Real Estate Became the Investment of Choice

Of course, people also want to invest in something safe, and what could be safer than

real estate? There had been relatively few instances of real estate values declining,

and when they did the declines were generally shallow and short-lived. A point of

pride in the United States was the high percentage of Americans who owned their

own homes. Investing in a home traditionally had been a very safe investment and

one that was slow to appreciate in value. But suddenly in the early 2000s, real estate

investing became a real moneymaker. With a backdrop of historically low interest

rates, real estate became such a popular way to invest that demand soon outstripped

supply and prices soared. The value of homes skyrocketed—homes that were selling

for $300,000 in one year sold for $450,000 the next. Prices rose so fast that speculation

grew tremendously. People bought houses with almost no down payment,

remodeled them or waited a few months, and then resold the houses for a quick profit.

A number of popular television programs showed viewers how to ‘‘flip’’ real estate

properties for profit.

Since the cost of borrowing was so low and home equity had grown so quickly,

many consumers borrowed on the equity in their homes and purchased additional real

estate or a new car or financed a luxury vacation. For example, suppose someone

purchased a house for $500,000 in 2003. By 2005, the home might have been worth

$800,000. The home owner refinanced the mortgage—borrowing as much as the

entire current worth of the house (because its value could only go up, right?), which

resulted in a $300,000 cash infusion for the home owner. This practice was very

popular, and it laid the groundwork for a huge disaster when the housing values fell

off a cliff in 2008 and 2009. Imagine the home owner who refinanced the home

just described. Imagine that he took the $300,000 and purchased a summer home and

a sports car and paid for his children’s college educations. Suddenly, home values

plummeted and his house lost 30 percent of its value, which was common in markets

such as California, Florida, Nevada, or Arizona, where the real estate bubble

was particularly inflated. After the real estate bubble burst, his house was worth

$560,000. Now suppose he loses his job and needs to sell his house because he can’t

afford the mortgage payments. He can’t get $800,000 for his home, which is what he

owes on his mortgage. His only choice is to work with the mortgage holder (probably

a bank) to refinance (unlikely) or declare bankruptcy and walk away from the house.

This is what a lot of home owners have done, and it is one of the factors at the heart

of the current financial crisis. Lots of folks were in on this bubble mentality, getting

what they could in the short term and not thinking very much about the likelihood (or

inevitability) that the bubble would burst.