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Don't Blame Subprimes
Those Bad Loans Were Just a Response to Our Real Problem

By Michael Hill
Monday, February 11, 2008

I am sick of everyone blaming the breakdown in the credit and housing markets on subprime loans. Subprime loans were certainly part of the problem, but they are a symptom of a deeper issue. What's happening in the market today is not the bursting of a five-year bubble but the bursting of a 40-year bubble and the failure of the mortgage loan system to meet the needs of the marketplace.

The truth is that subprime lenders, by responding to demand, were the finger in the dike for the whole housing market. The real problem is affordability and the incongruity between incomes and home pricing.

Forty years ago, the median national price of a house was about twice the median household income. In some parts of the country, this ratio was closer to 1 to 1. Twenty years ago, the median home price was about three times income. In the past 10 years, it jumped to four times income.

But in most major economic centers, typical families haven't been able to buy a home for anything near the national median price for decades. Try to find a single-family home in the D.C. area for the national median of $221,900. In the major markets, there is tremendous dependency on alternatives to the standard 30-year fixed-rate mortgage, which in turn has created a dependency on the least scrupulous mortgage companies and lenders.

The issue of affordability is not news to the major players in real estate. Each month, lenders, developers and government agencies study the National Association of Realtors' Housing Affordability Index. This index provides a way to track whether housing is becoming more or less affordable for typical households nationwide; it incorporates changes in key variables such as home prices, interest rates and incomes.

For the most part, the index is excellent for charting the strength of the market. But it has a few big flaws: First, it assumes that a borrower makes a 20 percent down payment and that the maximum mortgage payment is 25 percent of a household's gross monthly income. That used to be standard, but today many buyers can't meet this criteria. Second, it ignores patterns in the overall relationship between incomes and home prices and could therefore miss a growing bubble -- if interest rates are dropping, say, affordability could appear to be stable even if prices are rising and incomes are falling. Lenders, developers and the government could still miss trouble brewing under their noses.

Another problem is that this index is based on very broad averages. It tracks the whole country and the four major regions (the Northeast, South, Midwest and West). But the gap between the major markets and the national numbers has been widening rapidly, making the national figures all but worthless for millions of Americans. So even if the numbers look good nationally, and they do, housing affordability indexes for metropolitan areas confirm the impression of millions of home buyers -- that homes aren't affordable where the jobs are.

Consider Silicon Valley, home to much of the driving force for our economy in the '90s. Today the median price of an existing home in Silicon Valley is $775,000, but the median household income there is only $62,020. A home in the area costs almost 13 times annual income. Home prices in that market would have to drop nearly 70 percent or income would have to triple, and interest rates would have to stay low for the price-to-income ratio to reach a more affordable level. Here in the Washington metropolitan area, the median home price is about eight times the median household income. Income-affordability ratios are similarly out of balance in Boston, New York, San Diego and the other areas hit hardest by the current crisis.

Without mortgage options that provide lower monthly payments than traditional 30-year mortgages, a majority of families cannot afford homes in our nation's major population centers.

Today's crisis differs greatly from previous housing downturns. In past downturns, the housing market was influenced by and was an indicator of other economic issues. This time, millions of homes have been built around the country during the past few years using a financing option that no longer exists. There may never be enough capacity to absorb all of these homes and other existing homes using 30-year mortgages, because there simply aren't enough people with the incomes to meet the requirements. Prices could not roll back far enough without damaging the economy irreparably.

The solution is not to be found in a short-term stimulus nor in waiting things out. What is needed is a new standard mortgage product, something as revolutionary today as the 30-year fixed-rate loan was when it was introduced.

So many people bought into subprime loans because that was all they could afford. Subprime and Alt-A lenders exposed the market demand. Now it is time for more trustworthy capitalists, more focused on long-range outcomes, to meet this demand and reopen the door to homeownership to millions of Americans.

The writer is president and chief executive of Emerge Homes Inc., a luxury home builder.

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