I’ll start with a full disclosure: I hold a Real Estate Brokers License and am a member of the Board of Realtors. I was in business during the boom selling a home to almost anyone who could breathe and was minimally qualified by just picking up the phone and calling any Mortgage Broker. I am not writing this as a sales pitch or marketing angle. Believe me, I talk more people out of buying or selling in this market then I conduct transactions for.
Home Ownership, its the American Dream. We have all been told to invest in real estate. Will Rogers famously said “buy land, they ain’t making any more of the stuff.” But Will Rogers who also is often quoted about “how he never met a man he didn’t like” never met the Wall Street Bankers who came up with the concept of “Collateralized Debt Obligation” (CDO) to offset or more accurately hide the riskiest mortgage bonds from investors being created out of a huge sub-prime market. These whiz-kids figured if they packaged the riskier bonds together with the “A” paper they could, through showing diversification, get the whole package a higher bond rating. In fact they succeeded in getting these CDO’s the same rating as U.S. Treasuries, the Triple A (AAA).
With a AAA rating Wall Street could now sell these bonds to organizations prohibited from buying anything but AAA, public and private pension plans for example which, to their eventual detriment, invested heavily in them. This in turn created a huge appetite on Wall Street for these CDO’s which in turn drove the mortgage business to find new customers. Since most all of the Americans with good credit already owned a house or three, mortgage brokers had to look for new business and had to create new products to attract that business.
Wall Street had a partner. The Federal Government in the form of Rep. Barney Frank, Sen. Chris Dodd, future President and then-Sen. Barack Obama (who received 165K in political contributions from Political Action Commitees of Fannie Mae and Freddie Mac) and Presidents Clinton and Bush who pushed or allowed Government Sponsored Enterprises (GSE’s) like Fannie and Freddie to have quotas where a percentage of the loans they bought had to be to borrowers at or below the median income levels in their communities. At first the quotas were 30% of all loans but then under Clinton they were raised to 50% and later under Bush to 55%. To get to the point that over half the loans are required to be at or below median income levels underwriting standards have to be lowered. By 2008 half of all mortgages, some 27 million, were of this type of low quality loan. Think about that, half of all mortgages in the U. S. Financial system were risky loans, and 70% of those were held by a GSE. It was doomed to fail.
Initial easy terms and a long trend of rising housing prices encouraged borrowers to assume mortgages that were at their limit of borrowing power. We in the business called these “water heater” loans because the borrower was just one unforseen financial event, like a broken water heater, from defaulting on the mortgage. But the economy was booming, people would see increases in their incomes and then would be able to refinance at more favorable terms because they would have equity in their home because as we all knew home prices would continue to rise. Forever. And always. Right?
Home prices were artificially being inflated by government intervention and Wall Street’s desire to to create more CDO’s to sell and a booming economy. All of it based on some very shaky assumptions about the financial health of American consumers. One of those assumptions was that you could use the equity in your home, which was as any Realtor then would tell you (and was true) growing daily. Why not take that new found wealth and pay off higher interest credit cards for example, or better yet run up those credit cards and use your home equity to pay them off, or buy a new car or take a well deserved vacation? You could afford it, you were a real estate baron after all! And while your at it refinance the whole thing at even better interest rates!
Some on Wall Street and others outside of it could see that this was an unsustainable equation. Some were blowing the whistle on the whole process. But no one was listening including Realtors and Mortgage Brokers and certainly not the American Consumer who expected those of us in the business to find them their piece of the American Dream and a way to finance it. Others on Wall Street saw an opportunity to profit: Bet against the mortgage and housing industry. Thus was born the Credit Default Swap (CDS) which is insurance against the failure of a mortgage bond.
A really cool thing with the CDS is that you did not actually have to own the bonds you were buying insurance on. You were speculating that they would fail and that the insurance pay out would be greater, in this case a fortune, than the premium to insure it. Because they were AAA rated the insurers believed the risk was minimal and that they would profit off the premiums. AIG, an insurance giant liked the look of those profits and the ability to not just insure homes, but also mortgages. A major flaw in AIG’s approach is that they applied an insurance concept that insurable events are unrelated. If your neighbors house burns down it does not mean that yours will for example. But when bonds default they cause chain reactions and well the rest as they say is history.
Making it worse is that there was no regulation covering a CDS which did not require AIG to post a percentage of collateral which further freed up resources to buy, you guessed it more of these CDS instruments. Many on Wall Street played both sides of the street both buying and selling CDS’s. But AIG held onto them, collecting premiums on what they thought was a safe bet.
But these institutions were shackled to each other. Lehman Brothers, which had done over 700 Billion dollars worth of CDS’s, had much of it backed by AIG. When things started going bad AIG had to cover Billions in losses. AIG’s position in the Dow Jones dropped and further affected the stock market adversely. Then the panic came and with it the collapse of the market and the Death of Lehman Brothers. AIG would have gone that way as well had it not been for the American Taxpayer who will not get his money back for two generations at least.
Which brings us back to the housing collapse.
If you bought a home in most markets in the last 10 years you would lose money if you sold it today. Because many people bought at the height of the housing boom they are severely upside down, they owe more on the mortgage than they can sell for. For these people its not just a loss on paper they can write off. To actually sell to a buyer they have to write a check at the closing table for thousands, or tens of thousands of dollars and in many cases a hundred thousand or more. With the downturn in the economy many of the reasons that prompted a homeowner to sell to begin with contribute to their inability to cover that loss, like being newly unemployed.
Many just walk away, or as we have seen in Arizona excercise “strategic defaults” where they are in a position to pay the mortgage, have good credit but do not want a home worth in some cases less than 50% of what they paid for it. So they go out and buy another home (at 50% of its previous value) and then default on the first one letting the bank foreclose on it or sell it in a Short Sale. It’s easy to be critical of these people, but consider that Wall Street Bankers with the help of their friends in Washington D.C. did the same thing, letting someone else like the American Taxpayer cover the loss.
The number of homeowners who are underwater, the home is worth less than the mortgage on it, is at 1 in 5 nationally. In some areas it is 1 in 4 or worse. There is currently a log jam of foreclosures being held as a result of due process issues. As those cases are adjudicated it will free up those homes to come to market where they will be classified as distressed properties and be a drag on the market as they negatively affect other non-distressed homes for sale. Until those foreclosures and others still in the pipeline are liquidated it is unlikely that a bottom will be reached soon. Individual markets may see some stabilization or even slight appreciation. But generally speaking, if you buy a home today, in early 2012 it will be worth less at market if you had to sell in early 2013. For Sellers the situation is the same. You will get a better price today then a year from now.
It will take a decade or two to pay down those underwater loans which removes 20% of the homes with mortgages on them from being brought to sale without the seller writing a check to get it done. When you tack on the 8-10% of the sale’s price to actually sell almost any home (Realtor fees, inspections, title insurance, taxes, repairs etc.) it further pushes down the number of homeowners who will be in a position to sell. Not being in a position to sell equates to not being in a position to buy for most Americans. This will create a flat market well into the foreseeable future. This seems to almost be a historical trend going back to before the Civil War where home prices go through steep increases over a period of time and then collapse and level off for two or three decades. When the dust settles, and the bottom is reached in 2014 or so, we will see a period of time where home appreciation is flat or at 1-3 % a year. Something Realtors call a normal market.
It will also mean that a whole group of people who once owned homes will likely be renters for the rest of their lives which in an unkind turn of events will be more expensive then owning a home as the rental market is pushed to capacity and rental prices rise accordingly. For these people a housing boom became in effect a homeless boom created at the confluence of Government Social Engineering and Wall Street Greed.
Paraprosdokian Sentence of the day:
The Evening news is where they begin with ‘Good evening’, and then proceed to tell you why it isn’t.