News & Views on Real Estate


Whew! That Bailout Almost Destroyed the Housing Industry

Whew! That was a close one! Good thing that bail out failed - it almost wiped out the entire housing industry!

Only in the United States Congress can a plan to destroy the housing industry and credit markets be called a "rescue" plan. It's almost as farcical as calling  "card check" bill that effectively kills secret voting for unions a "secret ballot bill." Far more troubling, however, is the fact that the elements of the plan are laid out - in plain sight - for everyone to see and think about.

Why, then, does the real estate industry and average homeowner, not see the danger?

Set aside for a moment what "caused" the current financial crisis. Let's assume there's a lot of blame to go around: Stupid investment banks that didn't assess the risk of securitized mortgages. Political shenanigans for "affordable" housing through two lending institutions that thought they didn't have to actually check if borrowers could repay their loans. And a Federal Reserve that forgot to control inflation - and devalued the dollar - which is how homes, as commodities, are primarily priced.

How about the entire issue of Americans spending way beyond their means for a decade? Taking out home equity for plasma TVs, cars, remodelling, trips around the world - all consumption, no production. Oh, but never mind.

The issue is what to do "now." For starters, the only reason there's a "rush" to do a bailout is because there's a Presidential election coming up. In reality, private investment isn't sitting too far off on the sidelines. Warren Buffet put $5 billion in to the market yesterday and today, even though Washington Mutual "failed" it didn't "collapse." Bank of America had plenty of private capital cash - and a willingness to spend it. Consider it a private bailout.

The danger lies in the rush to do the proposed Government bailout. Injecting a trillion dollars - the real cost of $700 billion - cannot have only good effects. And the most likely - and ironic - negative effect is that the bailout will ultimately destroy the housing industry.

If Fannie and Freddie's business practices weren't a stab in the heart of the concepts of "credit worthiness" and "equity" in the American financial system, then the "bailout" will simply twist the knife until the housing industry dies. What's at stake here isn't the banking system; it's the fundamental basis of savings in our economy: home ownership.

Home ownership is the most common and primary "investment vehicle" for consumer savings. The bailout will destroy that investment for millions of Americans, today and tomorrow. Consider the "other investment" most Americans believed the Government was making on their behalf: Social Security. Essentially, it's worthless because the "assets" used to create its value are declining, as the number of American workers paying for each retiree declines. The same will happen to the mortgage "assets" held by the Government: Just because they suddenly own them doesn't mean they won't continue to decline. In fact, most of the provisions of the bailout bill will hasten - not slow - the pace of falling home prices.

Since the bill will transfer control of millions of American's basic investment vehicles - their home equity - to the Federal Treasurer, the result will be to ultimately push private lending out of the housing industry entirely. When that happens, the housing industry effectively becomes nationalized  - since the only lenders left will be Government-backed (through "equity" shares) banks. Without lending choices, sales will slow to a crawl and the housing industry - including REALTORS, inspectors, appraisers, builders and countless other associated industries - will likely shrink too. Without lending, the economy shrinks.

And just about everything in the bailout bill is designed to discourage - not expand - private lending. For example:

  • Foreclosure Prevention is a major provision of the bill. While distressed "renters in homeowners' clothing" may find this comforting, it should more properly be called "Contract Abrogation" authority. The provision would allow judges to - at their own whims - change the terms, conditions and value of a mortgage owed to a lender. If you want to kill lending entirely, then eliminate the law of contracts. Make lenders fear that their contracts might be abrogated or adjusted at any time by a judge who takes pity on a homeowner but never the lender who provided the means for their purchase - and the cost of mortgages will soar. Lenders might reasonably decide to stop lending to individuals at all. They have lots of other ways to make money, rather than risk a capricious legal system. Within the housing industry, builder financing will disappear, too. Why would a builder risk investing in new development, marketing it, and providing financing to the buyers  - when a court could decide at any time to lower the value or payment terms? Robin Hood would be proud.
  • Executive Compensation oversight is not just vindictive, it will slow the pace of the mortgage industry's growth. Limiting compensation simply pushes smart people out of the contention for the hard jobs of running a bank. Capping salaries in the finance industry means smart financiers will become executives in other industries. Lending will be left to political appointees. And we all know how well that worked out at Fannie Mae and Freddie Mac.
  • Equity Stakes in exchange for Fed money sounds like a great idea. When Warren Buffet bought shares of Goldman this week, he ended up with "equity" in the company. If the Government buys mortgages from failing banks, shouldn't it also get a stake? When a private individual invests in a company, it's called equity. When a government uses taxpayer money, it's called "nationalization." If the Government has equity in the banking industry, it simply has more control. For any indications on how a nationalized lending system will work out, refer back to Fannie and Freddie.
  • An Oversight Board to keep an eye on the Treasurer of the United States also sounds like a good idea. In fact, it has been tried for decades - in command-economies like North Korea and Communist China. Let one department of government - and some un-elected bureaucrats - start throwing around a trillion dollars, and you'll be creating more bubbles than a Lawrence Welk show. The Fed already tried this once - by inflating the money supply. Now it will try again with a trillion taxpayer dollars injected into the economy. It's still inflation of the money supply, which means devaluation of the housing industry. Rather than printing money or loose credit lending, the Fed will take it directly from taxpayers disposable income. It has to come from somewhere - which means more taxes - leaving only enough money left over for lower-cost housing. That's called "renting." And there's no housing industry when nobody can afford to actually buy a house.

Home owners should be terrified of the bailout plan. By destroying the lending industry - or making mortgages too expensive. When contracts become tentative, lenders will dramatically increase the interest required to take the risk; which will decrease the number of people who will qualify to repay the loans; which will freeze home-ownership to it's existing levels for years, if not decades. We have already seen frozen neighborhoods across America, where people can't afford to sell and nobody willing to buy.

REALTORS should be panicked: As a the new major equity partner in the lending business - Government will be involved in even more real estate transactions (if not the majority) bringing with them a vast array of government provisions for closing. Perhaps one provision will be capped commissions for REALTORS? Why not cap those along with executive pay? Already today FHA is flexing its muscle, setting standards for inspection and appraisal that the average homeowner cannot meet with enough money remaining for a down-payment on their next home.

Builders - who are essentially financiers who make a profit through housing investment and sales - will simply shift their capital to other markets, like commodities or overseas development where their property rights will be respected under the law, not judicial discretion.

The bailout plan is the exact opposite of what has to happen to correct the economic downturn. Adding more money to an inflation-weakened economy is no worse than devaluing the dollar or printing more of it. Buying distressed mortgages can only be called buying "assets" by Government accounting standards; if they were really worth something, more private equity would be out there snapping it up. Undermining contract law and abrogating lenders' rights to repayment on behalf of "distressed" homeowners will only mean more bank failures - as banks will be unable to recover the money due to them, with which they create jobs and pay employees. The cycle will only accellerate, eviscerating the lending industry, scaring the sidelined-buyers into waiting even further, discouraging foreign investment in what was once considered the safest place to invest: a country of (contract) laws, not of (judicial or political) men.

Now is that any way to bail out the housing industry?

- M

Comment balloon 8 commentsTim Maitski • September 30 2008 07:04AM
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