Beyond the froth.

Former Federal Reserve Chairman Alan Greenspan has been criticized for his assertion in May 2005 that real estate markets were suffering only from "a little froth" and that rising home prices would be forced to "simmer down" as properties became unaffordable.

Yet the recent publication of The State of the Nation's Housing: 2008, by Harvard University's Joint Center for Housing Studies (JCHS), Cambridge, Massachusetts, shows that Greenspan's analysis may have been more accurate than some give him credit for. Although the recent market turmoil seems severe, it also can be viewed as closing the door on the excesses at the end of a strong growth period.

"Despite all the attention that subprime and so-called afford-ability loans have gotten for fueling the housing boom, the national homeownership rate had already peaked by the time these products took off in 2004," the study concludes. "Indeed, the homeownership rate began to retreat in 2005 and 2006, and then dropped more sharply in 2007 to 67.8 percent in the fourth quarter," the report states.

The JCHS report adds, "It appears that these mortgage innovations did less to lift homeownership than to enable homebuyers to chase prices higher, investors to borrow money to speculate, and owners to borrow against home equity."

Subprime lending was the froth, not part of the boom's substance. "What sparked the decade-long homeownership boom was instead the improved affordability brought by lower interest rates and flat home prices in the wake of the 1990-1991 recession," the study explains. "That downturn was quickly followed by the longest economic expansion since World War II and unusually strong, broad-based income growth. During this period, Congress and regulators also leaned on financial institutions to step up lending in low-income and minority neighborhoods."

Automated underwriting made it easier for many renters to qualify for a mortgage, and helped push homeownership to a record 69 percent of all households. "From 1994 to 2001, the national homeownership rate surged by 3.8 percentage points and rose even more among minorities and younger households," notes the JCHS study.

Yet those advances are overshadowed now by the subprime lending debacle. Buyers and lenders tried to cope with higher home prices and rising interest rates by using exotic loan products, according to the report.

"Because of their abysmal performance, subprime loans fell from 20 percent of originations in 2005-2006 to just 3.1 percent in the fourth quarter of 2007," the JCHS report points out. "The real dollar volume plummeted from $139 billion in the fourth quarter of 2006 to $14 billion at the end of last year." Production of interest-only and payment-option mortgages also fell from 19.3 percent of 2006 originations to 10.7 of 2007's volume.

Not so bad

A housing crisis of any duration is worrisome for consumers. The Washington Post reported in June that the last time consumer confidence measures were so low was in 1980. Yet at that time, the so-called Misery Index was twice as high as it is now. "The jobless rate was 7.5 percent and inflation was 14.4 percent," explains the Post. "Now those numbers are 5.5 percent and 4.2 percent, respectively."

So conditions may not be all that bad after all. James Paulsen, chief investment strategist at Wells Capital Management, San Francisco, adds that even though energy costs are up, taxes remain relatively low. He says the combined burden of taxes and oil is lower today than it was in 2000.

Yet many consumers find today's economic situation frightening. One reason is that we've enjoyed two decades of low interest rates and a rising stock market. Higher food and gas prices also affect everyone, while a rise in unemployment mainly hurts just those who lose their jobs. Lower house prices also get the attention of most Americans, while a weak stock market causes worries only for the roughly half of all households who own shares.

America's economy has righted itself in the past after going through deeper difficulties than we're seeing now. Since hitting a low point in 2005, homebuyer affordability has shot up "about 35 percent," notes Wells Capital's Paulsen.

"The fundamentals of demand are likely to drive a strong rebound in housing once prices bottom out and the economy begins to recover," adds the JCHS report. Household growth in the United States from 2010 to 2020 should average more than 1.4 million per year. That increase in demand for housing will be greater than what we experienced in 1995-2006, according to the JCHS.

Yet challenges will remain even after conditions start to improve. America continues moving away from the traditional household anchored by a married couple. Increasing numbers of households headed by single adults will deepen affordability challenges, the report states.

Buying real estate also requires consumers to make large financial decisions, which makes homebuyer education important. A continuing challenge in this regard remains reaching out to potential minority buyers. From 2010-2020, "minorities will lead growth across all household types and age groups except seniors," reveals the study. More than 60 percent of household growth during 2000-2006 was due to increased numbers of minority households. But such challenges don't seem all that daunting after the year that the industry has just experienced.

Howard Schneider is a freelance writer based in Ojai, California. He can be reached at howard@mmol.net.