Rick Wade

November 30, 2007

A lot has been said about the current real estate and mortgage crisis and most of it centers on how long it will last, how it will affect the economy, what the Federal Reserve can or cannot do about it and to a much lesser degree, why it happened in the first place. It's that last point that I feel is most important because I believe it is a point that has been overlooked and because if we don't address it, we will not have learned from it.

  To begin with, no one can know with any real precision how long the current situation will last. For many people, current forecasts made by supposed experts only alarms them and skewers their decision on whether to buy or sell their home now. Many people feel that the media, hungry for a story, have caused much of the damage because of their "doom and gloom" reporting.  

In the case of those thinking about selling their home, they feel it is wise to wait for the market to improve. This is much like waiting to sell a stock and hoping you can get out when it hits it's highest point. However, if you wait too long, the stock price may drop precipitously and you may lose more than if you had not waited. This is exactly what many homeowners have done. In the case of those thinking about buying a home, many people still feel that they should wait until the market "hits bottom". But again, much like buying a stock, if you wait too long, the rest of the world may catch on and the price might soar to a point where you would have been better off had you not waited. The truth is, if you try to make decisions on buying or selling a home based on a desire to hit it at just the right time, you're as likely to lose as win, just as those who try to play the stock market on a daily basis. Think about the other reasons for buying and selling and let that be your guide.

How this current situation may affect the economy and whether or not the Federal Reserve can magically change it's course is likewise a matter of conjecture and a matter for those charged with the responsibility of the nation's economy to decide. I will say that over a year ago, many predicted that the economy would already be in trouble, and that no one saw the last recession coming. There are just too many variables involved for any hard formula to be applied and relied upon precisely. Again, when it comes to the real estate decision, I would advise anyone to not make it based on the guesses or forecasts of others.

As for the "why" in all of this, it has, in my opinion, been largely overlooked and unless we face up to the real cause, we will be in worse trouble, be longer getting out of trouble and will be destined to repeat it. For the most part, what has been discussed by the media and most experts has been that this crisis was caused by defaulting, sub-prime loans. 

But what does that mean exactly? What they are saying is that a really large number of mortgage loans were made to borrowers whose credit was "less than great" and that many of these borrowers have and will continue to default on those loans. Those defaults have closed many, many mortgage companies and some of the largest banks have been severely damaged by the resulting losses. The end result is tightened loan guidelines which directly affects the real estate business and as a result, the economy. So what does that tell us? It tells us that loans were made to people under circumstances that they should not have been, are not now and will not be for a while. Again, you have to ask why this happened.

The mortgage industry is a large part of the economy and can be viewed as a huge engine that requires a great deal of fuel (borrowers) to keep it running. What happened was that as people's credit became more damaged and they had less and less personal savings to put down on a house, this "fuel" became scarce for the banks. Faced with this enormous deficit in potential customers, the lending industry became more "creative" and relaxed in its loan programs to meet the needs of this new average borrower. They became creative in the sense that the loans were interest only for a certain period before "adjusting" to a "fully amortized" loan and at new and probably higher interest rate along with many other similar variations. Simply put, many of these loans made getting into the house much easier but also made what became very large adjustments upward in monthly costs later. How easy it was to qualify for these loans as well as how much they jumped and how soon they would "convert" varied greatly, but the basis is the same in that it brought in more customers, and these loans were not made with a realistic appraisal of how they might change down the road or how that would affect not only the customer but the banks that held these loans. This type of short sightedness is not new. It was the reason for the collapse of the Savings and Loan Banks years ago. Japan also did the same thing a few years back until the government stepped in and dictated that the qualifying guidelines be tightened.

So it was this wide array of new loan products that made it easier to get into a house that was responsible for some of the defaults. But low interest and "no money down" loans were only a part of the picture. The relaxing of the guidelines that determined a borrower's eligibility for a loan was an even larger player in what has and will continue to happen in terms of defaults. To meet the needs of the new average borrower who on average has damaged credit, the banks had to loosen the guidelines by which they would qualify them. Otherwise, the banks would be losing a lot of business and that is not their prime directive. So in essence, a person who earlier would not have qualified for a loan now did qualify. That is an over simplification but at the heart of the matter is true nonetheless. And when you loan money to people who represent a risk, those people default on their loans. Again, an oversimplification because "risk" can mean anything from very low to very high and not everyone who is a bad risk will necessarily default, but these things are based on averages and that is what we are talking about here.

So a lot of people would argue that the mortgage companies and banks became too greedy and in the face of a withering group of customers with low risk, decided to take on the customers who were of a higher risk, and now they are paying the price. That could be argued but our economy does in large part depend upon a healthy real estate market and if you don't have borrowers, you don't have sales so it is in the interests of not only these banks but also the country as whole that this "engine" be kept running, but at what cost? But it was not just the banks at fault but also the average borrower who has let their credit rating decline. However, no one seems to be addressing this part of the problem.

No one is talking about the steady decline in the average American's credit or the seemingly inability to save money, and this is a huge problem. For a lot of reasons, it does appear that the last couple of generations have come into the adult world without the proper education and tools in personal financial management and more importantly, the respect for the ideal of fiscal responsibility. Part of the problem is the media that tells us all we deserve to have this or that product, or that we must have this or that product. Too many parents are spoiling their children by giving them everything they want and so they grow up believing they are entitled to everything whether they can afford it or not. Credit card companies prey upon college campuses and lure these young people into the trap of living beyond their means with the predictable result that many come away from college already buried in personal debt. Schools are not doing enough to train our high school students about personal money management. So there are many segments of our society that are working against the best interests of our young people, or who are not doing enough to help them protect themselves from these influences but the bottom line is that it is the borrower, the customer who has fallen prey to such influences and who has let their credit slide to the point where they present too great a risk given sensible guidelines that is at the heart of this problem.

Yes, the banks should not loan money to risky applicants, but if that is all they have to choose from, what are they to do? The truth is, the fix lies in all of the areas I have touched on. The banks have to make sensible loans, the schools need to make credit and money management a required course, and parents need to not only set good examples but also actively work with their children to promote credit worthiness and sound financial responsibility. There is just not enough emphasis on the concept of having and keeping good credit, living within your means and for saving money, but nothing could be more important because it is the basis for any society or democracy to function properly.

So I propose we start looking at this from the bottom up and not the top down or what is happening now, and what may be coming in the next few years, may not hold a match to what will develop in the future. I view this as one of the largest problems this country will ever face and left unchecked will play a major role in the ever widening chasm between the "haves" and the "have nots", but that's an entirely different subject for another time.

Rick Wade

rickwadehomes.com