THE REAL ESTATE HANGOVER OF 2009
By Michael Williamsen — Published by Pro/Agent Magazine June, 2009
Real estate values are in a free fall, Wall Street icons are crashing, banks are imploding, businesses and jobs are disappearing. New subdivisions sit like ghost towns while REO’s and short sales compose most of the real estate market. Realtors are hiring homeless people to babysit their vacant REO’s in high crime areas. How could this happen to the American Dream? Let’s look at the basics.
Supply. Demand. Value. A simple economic balance, but it certainly applies to real estate. High demand and low supply yield higher prices. Low demand and high supply result in lower prices. Not exactly that simple when the balance gets messed up.
The Cycle of Real Estate Life. As paychecks and family sizes increase, so does the demand for bigger and better housing. Higher demand pushes up prices. Watching friends make money in real estate, new buyers jump into the market greedy for a piece of the appreciation and fearful to lose this opportunity. Prices shoot up and exceed the sanity level. The media announces a “real estate crash.” Values correct back to a sensible level, and there is balance once again.
To Regulate, or Not To Regulate.
Not Too Long Ago to Forget. Banks loaned their depositors’ money to help homebuyers. The government printed money but was limited to the gold standard: one dollar of paper money for every dollar in gold reserves.
Cure For Depression: Government Regulation. 1933 – Responding to the Great Depression, the Feds created the Glass-Steagall Act and the FDIC to regulate the financial markets. Maybe leaving the money of the naïve and greedy public in the hands of the greedy and ambitious financial industry wasn’t such a good idea.
In One Pocket and Out The Other. 1938 – The government created the secondary loan market and FNMA (Fannie Mae) which buys up bundles of real estate loans, then sells them to investors on Wall Street in the form of mortgage backed securities. Great! Now homebuyers don’t have to stop buying just because the banks are out of money.
More Is Always Better. Out of the 1970 Emergency Home Finance Act sprung the FHLMC, Freddie Mac, a new secondary mortgage market for conventional loans. The act also opened up conventional loans to FNMA. In 1971, the US government unshackled itself from the confinement of the gold standard. The printing press is a limitless source of money.
Don’t Try This At Home Kids. Towards the end of the 70’s, interest rates went ballistic. To stimulate demand, the real estate industry came up with a wonderful solution: creative financing. Owner financing and silent seconds up to, and over 100% of the sales price, helped buyers with down payment woes. Savings and Loans got real aggressive with new loan programs. Remember the RTC, (Resolution Trust Corp), the government organization that liquidated foreclosures from the failed S&L’s?
Don’t Need No Stinkin’ Regulation. 1986 – The Feds start repealing bank regulation. In 1999 – President Clinton signs the Gramm-Leach-Bliley Financial Modernization Act which virtually wipe out the regulation imposed in the 1930’s.
“We Have a Problem” President Bush said in 2002. “Too many Americans don’t own a home.” Greenspan said “We need more options to the fixed loan.”
Subprime Feeding Frenzy. Wall Street can’t resist the huge unregulated mortgage industry inhaling mortgage backed securities. Loan brokerages, getting paid on volume regardless of quality, and with non-licensed, un-trained mortgage consultants, sign up any homebuyer with a social security number, and shovel off the loans to Wall Street. Financial Engineers create collateralized debt obligations (CDO’s) which Wall Street sells off to the world. The world is hungry for the high returns secured on the forever appreciating “American Dream” and with the investment grade AAA stamp from the rating agencies. The rating agencies vie for Wall Street’s business and fees by competitively reducing their standards for the AAA rating.
The Inventory of Intoxication
Roll With It Baby. Fixed loans require long term bank investment forcing interest rates to remain high. Fluctuating rates of variable loans, mean less risk for banks, and lower initial rates.
Be Anything You Want To Be. Stated income loans, now dubbed “Liar Loans”, allow the self-employed, and hard-to-document income earners to simply their state income without verification. Requiring 20% down payment reduces lenders’ risk.
No Cover Charge. Would-be buyers with great income and good credit but no down payment are offered zero-down loans. Banks rely on verifiable jobs and good credit.
Just A Quick Fix To Get by. Re-financing and equity lines of credit allow homeowners to take advantage of all that unused appreciation.
Party Now, Pay Later. Negative amortization loans are available for buyers who simply can’t afford the house they want. The homeowner can simply borrow some more money to make their payments and add the advance to the loan balance. Appreciation will protect their equity, right?
Just Try A Little At First. Teaser rates offer drastically lowered interest rates for the first six months or so. Buyers can qualify at the lower introduction rate to get into more house than they can afford. They can just re-fi into another teaser rate loan.
NINJA LOANS – No Income, No Job, No Assets. Everyone is making tons of money, why stop now? No reason. Buyers can buy property on stated incomes, AND no down payment, AND forget the credit scores and security. Throw in teaser rates, just to be safe.
De-Regulation Gone Wild
The Party That Never Ends. First time buyers come out of everywhere. Move-up buyers up-grade with their hyper-inflated equity. Home buyers buy as much as twice the house they canrealistically afford. The market over-saturates with under-qualified buyers pumping up demand well beyond a normal real estate cycle.
I Promise I’ll Never Party Like This Again. A market correction is long overdue. Wild appreciation stops. Rates adjust up. Homeowners can’t make their payments – and don’t. The banks freak and stop making new loans, turning off the fuel for any demand. Wall Street sees not only their portfolios evaporate, but their companies. Credit-based spending strangles itself, businesses disappear, and jobs everywhere vanish. The housing supply floods, drowning demand, as buyers wait to see the bottom through the murk. Without bank loans, even willing buyers are not capable. Values plummet far below where they should have leveled out.
Real Estate Rehab.What about all the poor people who are now losing their homes? Most of those ‘poor people’ speculated on real estate valued much more than they could afford, without any of their own money, risked bank money with little accountability for failure, and certainly wouldn’t have complained if appreciation had made them a small fortune. For their mistake, they are offered a bailout through a loan modification or short sale, while their neighbor who actually could afford their home and put up some cash gets no favors. And what about all the profits sellers made selling at the top of the market? When the balance of supply and demand gets out of whack, so do values, and the distribution of value.
So why didn’t anyone see this and stop it? Economic prophets predicted the real estate crash. The SEC thought the banks would regulate themselves. Analysts knew this wouldn’t last forever. The big blinder was AIG who gave everyone the excuse that these investments were insured. All the research persistently pointed the finger at one word: greed. Greenspan said regulation wouldn’t have, and won’t save us next time – greed is just part of human nature.
Where do we go from here? FHA is offering loans with 3.5% down. Tax credits of $8k are being offered to first time home buyers. Cities are offering interest free loans to reduce the liability of so many vacant houses. Jumbo lenders are tip-toeing back into the market requiring solid down payments, good credit, verified income, just like the old days of a balanced market. Will the real estate industry get carried away again with the white-out? Maybe the question should simply be “when”. Certainly future real estate and economics books will have a new chapter about these times.
Follow-up media publicized videos:
“Why fool around with realtors that don’t understand the complexities of Marin real estate. Mike’s experience can make a big difference when buying and selling. He has smart clients who rely on his expertise and trust his advice. He has made a lot of money for a lot of people.” Len N. Investor/developer
When asked who he works for, people are expecting him to say a real estate company. His patent answer: “I work for my clients, the company I associate with works for me.”
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