SQUARE ONE
As the saying goes, “It’s all about housing, stupid.” Now that we know the problem; have pointed the appropriate fingers; and gotten the financial pledge for enough money to straighten this mess out – what’s first?
It doesn’t matter whether we (U.S. citizens) buy the bad real estate mortgages from bank portfolios and/or Wall Street securities packages or buy preferential stock in the nation’s banks. Either way we will have an equity stake and will get paid back once banks regain profitability. What matters is how this cash infusion is used to stabilize the most fundamental aspect of our financial system – the U.S. housing industry.
The market crash of 1929 was also fueled by sharply rising housing prices. When the bubble burst the over leveraged economy came crumbling down. It’s much different today as our economy is much more developed and we are a lot richer. Then, the feds thought that the best way to go was to allow the system to “self purge” by letting the financial industry deteriorate. This time the feds are all over this as are the world’s banks.
Since two thirds of our economy is driven by retail sales it is imperative that we get our consumer units functioning or the stock market will take forever to recover. Just as the housing market overbuilt because of the availability of subprime loans, the retail sector was greatly over expanded by people spending money from their home’s artificial appreciation.
Over the past 30 years a normal U.S. housing cycle ran about five years. Home prices would go along and then shoot up as the population grew before builders could satisfy the new demand. Once the supply caught up and demand waned, prices would adjust downward and then stabilize. They normally stabilized above the prices when the cycle started so everyone made money. That difference between the home prices at the start of the cycle and the new stabilized price was the new equity consumers had to spend, invest, or just leave in the house to create wealth. Since this revenue source no long exists the economy is contract accordingly.
Normally, population growth would grow us out of this problem. In California the current population of 38 million is expect to grow by 1.1 million by 2010. Considering a household population of 2.94 people we will need about 366,000 new housing units to house this growth. However, that’s an issue for the next real estate cycle and, anyway, we don’t have time to wait.
When the dotcom bust drained a couple of trillion dollars from the economy, the country found a new growth engine – unfortunately it was the housing industry. This is why we need not only a jobs stimulus package to replace this contraction’s employment declines but also a huge investment in alternative energy which will have the duel benefit of creating thousands of jobs and helping get us off oil.
If consumers don’t have a stable housing situation with a perceived upside, they’re not going to spend. If we ever want to see any growth in the U.S. again we have to get to the bottom of this housing market a.s.a.p.
According to Zillow.com, an internet provider of home valuation, reports as of August ’08 one three of the homeowners who bought in the last five years owe more on their mortgages than their homes are worth. The Seattle-based service that offers values for more than 80 million homes continues that almost one-quarter homes sold in the last year were for a loss.
California has the highest number of homeowners with negative equity. In Stockton, Modesto, Merced and Vallejo-Fairfield 90% of homeowners whose mortgages exceed the value of their homes. In Riverside-San Bernardino, Bakersfield, Yuba City, El Centro and Madera, the percentage was more than 80%.
Of the 51.2 million mortgage holders in the U.S. it is estimated that 1.4 million homeowners will lose their homes to foreclosure in 2008 through the first half of ‘09. It is estimated that by the end of this year 10.7 million will have no or negative equity. That’s 21% and $3 trillion in negative equity. That’s a lot of money to take out of the retail sector.
A little glimmer of a bottom is sticking its nose up from the subprime primordial ooze. National existing home sales surged in August ’08 jumping 7.4 percent over the previous month of July and 8.8% year over year. “What we’re seeing is the momentum of people taking advantage of low home prices, with pending home sales up strongly in California, Nevada, Arizona, Florida, Rhode Island and the Washington D.C. region, “said Lawrence Yun, National Association of Realtors chief economist.
In my neck or the woods (Sonoma County, California) the Santa Rosa Press Democrat, ran an article about a woman who had just purchased a condo for $99,000. This was a bank-owned property that had a mortgage of $245,200 when the bank took it back. Priced at $140,000 when the bank dropped the price to $99,000 she pounced. With a 75% mortgage at, say 6.0% (non-owner rate) her P.I.T.I would be $650. Based on a rental of $1,200 per month (the national median rent is $868 with the median mortgage payment at $1,687) her net would be $650 per month. First time buyers and investors are fueling the current market and that $650 will be going back into the economy (unless she buries it in her backyard but I sure hope we haven’t come to that).
Now the point isn’t that this is a bottom, the point is that THIS property has reached ITS bottom. Valuations are different across the country. Some communities are doing well with Pittsburgh, Oklahoma City and Austin, Texas seeing rising home values. Now what we have to do is get all of those 10.7 million homeowners that are facing zero or negative equity stabilized.
A lot of the money to do this already exists even without the $700 billion rescue package. The Federal Housing Finance Agency, which took over Fannie Mae and Freddie Mac, has lifted capital restrictions and gave them an initial $100 billion to buy more mortgage securities of all types, including those that hold subprime loans.
They say that the reason these mortgage backed securities are hard to sell is because any one issue could contain dozens of levels of investor seniority and different rules for being paid off. The “derivative” part of this was supposed to spread the risk among investors. What it really did was lead to the credit freeze because no investor (bank) wanted to be, just like a classic Ponzi scheme, the last guy in. Richard Dooling said, “The best and brightest geeks Wall Street firms could buy – fed $1 trillion in sub-prime mortgage debt into their super computers, added some derivatives, massaged the arrangements with computer algorithms and – poof! – created $62 trillion in imaginary wealth.”
Well, I’m just a street guy. All I know is that when a piece of real property is used to secure a debt the normal procedure is that a promise to repay is recorded by the county recorder which is commonly known as “a note secured by a deed of trust.” In my simple mind that’s all these mortgage securities are – nothing more than a bunch of notes secured by trust deeds. When a borrower wants to pay off the note, the escrow holder (normally a title company) submits a Payoff Demand to the note holder. As far as I know this is what happens when a borrower needs to payoff a mortgage that is part of a mortgage backed security.
These securities should be pulled apart and held like a portfolio lender would hold their mortgage assets. Once that particular mortgage is either paid off by a refinance or foreclosure the underlying owners of that note would get paid what they are owed. Any loss will be part of this rescue package. The feds could then sell the property and recoup some of the tax payer’s money.
What I propose is that the mortgage servicers (feds, banks, investment banks) adjust rather than foreclose. The qualified homeowner’s mortgage should be adjusted to the same amount that an investor would pay for the home. The homeowner’s new P.I.T.I should be no more than the traditional 30% of their income. In exchange, the bank would take an equity interest in the property as security for the newly reduced mortgage. Once the property appreciates to a value equal to the original mortgage amount the bank would get paid back when the property is either sold or refinanced. This mortgage instrument would be similar to a Reverse Annuity Mortgage in that the bank would take an equity position but in this case the homeowner would continue to make payments.
This would do two things. First it would allow the homeowner to stay in their homes and, since the homeowner’s housing costs would be capped at 30% of their income, the other 60% of their income can be saved in retirement accounts, used to pay off existing consumer debt, saved for college, or spent on consumer goods. This way the homeowner will benefit from the same appreciation that an investor would get and the U.S will get a pay-down of the national debt when the property is refinanced or sold.
The Treasury’s Hope Now Alliance, a government industry group trying to prevent individual mortgage foreclosure or Fannie Mae/Freddie Mac should hire an army of mortgage professionals who can go home-to-home to rate the homeowner’s situation and prequalify them for mortgage adjustments. There are thousands of honest, hardworking licensed mortgage brokers through out the country (I know, I’m one of them) that never dealt with subprime mortgages, that could move swiftly to implement the mortgage relief programs.
I think that we have a good one in assistant treasury secretary Neel Kashkari. He has been selected to head the Treasury’s new Office of Financial Stability. He is young, mutli-disciplined (he is a mathematician, scientist, a Wharton School MBA and I’ll bet he understands algorithms) and the type of thinker (not unlike Obama) that we need desperately right now. He and his team will be implementing the strategy to isolate our financial system’s non-performing assets, oversee a universal devaluation of assets, and stimulate the private and public sectors to create jobs and get our newly regulated system running again.
Our economic system may not be perfect but, as they say, it’s proven to be human friendly and so it will endure. The lessons we are now learning will serve us, and the world well, as we evolve toward a universal financial system. There is a way out. We all have to pull together and never underestimate the resolve of the American people.