While the bubble was inflating, self-serving explanations were offered for why traditional formulas of home valuation no longer applied. As it turns out, the laws are still in effect. These traditional measures, like the relationship between home prices, rents and income, indicate that prices need to fall at least 30 percent more nationally. The sooner this balance is achieved, the sooner lenders will again commit capital.
Everyone seems to agree that a return to traditional lending standards is a good idea, but no one seems willing to accept a return to rational prices as a consequence.
Borrowers with loans that are greater than the values of their homes will have few incentives to keep paying their mortgages or to maintain their properties. Why spend more on a home in which they have no equity and which they may lose to foreclosure anyway?
Irrational lending standards drove home prices up by sucking renters into homeownership. Having put nothing down or having extracted equity in previous refinances, most subprime borrowers will lose nothing financially from foreclosure. In some cases the low teaser rates allowed them to pay less than what they might otherwise have paid in rent. The real losses are borne by the lenders.
If home prices were still rising, defaults would be low, investment returns would be high, borrowers would still be cashing out equity, and lenders would be showering credit on home buyers.
Falling prices reverse this dynamic. A recent study by the Federal Reserve Bank of Boston found that most foreclosures result from falling home prices, not from the resetting of mortgage rates.
Higher down payments, mortgage rates and required credit scores — along with lower loan-to-income ratios and perhaps the death of adjustable-rate loans altogether — will further push down home prices.
