By Dennis O'Keefe on Nov 14, 2017

It has been a decade since the housing bubble began unraveling in front of our eyes.  Mortgages didn’t get paid.  Banks went belly-up.  Property values plummeted – in some places down 50% or more.

It was an ugly time.

The cause was a combination of stupidity.  That’s often the case with major financial disasters.  It isn’t just one thing that brings the system down.  

Think of the economy like a commercial aircraft.  It is said that it takes 7 different mistakes to cause an airliner to crash.  If you can avoid just one of those 7, you will arrive at your destination just fine – even if all of the other 6 go wrong.

The economy is the same thing.  For eight years I heard from conservative friends that Obama was going to ruin the economy.  Ever since November, I’ve heard from liberal friends that Trump will ruin the economy.  

Neither has the power to do that all by themselves.  Despite what the main-stream-media tells us.

History of the Real Estate Meltdown!

We have to go way back in our way-back machine to look at the roots of the global crisis in 2007-2009.  It started with an idea.  An idea that, on it’s face, appeared good.  Congress, led by none-other than my former esteemed Representative Barney Frank, wanted more Americans to be homeowners.  

It’s a noble cause.  Provided people want houses and are responsible enough to take care of them.

Congress mandates that the percentage of Americans owning a house should rise in order to further our economy.  This despite the fact that we were at an all-time high for home ownership.

To accomplish this, changes need to be made to FNMA and FHLMC (Fannie Mae and Freddie Mac, respectively).  These two quasi-government agencies are responsible for originating almost half of all mortgages in this country.   

In order to achieve the Congressional mandate, Fannie and Freddie lower their mortgage standards.  Not just once.  Several times.    I took out my first mortgage in 1994.  With the number of hoops I had to jump through, I qualified for a position in Ringling Brothers.  By 2005, you could spend up to half of your pre-tax income on your debt and still obtain a mortgage with Fannie and Freddie.

But that wasn’t enough.  A cadre of other brokers and originators showed up to the party, eager to do Congresses bidding.  The no-income-verification loan went from a fringe product to front-and-center at many banks and mortgage brokers.

I had a friend who was trying to purchase a piece of property.  The broker walked him through the entire application, then asked him how much he wanted to borrow.   On an income of about $75,000 per year, he wanted to borrow $500,000.  

“Sir, we can’t give you that much money on that salary.  But I’ll tell you what.  Let’s do this.”  He took the old application and shredded it.  He then took a new no-income-verification application and said, “OK, the only thing you need to do is tell me you make $150,000 per year.  Don’t worry – they can’t verify the information.  But do that and you’ll have your mortgage.”

Yikes!  No wonder we had problems.

At some point, Fannie, Freddie and the rest run out of money to loan.  How can they get new money?  By packaging all of their loans and selling them as a bond.  And that’s just what happened.  They packaged these questionable loans and sold them to the public.

But what moron would buy such terrible debt?

Well, the banks and brokers were able to secure AAA ratings on these new bonds via the various rating agencies such as Standard & Poor’s and Moody’s.  They showed how, historically, people have paid based on their FICO score (a form of credit rating), not on their actual income or ability to pay.  AAA ratings were standard.  All was well with the world!

Finally, and not the least guilty of the bunch, we had the consumer.  Here is the villain we never want to discuss – because we are that villain!

Prior to 2000, it seemed that consumers understood borrowing.  There were rules of thumb that guided us in our borrowing habits.  But somewhere along the line, we stopped looking at the total amount borrowed and began looking at the net monthly payment.   

That meant that if a mortgage broker could use a variable-interest vehicle with a low starting monthly payment, people never bothered to think, “How will I pay for this in 5 years?”  

As long as the market went up (and it was going up with this many more people buying, selling and trading homes), you could refinance in 5 years and all would be well.  You were sure to have more money then, right?

So, let’s see.  That’s Congress, FNMA/FHLMC, Mortgage Brokers, Bond Issuers, Ratings Agencies and Consumers.  That’s six.  Oh yeah, there was old Wall Street.  

Wall Street loves a good success story.  It doesn’t really focus on facts or reality.  So a hot real estate and mortgage and bond market comes their way, they’ll sell it with all of their gusto.

And with 7 failures combining, we had a global-killer market.  One that happens about every 80 years.  The last was 1929 and the Great Depression.  

Life Since The Bottom

But we’ve had it good since then.  Economic growth isn’t nearly as high as it should be.  No one is sure if that is because of government intervention, changing demographics or a nervous consumer.

But even though growth has been slower than desired, we’ve had eight years of positive growth.  And none more surprising than the growth the real estate sector.

In most of the country, property values are above where they were in early 2007.  In some markets, like parts of Florida and Nevada, this has translated into record growth in such a short period of time.

One has to wonder what is causing it. . . .


Enter the FHA

I’m sure that you haven’t heard of the FHA.  Or if you have, you have no idea what they do.

The Federal Housing Administration is the federal agency, created by FDR and now run under Housing and Urban Development (HUD), is currently tasked with facilitating mortgages to as many Americans as possible.

Prior to the housing crisis, the FHA provided loan guarantees to a small number of loans.  Their main focus for almost 80 years was to help provide housing for the poor, handicapped and elderly.

Post 2007, the FHA mandate changed.  From one to help individuals gain housing to one that helped prop up a flagging real estate market.

Currently, according to valuewalk.com, the government originates or guarantees 3 out of every 5 mortgages in this country.  Much of that is mortgages insured by the FHA – totaling about 8 million single-family mortgages!  

So what?  If people are paying their mortgages, what difference does it make if the FHA is guaranteeing them or not?

Ah, but it is the type of mortgage that is the problem.  It is a mortgage with generous borrowing limits, a low interest rate and a down payment as low as 3.5%.

Yep.  You read that right.  This whole mortgage/real estate fiasco was created by providing too much credit to people who too-easily could walk away from a home if they went “upside-down” on the venture.

Now the government is putting millions of homeowners in virtually the same exact position.
 

Is This A Bubble?

The big question, that no one seems to be asking at present, is “are we approaching another real estate bubble?”

The good news is:  Probably not.  The bad news is:  The real estate market should be headed for some difficulty at the very least.

Rising interest rates means that borrowers can’t borrow as much money.  It’s simple math.  Interest rates have been at historic lows.  (Also a goal of the federal government.  It’s almost like they just want to prop up the residential real estate market.)  Interest rates are on the rise.  Which means the days of 3% and 4% mortgages are coming to an end.

If you can afford a $300,000 mortgage at 4% interest, you can only borrow a little over $250,000 at 5.5%.  

That’s a 15% drop in prices!  

I don’t suspect we will see property values dropping by that much. In fact, I believe that we will see an extended period of price stagnation as interest rates rise to normal levels.

But that does not preclude another real estate crash.  Keep your eyes on FHA loans and how many mortgages the FHA truly guarantees.  The more they guarantee, the more dangerous the problem becomes.  

Also watch the employment situation.  People who don’t have jobs will have a hard time paying their mortgage.  And if they only have 3.5% of the purchase price of their own money in the house, it might be easier to walk away than face the bank.

Now for the worst thought of all:  The FHA is self-funding.  Meaning it collects premiums on the mortgages it guarantees and, in turn, pays out when someone walks away from the mortgage due to a loss of job or other reason.

What happens when you face a large economic downturn that causes thousands of homeowners to stop paying on their mortgage?

You guessed it – the full faith and credit of the United States of America stands behind those mortgage guarantees.   Uncle Sam.  The Big Cheese. . . . Ultimately, just you and me.  

We were lucky to have suffered through the last real estate crisis without massive government loses.  (In fact, Uncle Sam did OK financially in their plan to bail out the banks.)  With the government itself guaranteeing the loans, the next potential real estate crunch could look very similar to the taxpayer bailout that occurred during the late-1980’s Savings & Loan fiasco.

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This blog is the opinion of Successful Money Strategies, Inc. and is provided for informational purposes only and is not intended to provide any investment advice or service.  Statistics and other figures are accurate at the time of original publishing.  Any advice herein should not be acted upon without obtaining specific advice from a licensed professional regarding the readers own situation or concerns.  Always count your change.