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Friday, October 23, 2009
Current Real Estate Market In looking at the state of the real estate market, and the collapse it has incurred, in several markets around the
country, I have observed the same phenomena in all markets. The collapse of the market has occurred in
three distinct phases in all of the markets with the only difference being the timing of these phenomena.
The three distinct phases are as follows: DENIAL In this phase the
common theme is “it cannot happen here”. We are not a market with a lot of speculation as in
Florida or California. We did not have a lot of subprime mortgages in our market and foreclosures are not
a problem. Our market has slowed but otherwise we are doing just fine.
RATIONALIZATION In this phase the common theme is “the market is slow
and inventory is growing but prices are firm”. Prices are firm but few homes have sold; inventory
is growing dramatically because very little is selling. This phase is a disaster waiting to happen
as the only solution to getting the inventory under control is the third and final phase. CAPITULATION This phase occurs when cumulative days on market exceed 300 days and some sellers cannot continue
to manage the carrying costs these homes demand. Whether it is a home owner who wants to sell his current
home or a builder who is carrying a spec home, there comes a time when they just cannot afford to continue on and must negotiate
a short sale just to stay afloat. When one or two homes do this in a neighborhood, the remaining homes
on the market have no choice but to sell at these new comparisons. This phenomenon is accelerated by appraisals
on new and existing homes. Once the capitulation phase begins, homes will not appraise at values higher
than the recent comparisons and thus prices are forced lower even for well healed buyers. I have seen this not only with existing
homes but on new, custom homes, where appraisals come in too low to support the construction of homes as designed. Whether selling or buying a home, it is important
to understand in what phase of the market you are working.
2:21 pm edt
Financial Meltdown - Original Post 03/10/2008How did what started as a sub-prime mortgage issue catapult into the major financial crisis
we face today? It is all about greed and some of you who have chatted with me recall that I have likened
it to the S&L meltdown of the late eighties. It is ironic then that the cure enacted today has been
compared to the Resolution Trust Corporation (RTC) solution enacted to solve the S&L crisis. Recall
in those days bankers were compensated for how much money they lent, not
on the quality of the loans. If you went in to borrow 10 million dollars to develop a strip mall, the bank
offered 12 million so you could use the extra two million to pay off the first few years of the loan. The
result is history as all of the debt came tumbling down and the S&L bailout became the RTC which ended up owning all of
the over leveraged property at tax payer expense.In
the sub-prime crisis, there is plenty of blame to go around and I will try not to play that game but share my thoughts.
The government through HUD and The Community Reinvestment Act,
championed by ACORN among others, sought to increase home ownership among lower income families. Fannie
Mae took it as their charter to increase home ownership in the middle class, Specifically, this meant families that did not
have sufficient income to qualify for traditional loans were given financing at looser standards. The lenders
took this a license to provide loans to families that could not make payments, did not have jobs, and had bad credit history.
It was no problem because they knew that Fannie Mae and Fannie Mac would buy these loans as fast as bankers wrote them
as they were key drivers of the increased home ownership program. The banks could write very risky loans
and sell them the next day.We cannot blame only
the banks. When banks attempted to install ATMs or open branches in old neighborhoods, Community Organizations
for Reform, like ACORN, could put up roadblocks by complaining that these banks did not loan enough money to these neighborhoods.
The result was many press conferences with ACORN and bank executives announcing the availability of home loans to members
of this neighborhood even though they did not qualify and could not afford these loans. Thus the banks
and the government were complicit in this disaster.Lenders
competing for more business aggravated the sup-prime problem by offering new and creative loans. These
were 100% of purchase price, zero interest and/or teaser rate loans that sooner or later would revert to real loans at real
interest rates. The sales pitch was that home values were going up so quickly, that by the time you had
to pay real rates you would have significant equity in your home and could either sell the home or qualify for another loan.
A dangerous side event occured when many
home owners made home equity loans as fast as home values increased. Thus they piled more debt onto debt
that they already could not afford. When home values went down, that premise went down with them. Families
saw their payments go up anywhere from 10% to 50% while discovering their loan balance (recall zero interest loans) was significantly
higher than their home value. Many stopped making payments.When bankers loosened their lending guide lines (or lack-there-of) to the point that the Freddies would not buy them,
they sold these super sub-prime loans to hedge funds. These aggressive hedge funds bought tens or hundreds
of millions of dollars of deep sub-prime loans and bundled them as Collateralized Debt Obligations (CDOs). They
were often bundled and rebundled until a simple sub-prime loan was repackaged up to 30 times before it entered the market.
Thus these funds were leveraged to $30 for every $1 of under lying equity. To compound the problem
the CDOs were sold as a standard loan package in which 90% of the loans were solid and perhaps 10% were at risk when in fact
the entire package was made up of junk. These investments, which had been repackaged over 30 times by large
hedge funds, were sold around the world as investment grade portfolios and it became extremely difficult for even the most
diligent to know exactly what they were buying. Investment firms and insurance companies (AIG) who bought these CDOs without
proper due diligence no longer exist as they did then. Several major investment firms have agreed to repay
investor’s losses on CDO’s which were marketed to private investors under false pretense.As large institutions held more and more of this debt, the mark to market rules caused them
to implode. Mark to market accounting rules require that an asset portfolio be marked down on your books
to the value in today’s market regardless of the under lying value. Thus an internal accounting run
on the bank occurs when the market perceives your portfolio of CDOs has less value and you need to sell assets to remain solvent.
That action causes a Wall Street downgrade in your company which drives the stock price down which means you cannot
raise cash by selling stock. You cannot borrow at competitive rates and you enter the Bear Stearns Death
Spiral.As greed to increase your net worth by loaning
more and more money to flaky projects caused the S&L crisis of the past, it was greed to earn more and more return on
under collateralized investment instruments that fueled this crisis. It seems to be the common denominator.
2:18 pm edt
1:57 pm edt
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