The Real Estate Market Will Not Improve

 The Real Estate market in the U.S. will not improve any time in the near future.  This is because a combination of government actions and greed has severely hampered the ability of borrowers to find inexpensive mortgages, if they can find mortgages at all.  There are four events that have caused a severe downturn in the mortgage marketplace.  These four items are:  (1) Significant numbers of first time homebuyers have been shut out of mortgages.  (2)  The bankruptcy laws have been changed so that many first time homebuyers cannot clean up there credit in order to then qualify for mortgages. (3) The subprime debacle has eliminated programs and frightened potential mortgage lenders so that an originator of a mortgage cannot find anyone but four government or quasi-government agencies to purchase the mortgage.  (4)  Lenders have decided that real estate investors who purchase distressed properties are very high risk.  These lenders have eliminated Alt A products which were frequently used by real estate investors to purchase fix and flips and fix and hold properties.

(1)  First time home buyers are the lifeblood of the residential real estate market.  Very few expensive homes are purchased by first time buyers.  Normally expensive homes are purchase by individuals who already own a home and who sell and then move up.  In the late 1990’s and early 2000’s as the economy create many new jobs, there was a significant immigration of workers from other countries who entered this country, sometimes illegal.  Many of these illegal immigrants were able to get steady paying jobs and they acquired social security numbers.  Soon they were able to purchase inexpensive homes which then allowed the sellers of those homes to move up.  In about 2003 to 2004 some of those illegal immigrant loans began to go bad.  As a result, tests were devised by FHA, Fannie Mae, and Freddie Mac to validate social security numbers.  Shortly, thereafter, illegal immigrants were unable to purchase homes.  Thus, a valuable source of first time home buyers was eliminated. No political judgment is passed here, only the fact these immigrants can now rarely buy homes.

(2)  In October 2005, U.S. Bankruptcy rules were dramatically changed.  The result was that it was much more difficult to file a Chapter 7 bankruptcy for most individually.  These rules benefited the credit card industry by forcing individually to put credit card debt on a Chapter 13 repayment plan.  Prior to October 2005, individuals would become buried in debt, either through negligence and carelessness or through some unfortunate medical or other circumstance.  They would file for Chapter 7 and get their debt absolved.  Two years after the bankruptcy discharge date, provide they re-established good credit, they could qualify for a mortgage.  Now, many individuals are struggling with their Chapter 13 payments or they do not bother to file bankruptcy at all.  Consequently, those individuals are unable to qualify for a mortgage.  Another group of first time home buyers is eliminated from the landscape. 

 (3)  The demise of the subprime industry has had the most serious effect on mortgage originations.   Many of the subprime originations were to first time home buyers.  There are many explanations for the collapse of the subprime mortgage market but the basic cause was greed.  Originating, packaging and selling high priced mortgages was a market that created billions of dollars in fees for the participants.  Wall Street set and allowed very liberal underwriting of these loans which encouraged over a trillion dollars of loans to be made and sold.  The underwriting standards were very poor and it is no surprise to the originators who made the loans that many of them have gone bad.  The result of this debacle is severe.  Over 50% of the loan  program that were available in early 2007 are now gone.  Underwriting standards are much, much more restrictive and down payment requirements are significantly increased.  Furthermore, loans to individuals whose credit scores are below 680 have special adjustments to the price that raise the interest rate on those loans from .25% to 1.0%.  The higher the interest rate, the more income it takes to qualify.  The combination of higher down payment requirements and higher interest rates has caused a significant decrease in the number of individuals who can qualify. 

    A second aspect of the subprime debacle is that there are significantly fewer mortgage lenders who are willing to purchase packages of loans.  In the past, property and life insurance companies, hedge funds, pension funds, commercial banks, foreign banks, and others purchased these pools of mortgages, called collateralized  debt obligations CDO’s. (there are others names for these pools)  Because of the massive losses in the CDO’s, practically all investors have stopped buying them.  The only loans presently being purchase are through the quasi-government entities of Freddie Mac and Fannie Mae.  FHA and VA loans are guaranteed by the government and are also being purchased.   There are a few  conduits for Jumbo mortgages.

 Fannie Mae and Freddie Mac are under pressure from their regulators to scale back on their purchases of mortgages because of their capital ratios are already stretched too thin but Congress wants them to buy more mortgages.  Accounting irregularities at Fannie and Freddie also have not helped their creditability.  The result of the above mentioned analysis is that the subprime debacle has impacted the entire mortgage industry and has further hampered the ability of first time home buyers to obtain loans and purchase properties.

(4)  Historically, major purchasers of foreclosed / bank owned property have been real estate investors.  These foreclosed properties are frequently run down and in need of repair.  Many real estate investors would buy them and fix and flip or fix and hold.  Prior to early 2007, mortgages were readily available with 5% or 10% down payment.  The real estate investor would buy and repair, with his/her own down payment money and then sell or rent.  Mortgage underwriting is now harsh for real estate investors.  They must put down at least 20% and sometimes 30% and interest rates are much higher.  Furthermore, Fannie and Freddie are changing their rules so that a single investor can hold no more that 4 (down from 10) Fannie or Freddie loans.  Additionally, all investor loans are fully documented and income is verified.  Most real estate investors have been forced from the market.

 The U.S. must understand that first time home buyer is crucial to the health of our real estate industry.  The combination of fewer eligible buyers, larger down payments required and substantially few loan programs has endangered the first time buyer.  It will take some new and imaginative solutions to get the first time buyer back purchasing and the market going again.

 What is going to Save the American Consumer?