One of the nicer things about getting older is a lot of my friends are retiring or are semi-retired. They now have time to participate in some of the things that my career in real estate allows. Case in point, I have a friend who regularly goes yard saleing with me on Fridays, we rarely buy anything, but every once in a while someone really does want to sell the yard! (I explain this in my books “One House At A Time / Finding And Buying Single Family Rentals" and again in “Flipping For Fun And Profit".) We just couldn’t make it last Friday, but since both our wives were going to be out Saturday we decided to try a Saturday.
I arrived at my friends’ house at the appointed hour, his wife let me in, it seems he was walking the dog and would be back in ten to fifteen minuets. We sat down to talk something we seldom have a chance to do. She’s in the mortgage loan business too. In fact we met seven or eight years ago when she worked for me as a loan salesman, but she really found her niche as a processor so we do have mutual interest to talk about. I tell you all of this because you need to know she’s no spring chicken, no neophyte, no novice, she’s very good at mortgage lending!
We generally only discuss two subjects, our spouses and real estate, having learned long ago not to mention politics or religion. People from Nevada don’t discuss weather amongst themselves, it’s like discussing size with a Texan. The subject this day was real estate, specifically 100% mortgages and the soon to burst real estate bubble.
As I listened, she explained how upset she was that her employer wrote mostly adjustable rate 100% mortgages and other high loan to value mortgage loans. She was concerned about how the poor buyers were going to be in such trouble when the “sky falls" and the “real estate bubble" burst. Over and over she repeated the media mantra “the sky is falling," “the sky is falling!" She assured me, rates are going up, payments are going up! I couldn’t argue that rates and payments are not going up, that’s what ARMs do! But, the sky is falling? No way!
She went on. No one should be allowed to buy a house with less than 30% down, so that when the bubble burst and the “sky falls" they will still have some equity and they might be able to keep their house at it’s soon to be deflated value.
She went on to spew all the doom and gloom so prolific in the news! When I argued facts, she responded yes, but it’s all a bubble! This lady is an educated mortgage professional. She’s no kid. Her youngest daughter will never see middle age again. Despite it all she’s shouting “The Sky is Falling!" just like Chicken Little did!
You should be concerned! Or should you? All the doom and gloom reported ever hour on the radio and three times a day on TV is bound to convince more than a few of you, eventually. No matter what your politics if you look carefully, all the balderdash is misleading prophecy meant to displace Bush and his party. The doom and gloom is mostly political pandering. The tremendous growth in property values in the last four or five years is true!
Is it a bubble? What if the bubble should burst and the sky fall who’s going to get hurt? As always those among us with out a roof of their own are going to get hurt! Should you buy real estate in today’s market? Only if you want protection from falling skies!
But, what if the bubble burst and values do go down? The fact is real estate in general has gone down only twice since Manhattan was purchased for $26.00 worth of beads, it went down briefly during the Civil War and again during the Great Depression. Which do you anticipate? In both cases property values recovered in short order.
What about making large down payments to preserve your house incase values do drop or payments go up? Chicken Little’s problem is her experience has all been in good times! I started in lending in 1969 at a small loan company, the first thing I was taught about collections was to look at the collateral, never threaten anyone with nothing to lose. I quickly moved to a bank, it was the same story. When dealing in mortgages where deficiency judgements are rarely allowed, who stands to lose if you get in trouble?
Chicken Little is mistaken! Her common sense approach to protecting the consumer, is the equivalent to hiding under the only tall tree in the area to stay dry in a thunder storm! For those of you who don’t know a tall tree may keep you dry during a thunder storm, right up until the lighting kills you!
Those of you that have read any of my real estate books (“One House At A Time / Finding And Buying Single Family Rentals", “Flipping For Fun And Profit", “Get The Money / A Consumers Guide To A Successful Mortgage Application", or “A Bakers Dozen / A Real Estate Anthology") know that successful negotiating requires that everyone wins. When you’re in trouble you’re going to have to negotiate with your lenders. If you have enough equity for the lender to take your home getting all or most of their money back they win and you’re screwed! On the other hand, if the bank stands to lose money by adding to your problems they will work with you! Banks do this all the time, you’ve heard of “short sales" where a lender takes a known loss because it’s better for them than risking a known or probable higher loss. Savvy investors do this all the time, home owners can also compromise with the bank if it is in everyone best interest. High loan to value loans spread the risk between the buyers and the lenders. (FHA, VA, and PMI loans are normally, but not always, an exception.)
Back to our question and analogy. Should you buy real estate when the bubble might burst? What choice do you have? Renters (God Bless them, for they make landlords rich) without a roof of their own may well have the sky fall on them. Those home owners with only enough equity to protect the bank, may think the “Sky is Falling" on them, but it’s chicken droppings. Those few with so much equity that they are protected from the bank may lose money but they’ll come out of it.
The wise “Henny Penneys" among us will not only have leveraged their homes to the max forcing the bank to share the risk. They’ll also have several investment properties sharing the risk three ways, with the bank, and the volunteers!
Volunteers? Yes! Tenants volunteer to pay all the expenses with no chance of sharing in any of the winnings. God Bless them.
“Henny Penny" will have to actively protect her interest in case the bubble burst, but that’s the same as coming in out of the rain. “Chicken Little’s" only hope is the benevolence others.
Deteriorating economic conditions have policymakers in Washington, D.C. running around like Chicken Little. As a result of the perceived falling of the sky, these same policymakers are scrambling to come up with a fiscal stimulus plan which, coupled with aggressive monetary policy action by the Fed, is intended to stave off a recession and calm jittery financial markets. Whilst these initiatives are well-intentioned, these efforts are an exercise in futility. There is little, if anything, that can be done to stop the economic downturn that is in progress and that is coming.
There is little doubt the current economic downturn was caused by the deflating of the real estate bubble and the mortgage crisis. This caused the banking system to clam up and become more restrictive in lending. This began a chain reaction which sent a systemic shock throughout the economy, causing a credit crisis last summer that was particularly disruptive to financial institutions whose lending reluctance retarded liquidity and prompted some degree of panic in equity markets and in corporate boardrooms.
The Fed's actions in cutting the federal funds rate fifty basis points along with other policy actions in August was intended to build confidence and liquidity in the banking system and, perhaps, shore up struggling equity markets with a comforting "Bernanke put." Successive cuts along with the seventy-five basis point cut on January 22, 2008 were aimed at shoring up markets amid mounting turmoil and uncertainty over the magnitude and depth of the impact the housing contraction and mortgage crisis would ultimately have on the broader economy. Alas, the Fed's actions cannot possibly solve the banking crisis. This was a situation created by the banks that would only begin to be relieved by massive write-downs and massive capital infusions by foreign investors, namely Asians and Arabs, totaling in excess of $21 billion. To be sure, there is much more bloodletting to come at financial institutions who provided too much credit when interest rates were low with little apparent regard to attending risk of borrowers. The Fed shares a part of the blame for keeping rates much too low for much too long and in the process allowing the real estate bubble to inflate precipitously. The magnitude of this may ultimately be over $100 billion as derivatives are revalued in the process to reflect current fundamentals and counterparty risks are reassessed. And there is more revaluation to come in the real estate markets as prices adjust to reflect true fundamentals. This is all a painful process that cannot be avoided forever.
In addition to monetary policy action, policymakers now want to give taxpayers rebate cheques ranging from $300 to $1600 in hopes that these rebates will prompt consumers to continue spending and, thus, in the process revive the lagging economy. There is a problem with this. The federal government does not have this money to give away right now; we simply can't afford it. This will likely be funded through debt issuance. In all likelihood, either Asian or Arab investors will purchase this debt. Now we are in even more hock to these nations. And assuming consumers spend the money on goods produced in these foreign countries, the investors get their original money back! This hardly makes good sense. In addition, this fiscal stimulus does not address the mortgage crisis or rising consumer debt levels. More attention should be placed on financial responsibility and sound economic and financial decision-making by the government and individuals. To be sure, fiscal stimulus is good—but only at the right time. Throwing money at a problem, hoping it goes away, without addressing the fundamentals of the problem is wasteful and counterproductive.
But this is not to suggest that policymakers remain idle and twiddle their thumbs. To the contrary, action is needed. Now is the time to reassess the challenges facing the U.S. economy. A number of factors have resulted in the economy becoming less competitive. Wages are higher than in low cost countries. Manufacturing has moved overseas for cheaper labour. Government spending has grown dramatically. An entitlement program funding crisis looms. Corporate taxes are among the highest in the world. The tax code is complicated. Rather than the fiscal stimulus proposed, policymakers should consider making President Bush's tax cuts permanent, thereby eliminating a great and looming uncertainty. The limits on tax deferred contributions to retirement or 401k plans should be increased as a means of increasing savings. The corporate tax code should be reformed to make businesses domiciled here more competitive so that U.S. companies don't move offshore to avoid an onerous tax burden. The federal government should reduce spending so that debt levels do not increase significantly only to be further indebted to foreigners. Congress should give the President the line-item veto and restore pay-go rules as much as possible, even though this is difficult in times of war. Policymakers must begin the process of shifting to a consumption tax as opposed to an income tax so that taxation is equitable and so that even illegal aliens here pay their fair share of the burden. The Federal Reserve should increase the reserve requirements so that financial institutions are more judicious when it comes to lending depositors' money. This should help to avert another near financial system collapse which could, the next time, have more significant and more far reaching implications than the current situation.
Undoubtedly, policymakers are doing what they deem best. There is an old saying: The path to Hell is paved with good intentions. The Fed's efforts to cut rates and the policymakers' fiscal stimulus plan are aimed at helping avoid a recession or at least soften the impact. No one likes the thought of a recession, particularly in an election year. Recessions are not a necessarily bad phenomenon. All economies must undergo a cooling period. The longer and higher the rate of expansion, the sharper and deeper the cooling and contraction. These periods of cooling are healthy for an economy. They temper excess and help reign in moral hazards and excessive risk taking associated with speculative activity. They serve as a wake-up call to businesses, investors, and financial market participants.
But rushing to make fiscal and monetary policy decisions may only compound an already fragile situation. Now may be the time to show fiscal and policy restraint, even in the face of massive opposition. Fiscal stimulus and rate cuts won't help. The banks and mortgage market participants have to work this out for themselves. Shoring up their balance sheets with equity injections and write-downs is the only solution. Recent rate cuts or any further cuts may well be mistimed and prompt higher inflation in a period of lower growth. Sometimes it is best to bite the bullet and let matters sort themselves out. Hopefully, policymakers will show better financial decision making skill than thus far. Going too far may open an economic Pandora's box. Once that happens, the sky may really be falling.
Both William J Archambault Jr & Robert M. Clinger Iii are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
William J Archambault Jr has sinced written about articles on various topics from Finances, Network Marketing and Property Investment. William J Archambault Jr, is the author of “One House At A Time / Finding And Buying Single Family Rentals" “Get The Money / A Consumers Guide To A Successful Mortgage Application’ and “Flipping For Fun And Profit" Available @ www.reii.org. William J Archambault Jr's top article generates over 49500 views. to your Favourites.
Robert M. Clinger Iii has sinced written about articles on various topics from Finances, Mortgage and Family Business. About Thinking Outside the Boxe—Thinking Outside the Boxe is a private, nonpartisan think tank that is dedicated to providing a wide variety of perspectives on issues that are of interest to the general public. The views that are expressed in Think. Robert M. Clinger Iii's top article generates over 6600 views. to your Favourites.