While sub-prime financing played a somewhat significant part in the housing bubble and bust, it was only part of the problem. Average people who bought their homes were fine and could afford the payments, until the bubble burst and they lost their jobs in the ensuing meltdown. Once they lost their jobs, they could no longer afford the payments, but it wasn't because of the financing.
The real problem was caused by speculators flipping houses. As prices were going up and up, investors stepped into the action in a very big way. As they purchased these homes, they continued to drive up the price as they could turn those homes for a 20% profit overnight. This continued to a point that in the last two years before the market bust, about one-third of all homes sold were sold to speculators or to individuals buying a second or third home.
The charts reveal some astonishing facts. At the peak of the boom in 2006, over a third of all U.S. home purchase lending was made to people who already owned at least one house. In the four states with the most pronounced housing cycles, the investor share was nearly half—45 percent. Investor shares roughly doubled between 2000 and 2006. While some of these loans went to borrowers with “just” two homes, the increase in percentage terms is largest among those owning three or more properties. In 2006, Arizona, California, Florida, and Nevada investors owning three or more properties were responsible for nearly 20 percent of originations, almost triple their share in 2000.
Investors Are Different from Owner-Occupants
Whether they were buying vacation homes or flipping houses, real estate investors behaved very differently from borrowers with just one first lien, a group almost certainly dominated by owner-occupants. For one thing, investors are very unlikely to move to the house they bought, especially if they own three or more properties. In rising markets, “buy-and-flip” investors typically want to hold properties for relatively short periods, and we show in our study that multiple-property owners in the mid-2000s tended to sell their properties much more quickly than those with just one first-lien mortgage. Importantly, we also show how buy-and-flip investors can make higher bids on houses, even if they had relatively little cash, by using low-down-payment loans. Nonprime credit—mortgage lending to borrowers who were unable or unwilling to qualify for cheaper, prime loans—enabled optimistic investors to speculate by making highly leveraged bets on house prices.
Because investors don’t plan to own properties for long, they care much more about reducing their down-payments than reducing their interest rates. The expansion of the nonprime mortgage market during the 2000s provided the perfect opportunity for optimistic investors to get low-down-payment credit, albeit at high interest rates. As shown in the charts below, investors were far more likely than owner-occupants to use nonprime credit to make their purchases, especially at the peak. Again, the colors show the number of properties the borrower owns, but this time we leave in the single-property borrowers for comparison.
?Flip This House?: Investor Speculation and the Housing Bubble - Liberty Street Economics
The problem with this is that all of a sudden, there were no more buyers. Because speculators pushed the market so hard, builders were going crazy building like there was no tomorrow and like there was an unlimited stream of buyers out there. The problem was that everyone that wanted to buy a house had done so, and then all of a sudden these speculators were caught holding all the excess inventory which nobody wanted. Since they couldn't even rent out these homes let alone sell them, they couldn't make the payments. We all know what happened after that.
So, the easy financing was somewhat of a problem, but it was exasperated by the speculators. Had the easy lending terms been limited to primary home buyers only, the bubble would likely have never happened.
