Previously, I have posted articles regarding housing and foreclosure issues. The purpose was to begin a dialogue on the steps to be taken to alleviate the foreclosure crisis, and to promote housing recovery.   Now, we need to explore how to restart lending in the private sector.  This will be a three part article, with parts I and II herein, and III in the next post.

To begin, we must understand how we got to the point of where we are today, and whereby housing became so critical a factor in the economy. (This is only an overview. I leave it to the historians to fill in all the details.)

Part One – Agreeing On The Problems

Historical Backdrop

At the beginning of the 20th century, the U.S. population stood about 76,000,000 people. By the end of 2000, the population was over 310 million. The unprecedented growth in population resulted in the housing industry and related services becoming one of several major engines of wealth creation during the 20^th century.

During the Depression, large numbers of farm and home foreclosures were occurring. The government began to get involved in housing to stop foreclosures and stimulate housing growth. This resulted in the creation of an FHA/Fannie Mae– like program, to support housing.

WWII led to major structural changes in the U.S., both economically and culturally. Manufacturing and technological changes spurred economic growth. Women entered the work force in huge numbers. Returning veterans came back from the war desiring to leave the rural areas, begin families, and enter the civilian workforce. The result was the baby boom generation and its coming influence.

From the 1950s through the 1970s, the US dominated the world economically. Real income growth was occurring for all households. Homeownership was obtainable for ever increasing numbers of people. Consumerism was rampant.

To support homeownership, the government created Fannie Mae and Freddie Mac so that more people could partake in the American Dream. These entities would eventually become the primary source of mortgages in the U.S. F&F changed the way mortgages were funded, and changed the terms of mortgages, so that 30 year mortgages became the common type of loan, instead of 5 to 15 year mortgages.

Storm clouds were beginning to appear on the horizon at the same time. Japan, Korea, Germany, and other countries had now come out of their post war depressions. Manufacturing and industrial bases had been rebuilt. These countries now posed an economic threat to the U.S. by offering improved products, cheaper labor costs, and innovation. By the end of the 1970s, for many reasons, US manufacturing was decreasing, and service related industries were gaining importance.

In the 1980s and 1990s, manufacturing began to decline in the U.S. Service Industries were now becoming a major force in the economy. With the end of the Cold War in 1989, defense spending began to decline dramatically, further depressing the economy.

In the early 1990s, F&F engaged in efforts to increase their share of the mortgage market. They freely admitted wanting to control the housing market, and took steps to do so, undermining lenders and competition, and any attempts to regulate them.

In 1994, homeownership rates were at 64% in the US. President Clinton, along with Congress and in conjunction with Fannie and Freddie, came out with a new program with the intent to promote a 70% homeownership rate. This program was promoted even though economists generally considered 64% to be the maximum amount of homeownership that an economy could readily support. Above 64%, people would be 

“buying” homes, but without having the financial capabilities to repay a loan. The program focused upon low income persons and minorities. The result was greater demand for housing and homeownership, and housing values began to increase.

Lenders and Wall Street were being pushed out of the housing market by F&F, and had to find new markets to serve. F&F did not want to service the new markets being created by the government homeownership programs. The result was that Wall Street would naturally gravitate to that market, which was generally subprime, and also to the jumbo market, which F&F could not serve due to loan amount restrictions. This was the true beginning of securitized loan products.

The events of 9/11 would ultimately stoke the fires of home ownership even further. 9/11 occurred as the US was coming out of a significant recession, and to keep the country from sliding back into recession, the Fed lowered interest rates and kept them artificially low until 2003. Wall Street, recognizing the promise of good financial returns from securitized loans, freed up more and more capital for banks and mortgage bankers to lend. This led to even greater demand for homes and mortgages.

To meet the increased demand, home construction exploded. Ancillary services did well also, from infrastructure, schools, hospitals, roads, building materials, and home decor. The economy was booming, even though this was “mal-investment” of resources. (Currently, as a result of this activity, there are estimated to be from 2m to 3.5m in excess housing units, with approximately 400k being added yearly to housing stock.)

It did not stop there. Buyers, in their increasing zeal, were bidding for homes, increasing the price of homes in many states by 50 to 100,000 dollars more than what was reasonable. The perception was that if they did not buy now, then they could never buy. Additionally, investors began to purchase multiple properties, hoping to create a home rental empire. This led to unsustainable home values.

Concurrently, the Fed was still engaged in a loose money policy. This pumped hundreds of billions of dollars into the housing economy, with predictable results. With increasing home values, homeowners could refinance their homes, often multiple times over, pulling cash out and keeping the economy pumped up artificially. A homeowner could pull out 50,000 to 100,000 dollars or more, often every year or two, and use that money to indulge themselves, pretending they had a higher standard of living than what existed. The government knew that this was not a reasonable practice, but indulged in it anyway, so as to keep up an appearance of a healthy economy. Of course, this only compounded the problem.

The end result of the past 40 years of government intervention (and popular support for that intervention) has been a housing market that is currently overbuilt and still overvalued. In the meantime, real wages have not increased since the mid 1990s and for large numbers of the population, negative income growth has been experienced. Today, all segments of the population, homeowners especially so, are saddled with significant mortgage debt, consumer debt, and revolving credit debt. This has led to an inability on the part of the population to buy homes or other products. Until wage and debt issues are resolved, employment increases, and housing prices have returned to more reasonable values, there can be no housing recovery.

Current Status

As all know, the current status of housing in the US is like a ship dead in the water, with no ability to steer except to roll with the waves. A recap:

Private securitization once accounted for over 25% of all mortgage loans. These efforts are currently nonexistent except for one entity, Redwood Trust, which has issued one securitized offerings in 2010 and one in 2011. Other than this, Wall Street is afraid to invest in Mortgage Products (to say nothing of downstream investors).

Banks are unable to lend their own money, which represented up to 15% of all lending. Most banks are capital impaired and have liquidity issues, as well as unknown liabilities from bad loans dating to the bubble.

Additionally, banks are suffering from a lack of qualified borrowers. Either there is no equity in the home to lend on, or the borrowers don’t have the financial ability to afford the loan. Therefore, the only lending that a bank can engage in is to execute loans and sell them to Fannie Mae, Freddie Mac, or VA and FHA. There are simply no other options available.

F&F are buying loans from the banks, but their lending standards have increased, so the loan purchases are down. F&F still distort the market because of government guarantees on their loans (now explicit instead of implicit), and they are still able to purchase loans above $700k, which was implemented in response to the housing crisis.

F&F are still having financial issues, with the government having bailed them out to the tune of $140b, with much more to come.

VA is buying loans and doing reasonably well, but they serve a tiny portion of the market.

FHA has turned into the new subprime, accepting credit challenged borrowers, and with loan to values of 95% or greater. Default rates on FHA loans are rising significantly, and will pose issues for the government when losses absorb all FHA loss reserves, which may have already happened (depending on how you look at the accounting).

The Mortgage Insurance companies are financially depressed, with PMI being forced to stop writing new policies due to loan loss reserves being depleted. Likely, they will cease business or be absorbed by another company. Other companies are believed to be similarly in trouble, though none have failed yet.

The US population is still overburdened with debt. It is believed that the household consumer debt burden is over 11%, for disposable income. This is far too high for effective purchasing of any products, especially high end. (There has been a lessening of this debt from its high of 14% in 2008, but this has primarily been the result of defaults, so most of those persons are not in a position to buy.)

Patrick Pulatie is the CEO of LFI Analytics. He can be reached at 925-522-0371, or 925-238-1221 for further information. http://www.LFI-Analytics.com, patrick@lfi-analytics.com.

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