Monday, August 13, 2007

The root cause

I think this graph captures it:

While the data on households seems much to noisy (taken from the Census Bureau), it is clear that starting on 2004 housing completions began to seriously outstrip demographic demand. So why did price growth take until mid-2006 to cool? Because the market had taken a life of its own with so much cheap financing availible. And it seems to me that to keep the party going, lenders had to agressively recruit ever more unsound borrowers. This explains why recent vintage subprime mortgages have much higher default rates.

The bad news is that the market will undershoot on its way down, just as it overshot on the way up.