After booming the first half of this decade, U.S. housing activity has retrenched sharply. Single-family building permits have plunged 52 percent and existing-home sales have declined 30 percent since their September 2005 peaks. By August 2007, the housing market’s weaknesses were apparent: loan-quality problems, uncertainty about inventories, interest rate resets and spillovers from weaker home prices. These, coupled with ratings agencies’ downgrading of many subprime RMBS, led to a dramatic thinning in trading for subprime credit instruments, many of which carried synthetic, rather than market, values based on models because of the instruments’ illiquidity.
A housing slowdown mainly affects gross domestic product by curtailing housing construction and home-related spending. It also reins in spending by consumers who have less housing wealth against which to borrow. The rise and fall of nonprime mortgages has taken us into largely uncharted territory. Past behavior, however, suggests that housing markets’ adjustment to more realistic lending standards is likely to be prolonged.