The Seeds are Sprouting for the Next Real Estate Bust
A recent Bloomberg article, “There’s Some Hope for First-Time Home Buyers” caught my attention.
“First-time homebuyers are finally jumping into the U.S. property market.
….Originations of FHA-backed mortgages, used predominately by first-time buyers, were up 54 percent in September from a year earlier….
By December, the FHA insured 22 percent of all loan originations, up from 17 percent a year earlier, according to data compiled by Ellie Mae Inc.”
Why the jump?
“(The) Obama administration, in January 2015, reduced mortgage-insurance premiums for FHA loans. That lowered the cost of getting a home loan and brought in at least 75,000 new borrowers with credit scores of less than 680…
…The rate of FHA lending, which had been in decline through most of 2014, tripled the month after the insurance premium was cut….”
Perhaps new homeowners are excited because they can get an FHA mortgage with as little as 3% down and credit scores below 680, but as a taxpayer I’m sure as hell not happy about it. Another taxpayer bank bailout package will surely follow.
Problem Solving 101
Fundamental rules in problem solving – If you don’t fix the cause:
- You don’t solve the problem.
- The problem will happen again.
- Find ways around it.
- Protect yourself; avoid the fall out when it reoccurs.
The Real History
The underlying cause of the 2008 real estate bust is not something the political class or mainstream media chooses to dwell on. Investors need to understand the cause; however it is not likely to be fixed. Protecting ourselves should be our focus.
The premise behind the Troubled Asset Relief Program (TARP) and subsequent bank bailouts was to give the treasury department money to buy illiquid mortgage backed securities to restore liquidity to the financial markets.
What was not widely reported was why there were so many toxic mortgages in the first place.
Craig Smith spells out the history in Chapter 5 of his book, “Don’t Bank on It” very well.
“…the seeds of today’s Great Recession were planted by President Jimmy Carter. …In 1977 Mr. Carter signed into law the Community Reinvestment Act (CRA), which would weaken banks and ultimately lead to the housing value meltdown and economic near-collapse of 2008.”
To save readers a lot of political rhetoric (that we can do nothing about), the CRA led to the Federal Government demanding banks lower their lending standards so more buyers with questionable credit could qualify for loans. Banks were given CRA ratings based on how many loans were made to what is now called sub-prime borrowers. The more of these type loans the bank made, the higher the rating.
“Banks given a “poor” CRA rating could be refused permission to expand as their competitors did, or to add new branches. “Banks that got poor reviews were punished,” wrote University of Texas economics Professor Stan Liebowitz. “Some (banks) saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.
…Making loans on the basis of politicized social engineering rather than credit worthiness is never a sound business decision, and it always creates unintended consequences.”
Unintended consequences mean the solution creates a bigger problem.
The inevitable unintended consequences
The government allowed the banks to package and sell their Mortgage Backed Securities (MBS). Many ended up being owned by Fannie Mae and Freddie Mac.
With the banks no longer concerned about creditworthiness, they wrote loans to most anyone, repackaged and sold them. These were referred to as “NINJA loans”, (No Job or Assets) or “liar loans” – in which buyers, not required to provide documentation, simply lied about their income.
Faced with billions in defaulted loans, in September 2008 both Fannie and Freddie were placed under the conservatorship of the Federal Housing Finance Agency (FHFA). In 2010 the government announced that it was bailing out Fannie and Freddie to the tune of about $150 Billion.
The massive bank bailouts came on the backs of taxpayers. Not only did the government borrow money to keep the banking system solvent, they also dropped interest rates costing seniors and savers trillions of dollars. Interest that should have been paid to hard working Americans was given to the banks and government in the form of lowering their interest expense.
Blaming the banks for the housing bust is like the National Transportation Safety Board ruling a mid air collision “pilot error”, while failing to mention both aircraft were in full instrument conditions, at the altitude and course heading the air traffic controller assigned to them. The only error the pilots made was following the instruction from the government.
Governments throughout history never take the blame; hide the truth from the citizens and tax the hell out of them to cover their mistakes. That is not going to change.
“…(I)n 2013 President Obama had resumed strong-arming banks to do such lending…and by mid-2014 banks were, indeed, giving away subprime mortgages again in growing numbers…. Welcome to CRA 2.0.”
Just how safe is a 3% down payment FHA mortgage to someone with a credit score under 680? A credit score of 680 is on the lower edge of good with fair and poor following closely behind.
I found this comment on creditscoring.com both amusing and sad,
Kenneth Harney, Washington Post: “For borrowers with scores over 660, Freddie Mac presumes they’re willing to repay the loan. (emphasis mine)”
Pardon me! Why would anyone lend money if there were any doubt the borrower was not highly motivated to repay the loan? Perhaps a larger down payment would give them greater motivation to repay their debt.
This is certainly a political hot potato, and not the purpose of this article. I have yet to hear any candidate mention the underlying cause of the problem – much less action being taken to prevent taxpayers from having to bail out the banks in the future.
If the cause is not addressed, eventually we will have another boom and collapse. No one knows how long it will take. Who cares? Right now our only choice is to protect ourselves from getting caught in the crossfire.
What can we do?
- Understand your home is not an investment. When baby boomers were younger we were taught to buy the biggest home we could afford because it will always go up in value. Real estate prices are based on the law of supply and demand. Many boomers are now retiring and downsizing from the big house they owned to raise their family. When you buy, buy what you need and understand when you sell, if you make a profit it’s gravy.
- Be wary of the mania phase. A housing boom fueled by easy credit to risky buyers will collapse. In 2006 a friend, whose son worked for a builder in south Florida, was trying to get his mother to buy several condos at preconstruction pricing. He said she would double her money like the investors did on the building just completed. Fortunately she did not follow his advice. When the crash happened many units sat empty, “investors” lost a lot of money.
- Keep your powder dry. While no one knows when the peak and trough will happen, the best time to “invest” in real estate is when there is blood in the streets. That time will come.
- Don’t go into a business you don’t understand. The “house flippers” you see on television may exist, but in most markets real estate is not that liquid. I have friends who bought bank foreclosures, fixed them up and are now renting them because they could not resell them profitably. It’s not as easy as they make it look.
- Location, location, location. Protecting your investment in your home is best assured by investing in a stable neighborhood. First time homebuyers may have restricted choices. Many times, due to cost and attractive financing, they build a new home which adds some risk. When it comes time to sell, you want to be in a location with high demand and few homes on the market. If you are in a new subdivision trying to resell your home may be difficult; you could be competing with the builder for several years.
- Accept the fact that low interest rates are probably here to stay. While they may help first time home buyers, baby boomers and retirees are lenders looking to invest their nest egg safely. If you are waiting for the “good old 6% CD’s” to come back you may be disappointed. There are other safe ways to fund your retirement; it just requires a little more work.
I hope the jump in first time buyers helps them get started; however forcing banks to lend to marginal buyers, with little money down, never ends well no matter how many times you try. While the political class may never learn does not mean we have to repeat the same mistakes. Friend Dennis A. sent me a graphic that is worth 1000 words.
Now is as good a time as any.
On the Lighter Side
With Easter weekend behind us, the mass migration of snowbirds from the southern climates heading north has now begun. The roads and restaurants are not quite so crowded.
Here in Arizona we have had to turn on the air conditioner a few times in the late afternoon. It will be a couple more months before the second migration begins and those in the northern climates see license plates from Florida and Arizona, as retirees try to escape from the extreme heat of the summer.
Friend Bob D. sent along some “adult truths” for us to enjoy:
- Can we all just agree to ignore whatever comes after Blue-Ray? I don’t want to have to restart my collection…again.
- I love the sense of camaraderie when an entire line of cars team up to prevent a jerk from cutting in at the front.
This one hits very close to home for me personally:
- How many times is it appropriate to say “What?” before you just nod and smile because you still didn’t hear or understand a word they said?
Until next time…