Imagine housing without a secondary market
Perspective: 10 predictions
By Bradley Inman, Friday, July 11, 2008.Bookmarking Sites
In 1974, the United States was reeling from Watergate and the Vietnam War and stuck in a vexing recession. Inflation was out of control and President Gerald Ford was struggling to get control of the country and its economy. A collectible from those days is a "WIN" button, which stood for "Whip Inflation Now" -- a promotional device that the desperate Ford administration ginned up.
At the time, I was fresh out of college, living in Peoria, Ill., and working as an urban planner. One distinct memory I have was passing the downtown office of Peoria Savings with a sign on the window that read "No Home Loans."
A moratorium on home loans -- can you imagine?
Get ready.
In the early 1970s, the housing market had no meaningful secondary mortgage market. When passbooks savings -- which capitalized most mortgages -- shrank, money for home loans dried up.
In 1968, Fannie Mae and Freddie Mac were re-chartered by Congress as shareholder-owned companies funded solely with private capital raised from investors on Wall Street and around the world. But it was not until the 1980s that they found their footing and their growth mushroomed. Mortgage-backed securities got traction in the early part of this decade with the national push for home ownership. New mortgage instruments were invented to capture global interest in U.S. home loans.
In this period, a secondary market came onto the scene with brute force. By 2005, the size of the market had ballooned to $3 trillion.
And today? It has collapsed. Even Fannie Mae and Freddie Mac are poised for a government bailout. Today, Fannie Mae's stock has tumbled 45 percent and Freddie's has fallen 20 percent. This is after steep declines all week.
So, imagine a return to a housing market without a robust and functional secondary housing market. In other words: a severe credit crunch.
Here are 10 things that I predict will flow from its collapse (many of which have already hit the beleaguered housing market):
1. The capital that exists from direct lenders such as community banks, savings institutions and large commercial banks will fall short of potential demand and focus on bread-and-butter loans, leaving most borrowers out in the cold.
2. Exotic loans of any kind will be completely out of favor, leaving many borrowers and many properties unfundable.
3. Home sellers will become active lenders, but only those who have equity. Seller financing will help some transactions.
4. Second homes, expensive houses and certain types of investment property will be penalized and difficult to fund.
5. Small boutique lenders will enter the business, capitalizing on market voids, funding specialized but secure niches.
6. Investment banks will take care of unleveraged high-net-worth customers, but terms will be unfavorable so this market will further shrink.
7. Sovereign wealth funds are not the solution, because many were burnt on mortgage-backed securities.
8. Those that do lend will revert to back-to-basics underwriting: perfect credit, large down payments, proof of income, personal character and good family upbringing.
9. Housing industry lobbyists will make the mortgage liquidity problem their number one policy issue in the next two years. They will argue that the sky is falling and it is.
10. The trend will keep the housing market starved for capital, prolonging the slump.
Like so many parts of our American culture, the accessibility to unlimited and poorly scrutinized debt helped turn Americans into a sloppy group of consumers, which spawned greedy Wall Streeters, out of control lenders and starry-eyed investors.
Brad Inman is founder and publisher of Inman News.
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Submitted by Roberta Murphy on July 11, 2008 - 2:39pm.
Brad,
I am parked here, with headlights on.
Am also digging out dusty forms from the 80's with titles like: Contract for Deed, Installment Sale and All-Inclusive Trust Deed.
There will be many seeking practical solutions at this year's Inman Connect.
Roberta Murphy
Villa Sotheby's International Realty
http://www/SanDiegoPreviews.com
http://www.LuxuryHomeDigest.com
877-818-8197/760-402-9101
Submitted by Diane Cipa on July 11, 2008 - 2:39pm.
Nicely written, Brad. My thinking though is that we are headed to a mortgage lending style reminiscent more of 1980 than 1970. we had a fairly dynamic secondary market by then, though it will seem much more primitive than it really is. We sure can get back to whole loan sales and restore agency style underwriting - pre-FICO and then maybe even stick our collective toes back into securitization.
There are still folks around that remember how to do traditional mortgage lending and if we would allow them to take over the reins, we could help restore order. We can start by ditching FICO and teaching our young people how to make credit decisions.
Part of the problem is that much of our real estate community did not know that easy credit such as we've experienced for over 20 years is not normal. It was like mainlining a hard drug and getting used to lives of financial responsibility might be hard but we can do it.
Submitted by David Smith on July 11, 2008 - 3:11pm.
Brad,
Between you and Stefan Swanepoel's "...Two Rusty Nails" I'm thinking about digging a bomb shelter.
So what do you really think is going to happen. Should we all get our Walmart applications polished up?
Are we on the verge of a nuclear winter in the housing industry? Did the bomb go off in 05 and 06 and all we saw was the pretty white cloud?
Are we now taking the pill which will bring us out of the Matrix of our created image of the housing world and into a reality similar to the one depicted in those films?
If this is your version of a "Friday Fun Post" it isn't helping.
A firm grip on reality before seeing "Hellboy II" this weekend is refreshing (I'm kidding it isn't refreshing at all, it is scary).
Submitted by Jason Spencer on July 11, 2008 - 3:24pm.
Brad,
I can give you a very interesting perspective from the world of Australia where our secondary mortgage market has all but dried up!
I was fortunate enough in my previous business to be involved in the creation of Australia's secondary market, we were the first to issue residential mortgage backed certificates and obtain a AAA rating and over the next 15 years the market exploded to be one of the most active in the world with our bonds purchased throughout the USA and Europe. (we sold the business in 2001)
Before this time our 4 major banks using their deposit base to fund home loans made up virtually 100% of all lending.
The non-bank boom as we refer to it brought cheap home ownership to Australians, rates suddenly dropped to record levels due to competition.
Then, last year we got hit, just like you.
Global investors in MBS suddenly would not buy bonds, lenders were left with warehouse facilities they could not replace. Most mortgage lenders (other than banks using their deposits) stopped accepting prime quality applications...and now rates are approaching 10%. Mortgage brokers here are getting out of the business in big quantities as commission rates are slashed. Amazingly and something I still find hard to believe, most Australian loans are prime, very low default rates and 100% mortgage insured by PMI/Genworth.
Now, many experts are talking about creating a Freddie/Fannie equivalent ("Aussiemac") to ensure liquidity, some are calling this a short-sighted measure.
Some are looking at the Canadian model, thinking it has suffered the least and should be emulated.
Either way, it is extremely sad to see what was a major development to Australia's home loan landscape wiped out almost overnight.
Jason Spencer
Co-Founder/CEO
www.streetadvisor.com
Submitted by Alexis Eldorrado on July 11, 2008 - 6:43pm.
Brad,
Your 10 Predictions are very informative.
Dating myself, I remember as a youngster, getting licensed to sell real estate in Chicago in 1980. Even if your credit was like gold,the best interest rate available for home buying was in the neighborhood of 18%. I was in and out of the real estate business within 6 months.
I started doing active brokerage again in late 1999. FICO is all that mattered,and then opportunists of the wrong caliber came up with credit repair and other fraudulent practices. Borrowing money was like a drug, used carelessly, and obtainable by anyone. Recovery will be long, I agree.
By the way, belated congrats on your 2007 NAREE Award for Best Web Site Solely Devoted to Real Estate. I love your site and its continual evolution of development. You provide a great service to the consumer and the professionals in the real estate industry. Thank you.
Alexis Eldorrado
Eldorrado Chicago Real Estate LLC
www.Eldorrado.com
Submitted by Steve Simon on July 12, 2008 - 5:37am.
The Perfect Storm (I have been using it and writing about it for two years now) has become a reality!
The 10 predicitions are only a slice of this large "Crappy" pie:
The oil situation and its result, the largest shift of wealth in the history of mankind, will have our beloved America on its knees unless there is quick action.
35 years of special interest hidden steering (of a few dozen select leaders) has brought us to the brink of disaster.
T. Boone Pickens is an unlikely Hero or Savior but even this Old Oil Man knows the score and has decided to try and reverses the rape of our country.
The economic woes of the housing industry have been heightened by the energy crisis and federal action including:
alternative energy incentives, tax credits for conservation, legislative constraint removal on drilling, new regulation on speculative investing when it puts the country in danger, etc., etc., is our only hope!
Steve Simon
www.stevesimon.us
A Former two term elected official...
Submitted by Lucy Brenton on July 12, 2008 - 5:49am.
I only wish that this article were alarmist, it is not. In fact, it is probably conservative. I agree with Steve Simon's comments...this has been coming for a long time. As a libertarian, I am dismayed at the further erosion of freedom that this will entail as the masses clamor for guvmint to help them.
We are entering a new era of personal responsibility and entrepreneurism. For those of us in housing, I, too, have my Land Contract courses and selling with owner financing ready to go. We have long been investing with IRA funds (those and our business partners) and will create our own secondary markets to sell loans to. Of course, we will require equity, ability to pay, etc...
There is always profit to be had in this type of situation. How? I don't know yet. But I imagine the ability to provide food, shelter and water will be the major growth industries as America struggles to survive.
What a shame that our "leaders" sold us out...
Lucy Brenton
www.NetREIA.com
Submitted by Doug Crowe on July 12, 2008 - 8:11am.
Yup...an optimist at heart, and a realist with my checkbook. Brad is right on. For futher sobering news, I just finished Kevin Phillips book, "Bad Money" and the whole mess is draining my spirit. Combining the mortgage mess, energy prices, the avalanche of ignorance in this country, along with China and India's rise, I have not dug a "bomb shelter" like David's comment, but I have started buildng my own refuge...in Belize.
I love my country, but I don't trust the economic policies. Adopting offhore wealth management strategies is something that anyone can do and most people won't do. For years I was worried about what would happen if I ventured offshore. Now I am fearful of what would happen to my family financially if I DIDN'T have an offshore component in my portfolio.
Don't put your head in the sand, people. The USA may have reached its peak as a world power, but smart money always finds a way...there are caribbean banks, investments, and real estate that the ultra rich are very keen on. You can "follow the money" and shore up your defenses...looks like a normal "recovery" is out of the question.
Doug Crowe
www.dougcrowe.com