dominoes started to fall -- and they're still falling. The Bank of England recently estimated world losses to investors due to the meltdown at $2.8 trillion so far.
Texas exception?
Texas seems to be avoiding the worst effects of the meltdown.
"Most of the national forecasters say Texas looks better than the rest of the nation, and our job situation is better," Heleman said.
Kellison said the recession will be less severe in Texas.
"We avoided the housing bubble, generally speaking," he said. "We have a very strong housing base in Texas, and new arrivals will soak up excess housing inventories pretty quickly.
"And at the end of the day, Texas is relatively insulated from this financial crisis because Texas banks avoided making huge numbers of subprime loans in the last seven or eight years," Kellison said. "Texas didn't have disproportionate numbers of subprime loans. We didn't get caught up in the frenzy."
* Bruce Wright is a staff member of the Texas Comptroller's Office. For more detailed information on the outlook for the state and national economies, see the Comptroller's 2010-2011 Biennial Revenue Estimate at www.window.state.tx.us.
