The Tycoon Report

The Mortgage Industry Is Killing The Real Estate Market!

Friday, April 18, 2008 | Ethan Roberts

In last week's Tycoon Report, I wrote about how the politicians continue to spit out one proposal after another, ostensibly designed to help poor homeowners who can't pay their subprime mortgage payments, but in reality just new ways to stick it to the taxpayers to foot the bill for the needy and the greedy. 

Today I want to tell you about another facet of the Real Estate fiasco.  This is the story that few in the general public really know about.  This is about how the mortgage industry itself is killing the Real Estate market!

Now, that would seem to be a contradiction, would it not?  I mean, isn't it suicidal for those who make their living selling mortgages to actually kill the golden goose (aka Real Estate) that creates those very loans?

This paradox does not go unnoticed by savvy individuals in the Real Estate industry.  The cause of this suicidal behavior is nothing more than fear.  The big money mortgage lenders are terrified of the ongoing risk of defaults, precipitated by falling home values.  Yet their latest actions, while designed for self protection (CYA), are ironically hurting the Real Estate industry even more.  It is akin to panicky people on a lifeboat in a stormy sea, rocking the boat in an effort to save themselves.  In so doing, the boat turns over, drowning them all.  Let me explain.

This week, Vertice Lending, the wholesale mortgage subsidiary of Wachovia Securities, put out a "Declining-Distressed Markets Policy Update" bulletin to all mortgage companies that in essence said the following:

Maximum financing should not be considered when property values are declining.  If Vertice has assessed that a particular area is "soft", i.e. declining in value, instead of the minimum 5% down payment that is now required, the minimum will be increased to 10%.  Plus the loan must be a "Full Doc" documentation type of loan.

In addition, if the appraiser indicates that there is an oversupply of properties in the subject neighborhood, or that the marketing time is over six months, or makes any other comments that might suggest a declining or distressed market, then again the maximum loan amount given must be reduced by 5%.

Included with the bulletin was an absurd 263 page PDF of the various "distressed" areas across the country, as identified by Vertice.  Had they put out a PDF of the "non-distressed" areas, it probably would have run about two pages and saved the reader a lot of time!  In my region of Florida, some of the nicest parts of town were said to be "distressed", including my own zip code!

What?!  Suddenly, I got so angry, I ran outside and like a mad man, started pulling all the weeds up from my lawn.  "Distressed?  Who, me?  I'll show them!" I said to nobody in particular.  But alas, an hour later, even though my lawn was now the absolute toast of the neighborhood, the Vertice PDF still contained my zip code, and my house was still listed as "distressed".  Oh, swell.

These days, mortgage loan officers just don't know what to do.  Mortgage standards keep changing on a weekly basis, and there is no consistency among the major lenders.  The underwriting process for FHA loans, which once took about two days, is now averaging more like nine days.  New regulations have the mortgage processors scrambling to get the correct documentation to the underwriters.  But if the documentation isn't correct or complete, the underwriters kick it back, and suspend the file until it is.  Conventional loans that once took 14-21 days to complete are now running 30-40 days.  Inexperienced mortgage companies are glutting up the system by sending application packages to multiple lenders, in an effort to guarantee their loans will go through.  Even among experienced Brokers, chaos is ruling the day.

So on the one hand, you have the FED and the Washington politicians doling out rate cuts and stimulus packages like it's Christmas morning.  But on the other hand, you have the mortgage industry, under pressure from Freddie Mac, tightening and tightening their own requirements.  The average consumer is caught in this holy war between Santa Claus and the Grinch. 

Average Joe says, "Honey, let's buy a house!  Rates are low, prices have come down, and this apartment is just too small for us."  So they go to a mortgage company to get pre-qualified for a loan.  A Realtor takes them out, and shows them 6-10 homes.  They find a home they like, their offer to the seller is accepted, and then begins the nightmare that is the 2008 mortgage process.  Initially, all goes well.  They meet with the mortgage loan officer, fill out some forms, and hand over documents such as their W-2's, and two years of tax returns.  They are filled with excitement, and start telling all their friends and relatives about the great home they have found.

But two weeks later, they receive the dreaded phone call.
 
"Hello, Average Joe?  This is Marty Mortgage.  I'm afraid I have some bad news.  Due to some new changes in the mortgage lender's requirements, they are saying that you need to increase your down payment from 5% to 10% for that house over on Blueberry Hill Lane.  Yes, that's right... What's that, you don't have enough money?  Hmmm, well, can you borrow from Mom or Dad?  Sell an old truck?  Anything? No? Well then we may have to go with an FHA loan, there's a much smaller down payment required...  What's that?  Why is the additional down payment needed?  Well, the lender says the house is considered distressed, because it's in an area with an oversupply of homes, declining home values, and..."

"CLICK!"

"Hello?...  Joe, are you still there?...  Hello?!"

There is a similar version of this phone call, in which Marty Mortgage calls Average Joe to tell him that due to changes in the lender's requirements, Joe's mediocre credit score is no longer acceptable without an additional 5% down or perhaps a 2% higher interest rate.  You can imagine how happy Joe is to receive that call as well.

I like to sit back in my chair sometimes, close my eyes, and dream a little.  In Ethan Roberts' perfect world, every potential first time home buyer has their 20% down payment already in savings, buys an affordable home with no more than a 15 year mortgage, and has at least a 700 credit score.  Then I open my eyes, and remember that in the real world, most potential first time buyers have $1500 or less in the bank, a credit score in the low 600's, a wallet full of maxed out credit cards, and would gladly take a 60 year mortgage if it were offered!

To reiterate a point that I made in my last article, if we are going to expect 1970 behavioral standards from a society with 2008 lifestyles, we will have a real problem. 

The mortgage industry is about to choke itself to death with their ever tightening requirements, simply as a means to protect themselves from having more defaults in the future.  As fewer and fewer people can qualify to buy a home, the inventory of unsold homes will continue to rise, and the prices will continue to fall.  As a result, we are nowhere near the bottom of the market yet.

I cannot say that I blame the mortgage industry for their timidity.  Once burned, twice shy is the old saying.  One reader called me to task last week for not providing any solutions myself for the housing mess.   So this week I will offer the following four suggestions:

1) Give a tax credit to anyone who buys a foreclosure home.  Owner occupants can get a larger credit, but investors should get a small one as well.  Let's clean up the blighted homes, get the huge supply of neglected foreclosures off the market which kill area values, and reward people for a change whose sweat and labor help to stabilize communities.  To those who say that doing this will keep non-foreclosure homes sitting longer on the market, I say bunk.  Despite the tax credit, most people still prefer to move into a home that does not need cosmetic and/or structural work.

2) The Government needs to pressure companies like Vertice to back off from their "Declining-Distressed" policy.  Any policies which reduce the number of potential home buyers are not going to help the home market to stabilize.  Let the lender raise the interest rate another 1/4 point if need be, but don't increase the down payment requirement.  Additionally, there should be a differentiation made between areas that are declining by just a few percent versus areas that are down 15-20%.  Not every zip code in the entire country is declining to the same degree!

3) Before they can get a mortgage, all potential home buyers with credit scores below 700 should be required to complete an extensive course in homeownership, with a heavy emphasis on budgeting and financial responsibility.  Our national failure to educate people on how to manage and maintain a home is one of the reasons we have so many mortgage defaults and subsequent foreclosures.

4) Make it mandatory that all new FHA mortgages are set up to have direct withdraws from the home owner's paycheck(s) sent directly from the employer to the mortgage company.  This could be done in the same way that pay is taken out for 401k plans or health care.  Businesses can be compensated via tax benefit for any costs incurred to do this.  In this way the mortgage gets paid before the home owner ever sees their pay check.  If the home owner gets paid twice a month, the amount deducted from each check can be half of each payment.  If both spouses work, the system can be set up for whatever way will be most convenient and best for them.

Another comment from last week's article questioned why I said that something needs to be done.  Why can't we just let the Real Estate market find its own level of price support? 

I think we need to realize that houses are not like apples, in that the free market takes care of prices and we should just let it be, no matter what happens. 

There are hundreds of thousands of jobs that depend on the Real Estate market.  Think about it:  Mortgage companies, Realtors, appraisers, surveyors, attorneys, title companies, home and termite inspectors, builders, roofers, tilers, plumbers, electricians, painters, landscapers, companies like Home Depot and Lowes, and on and on.  Many of those people are now underemployed or unemployed, and not spending money in your restaurant or beauty salon or retail store.  Then your small business loses money, so what do you do?  You are forced to lay off some of your staff.  Then those people cut back on what they can buy as well. 

According to the latest Associated Press-AOL poll, only 11% of the people asked said they will buy a house within the next two years, and 60% said they definitely won't buy, because they believe that prices will continue to decline over the next year.

So if we do NOTHING, and the housing market is allowed to decay, the ripple effect will throw us into a severe recession, perhaps even a depression, a la 1930.  Granted, homes did appreciate too much and too quickly between 2003-2006.  But if we do nothing, depreciation could mean that even homes that were purchased a dozen or more years ago will no longer have any equity left. 

Is that what we want?  Do you think that a Laissez Faire attitude toward our largest assets is really good for our economy and our future? 

My answer is NO, and so I implore Vertice, and all the other mortgage companies to:

 "Stop killing the Real Estate market!"




Ethan Roberts
Contributing Editor
The Tycoon Report