House Flipping Fueled Housing Collapse, Says Fed

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NEW YORK (MainStreet) — The icy finger of guilt is hovering over the notorious “house flipper,” the real estate investor with a penchant for buying and selling homes in a short period was a big reason the housing crisis caught fire, says a new report from the Federal Reserve Bank of New York.

Data from the report, compiled by Andrew Haughwout, Donghoon Lee, Joseph Tracy, and Wilbert van der Klaauw of the Fed, says that “speculative” investing was “much more important in the housing boom and bust during the 2000s than previously thought.”

The study points out that house flippers drove up home prices between 2004 and 2006 – right before the hammer fell on the housing sector. But in 2007 and 2008, when the housing market was teetering on the brink, speculators began losing serious ground and fell badly behind on multiple home payments they hoped would sell quickly.

That helped lead to the first big cycle of property foreclosures, which in turn drove local property values down, further burying the housing sector. The study points out that in hard-hit states like Arizona and California, 20% of all home sales were purchased by buyers who already owned three or more properties. The Fed report says that’s three times the amount measured back in 2000. Once property prices really began falling in such states, multiple-home speculators headed for the hills – and left behind an avalanche of busted loans and foreclosed homes.

“Longstanding tradition in the mortgage lending business and the predictions of economic models hold that investors will quickly default if prices begin a persistent fall. This is what happened starting in 2006,” the report says. Such "strategic default" has left more than one lender holding a worthless property it's unable to move off its books.

Overall, the Fed report estimates that in the vortex of the housing crisis – between 2007 and 2009 – home speculators were responsible for more than 25% of “seriously delinquent” home mortgage loans in the U.S. And that, the study concludes, is a big reason (but not the only reason) why the housing market is in the disrepair it is today.

According to the report, current estimates are that around 23% of active mortgages are underwater (when the balance of the mortgage exceeds the resale value of the house) in that the balance on the mortgage exceeds the current value of the house. As of 2010 Q4, nearly 2.8 million homes have gone through foreclosure, and another 2 million homes are in the process of foreclosure.

Nationally, distress sales represent around half of all repeat-sale transactions. These distress sales continue to exert downward pressure on house prices and make it more difficult for housing markets to recover.

That’s bad news for the American public, and it looks like house flippers have a lot of explaining to do.

If you're a homeowner who depends on housing prices to recover your major investment, check out MainStreet's look at 3 Numbers That Point to a Housing Recovery!

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