Investors seeking to "flip" homes for quick profits played a significant role in driving up home prices during the housing bubble and their subsequent collapse, economists at the New York Federal Reserve have concluded.

Investors took advantage of the availability of subprime credit to buy multiple properties with little or no money down, the researchers found, driving up the price of real estate in general. When prices fell, these investors began bailing out by defaulting on their loans, accelerating the rate of decline and feeding the collapse.

"Optimistic investors - speculators - used low-down-payment, nonprime credit to place highly leveraged bets on the housing market, perhaps facilitated for some by reporting an intention to live in the house," the report said. "Because they didn't have to put much money at risk, these investors were able to continue to buy housing even as prices rose further."

The report notes that economic models and conventional wisdom in the mortgage business hold that investors will quickly default if home prices enter a persistent fall, which is exactly what happened beginning in 2006.

Investors tapped subprime credit

At the peak of the housing boom, over one-third of all home purchase mortgages were made by people who already owned at least one house, according to the report. That figure rose to 45 percent in the four states where the boom-and-bust was most pronounced - Arizona, California, Florida and Nevada.

Investors were also found to be considerably more likely to use subprime credit than owner-occupants were, which the researchers attributed to a desire to avoid tying up their money in down payments. At the peak, some 25 percent of buyers with three or more homes were using subprime credit, compared to 15 percent of owner occupants.

Higher defaults among buyers of multiple homes

Ironically, borrowers with multiple mortgages started out being better credit risks and less likely to become seriously delinquent on their loans prior to 2006, but made up a disproportionate share of defaults once the downturn hit. From 2007-09, borrowers with multiple mortgages accounted for more than one-fourth of all seriously delinquent home loans nationally, and more than a third of the total in the four main boom-and-bust states.

The report's authors say the results suggest that speculative borrowing by investors played a greater role in the development of the housing bubble and its subsequent collapse than had been previously realized. The four authors, all economists with the New York Federal Reserve, published their report this week.

Published on December 9, 2011