Posted on 04/02/2005 5:37:40 PM PST by ex-Texan
Cheap money and refinancing have fueled an unparalleled boom/inflation of real estate prices across the nation. Most gains have been cashed out via the equity loans that have provided a supplemental "income" for households to keep this economy spending. It’s the costly S&L tragedy all over again.
I’ve been thinking about real estate, equity, liquidity, CMO’s, GSE’s, and bubbles.
Home ownership was a central component of the American dream. It was the foundation of community, security, accomplishment, and family. However... all that has been eclipsed because "renting" from lenders is NOT ownership.
You see, real estate has evolved from being more than home and hearth and a family’s largest single asset. It is now viewed as THE hot investment vehicle (an "equity cow," if you will) to be tapped as an evergreen source of collateral/cash. When that Italian monk invented double-entry bookkeeping (with debits equaling credits), assets equaled liabilities plus/ minus equity. If assets exceed liabilities, equity is positive and can be used to secure more credit.
In simpler times, loans were financed by deposits. Lending more required liquidity--an ongoing flow of new/additional money. In the post-WWII era, the Federal Reserve functioned as a broker, matching institutions having excess deposits with institutions having excess demand for loans. There were also the Savings and Loans, which specialized in real estate lending. To improve things, the 1970’s/1980’s saw a deregulation/blurring of financial service. However...when the cost of funds suddenly rose to exceed the "locked in" longer-term rates on loans, we saw the death of the Savings and Loan industry and a slew of major bank failures to boot. Read on.
To accelerate the lending cycle, and to spread the interest rate differential risk, we saw the birth of the real estate investment derivatives called CMO’s--collateralized mortgage obligations. To get a fresh supply of cash to fund more credit, the lenders pooled the mortgage loans and sold them to investment bankers who in-turn packaged and resold them to investors. The dollars were huge, and so were the fees. Uncle $ugar entered the game by authorizing the creation of the GSE’s (Government Sponsored Enterprises) called Fannie Mae and Freddie Mac.
Back in the 1970s and 1980s, the cost of funds suddenly rose to exceed the "locked in" longer-term rates on loans. That's when we saw the death of the Savings and Loan industry and a slew of major bank failures to boot. See a parallel here?
The process accelerated, with more loans being packaged and sold (and repackaged and resold) in a manner not unlike publicly traded stocks and bonds. These CMO’s were seen as safe investments since their value was "derived" from underlying mortgages that were collateralized by the real property itself. These were snapped up and traded by pension funds, insurance companies and banks as well as by corporations and wealthy individuals--domestic and foreign. Refinancing became common. (It’s 10 PM; do you know where your mortgage is tonight?)
Fannie and Freddie had the extra advantage of a multi-TRILLION dollar line of credit from the US Treasury. There is the "perception" that their CMO’s are as good as US Treasury securities themselves, even though they do NOT have the "full faith and credit of the US Government" behind them. (SOURCE: US Code, Title 12 - Banks and Banking, Chapter 46 - GSE’s, Section 4503 - Protection of Taxpayers against Liability).
As interest rates rose in the 1990’s to challenge the "irrational exuberance" of a dot-com stock bubble run amok, all markets dropped. (You can’t blame this only on the 9/11 attacks, as the market indexes were headed south well before the terrorists hit.) We then saw the PPT (Plunge Protection Team, AKA the Fed) cut rates to practically zero to swing the pendulum back again. However...the cheaper interest rates "compounded" by an investing public mourning the "loss" of their paper stock fortunes focused attention on homes and real estate. The Fed now lost control of the money creation process and this next bubble was on its way.
These past two Februarys saw Chairman Greenspan beseeching Congress to rein in both Fannie and Freddie. Cheap money and refinancing fueled an unparalleled boom/inflation of real estate prices across the nation. It would be one thing if the so-called paper equity gains stayed in the property for the occupants. However...most gains were cashed out via the equity loans that provided a supplemental "income" for households to keep this economy spending! It’s the costly S&L tragedy all over again--only bigger; the characters may be different, but I fear the plot and outcome are the same.
I’m Fred Cederholm and I’ve been thinking. You should be thinking, too.
Fred Cederholm is a CPA/CFE, a forensic accountant, and writer who contributes the column "TH*NK*NG" to The Weekly Observer in Creston, (Ogle County) Illinois. He is a graduate of the University of Illinois (B.A., M.A. and M.A.S.).
Three dinky building lots on Lake Minnetonka in the western Twin Cities. $350,000 each.
Those dinky little lots would fetch $5-600,000 in Kalifornia.
Not the cause of the S&L crisis.
ping
Various real estate bubbles HAVE burst at various times over the last 60 years!
The SOB's need to stop spending money for everylittle thing that pops up. The market is rediculous, My house has gone up over 20,000 in the last 3 years. It isn't worth it I gaurantee you, and I have done improvements.
Ping
Give the author an award...and some police protection. Powerful entities from Fannie Mae to Larry Kudlow don't like hearing anybody point this out. If the public wakes up, the whole scam will unwind.
Your house hasn't gone up in price, the value of the US Dollar just went down. The $ value of your house then changed accordingly. Have a look at USD vs. gold for the last few years.
wow i must be a great investor all my stocks are gloom and doom...
Here, here! Amen and Amen.
IMHO, this "refinancing bubble" is about to break. It has no foundation. Except for a bunch of paper.
Glad I own my home free and clear.
Ping for later.
You betcha! In 1991 I bought a house on Cape Cod in a market that was greatly depressed. Lots that had sold for $80K a couple of years prior were going for $30K.
At the settlement, I calculated that the lady from whom I bought the house had lost $50K in cash in three years.
Unfortunately for her, she had also lost a younger husband to another woman.
A good place to monitor the housing finance scene is:
http://www.ofheo.gov/
The documents on restatements of earnings at Freddie and Fannie, the turnover in their top management, and ongoing accounting scandals make interesting reading on current developments, and the home price index data:
http://www.ofheo.gov/HPI.asp
provides some historical perspective on regional housing market slumps. There have been three major regional downturns in the past 20 years: "oil patch" in the early 1980's, New England in late 1980's, Southern California in the early 1990's. Since then, the illusion has once again developed that prices only increase.
There are regional imbalances that could develop into slumps, but they are notoriously hard to forecast. The federal reserve has done extensive research on this, and other, "asset price bubbles", without identifying any useful analytical methods to anticipate "busts".
http://www.federalreserve.gov/boarddocs/speeches/2005/20050112/default.htm
The turmoil in housing finance, and softness of dollar and the bond markets are warnings of systemic vulnerability, but one way this could develop would be high levels of inflation that prevent nominal drops in housing prices, but destroy value nevertheless. People with lots of their assets for retirement held in dollar-denominated paper could find themselves with piles of expensive toilet paper in their larder. That, more than housing price fluctuations (which even in the "busts" tend to be rather mild as asset price fluctuations go), is a matter for concern.
Sixty? You mean the last 160+ years, if you include land speculation as well as housing, i.e. California land speculation, Florida land speculation, the late 18th-early 19th c. speculation on "western" lands (W. Penn., Ohio, Kentucky), etc.
Hogwash. No matter how long the loan term you are still buying equity every time you make a payment, assuming the value stays reasonably stable. Plus, there is a huge benefit to the interest deduction.
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