CONSEQUENCES OF THE BAILOUT - REAL ESTATE OPPORTUNITIES
September 23rd, 2008 categories: Assessing the Local Market
Last week, in my article, Mortgage Crisis: Where Do You Draw The Line?, I quoted Former Fed Chairman, Alan Greenspan as he spoke about the current financial crisis and the effects of federal government intervention. He agreed that there were certain instances where government intervention was necessary in order to “maintain the smooth functioning of the economy”; however, warned that using federal funds to accomplish it would have negative effects (e.g., “our scarce savings” will be used up and cause “economic stagnation”).
Well … the Line was drawn last Friday by Treasury Secretary, Henry Paulson, with his Bailout Plan for the U.S. Financial System. Here is his statement released September 19, 2008 (hp-1149). I include it because, with all the commentary out there, it is important to make sure we have listened to ALL sides.
Statement by Secretary Henry M. Paulson, Jr. on Comprehensive Approach to Market Developments
Washington, DC– Last night, Federal Reserve Chairman Ben Bernanke, SEC Chairman Chris Cox and I had a lengthy and productive working session with Congressional leaders. We began a substantive discussion on the need for a comprehensive approach to relieving the stresses on our financial institutions and markets.
We have acted on a case-by-case basis in recent weeks, addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner. And this morning we’ve taken a number of powerful tactical steps to increase confidence in the system, including the establishment of a temporary guaranty program for the U.S. money market mutual fund industry.
Despite these steps, more is needed. We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system’s stresses.
The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy. When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy.
As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing. This simply put too many families into mortgages they could not afford. We are seeing the impact on homeowners and neighborhoods, with 5 million homeowners now delinquent or in foreclosure. What began as a sub-prime lending problem has spread to other, less-risky mortgages, and contributed to excess home inventories that have pushed down home prices for responsible homeowners.
A similar scenario is playing out among the lenders who made those mortgages, the securitizers who bought, repackaged and resold them, and the investors who bought them. These troubled loans are now parked, or frozen, on the balance sheets of banks and other financial institutions, preventing them from financing productive loans. The inability to determine their worth has fostered uncertainty about mortgage assets, and even about the financial condition of the institutions that own them. The normal buying and selling of nearly all types of mortgage assets has become challenged.
These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans’ personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.
To restore confidence in our markets and our financial institutions, so they can fuel continued growth and prosperity, we must address the underlying problem.
The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.
I believe many Members of Congress share my conviction. I will spend the weekend working with members of Congress of both parties to examine approaches to alleviate the pressure of these bad loans on our system, so credit can flow once again to American consumers and companies. Our economic health requires that we work together for prompt, bipartisan action.
As we work with the Congress to pass this legislation over the next week, other immediate actions will provide relief.
First, to provide critical additional funding to our mortgage markets, the GSEs Fannie Mae and Freddie Mac will increase their purchases of mortgage-backed securities (MBS). These two enterprises must carry out their mission to support the mortgage market.
Second, to increase the availability of capital for new home loans, Treasury will expand the MBS purchase program we announced earlier this month. This will complement the capital provided by the GSEs and will help facilitate mortgage availability and affordability.
These two steps will provide some initial support to mortgage assets, but they are not enough. Many of the illiquid assets clogging our system today do not meet the regulatory requirements to be eligible for purchase by the GSEs or by the Treasury program.
I look forward to working with Congress to pass necessary legislation to remove these troubled assets from our financial system. When we get through this difficult period, which we will, our next task must be to improve the financial regulatory structure so that these past excesses do not recur. This crisis demonstrates in vivid terms that our financial regulatory structure is sub-optimal, duplicative and outdated. I have put forward my ideas for a modernized financial oversight structure that matches our modern economy, and more closely links the regulatory structure to the reasons why we regulate. That is a critical debate for another day.
Right now, our focus is restoring the strength of our financial system so it can again finance economic growth. The financial security of all Americans – their retirement savings, their home values, their ability to borrow for college, and the opportunities for more and higher-paying jobs – depends on our ability to restore our financial institutions to a sound footing.
Obviously, from these comments, Treasury Secretary Paulsen believes that this is a situation where intervention is necessary to “maintain the smooth functioning of the economy.” He is on record as saying, “The risks of doing nothing are far greater than the risks of acting.”
Take a look, however, at the amount of our “scarce savings” that will be used for this purpose:
Although the risks of not acting may have been greater than acting, let us not be naive that there won’t also be a great cost with that choice. Greenspan called that cost: “economic stagnation.”
According to Wikipedia, “Economic stagnation is a prolonged period of slow economic growth … less than 2-3% per year is a sign of stagnation.” Sounds like a nice way to talk about recession. Actually, when asked (during that same interview referred to in last week’s article) about the chances of 
escaping a recession, Alan Greenspan referred to more than stagnation:
I think it (e.g., the chances of escaping a recession) is less than 50% … I can’t believe that we can have a once in a century type of financial crisis without a significant affect on the real economy globally. I think that indeed is what is in the process of occurring.
Nouriel Roubini of NYU’s Stern School takes it a lot farther. In his September 21, 2008 article entitled, The shadow banking system is unravelling, he says that “the real economic side of this financial crisis will be a severe US recession.” Keep in mind that Mr. Roubini is often referred to as “Dr. Doom” … He is, however, worthy of note as we are seeing the beginnings of what he has been prophesying for some time. The hope is that what he refers to as “the shadow banking system” can be corrected with a mild recession rather than a severe one.
What does all this mean for Real Estate? Here are some observations about the Bailout Plan, Recessionary Markets and Potential Opportunities:
1. The rescue of the financial system is good thing for Real Estate. The goal of the plan is to remove illiquid assets that are weighing down financial institutions. What that means is: Financial institutions (e.g., where buyers get their money to purchase homes) only have a limited amount of money that they can lend out (e.g., deposits on hand). Once they loan out that fixed amount of money, they try to regain their lending power by selling the loan in the secondary market which enables them to continue lending money out again and again. If the primary lenders can not sell the loan in the secondary market, the process stops and the next buyer is not able to get a loan. It is the secondary market that currently is in big trouble (e.g., the ones causing all of the stir: Fannie Mae, Freddie Mac, Insurance companies with large deposits, such as AIG, large securities companies, again with large customer deposits, such as Lehman, etc.). They own the majority of the loans that are being foreclosed on.
2. The mortgage market will continue to be tight even with a Bailout as it takes time to work these things out. In a tight market, only the best qualified buyers can get loans … so if you are a qualified buyer, count your blessings. There are things that you can do to increase your creditworthiness. Feel free to ask about them.
3. It will take a while for the large supply of real estate inventory (which includes empty, foreclosed homes) to be liquidated. This will continue to drive home prices down. We in the Hill Country are not excluded from this phenomenon although, thankfully, our market is doing better than the national average.
4. Days on market (the average amount of time a house stays on the market before it sells) and housing inventory will likely continue to increase for a while. Only the best quality, best priced homes will sell. Owners will need to make sure that their homes are priced well if they want to move them. Both buyers and sellers should know what inventory levels are before pricing their home or making an offer! Ask us to help you with this!
5. Even with a Bailout, foreclosures will continue despite the economic bailout. The only difference is that the government will be involved! It will be interesting to see if Government involvement will speed up the liquidity of these homes. Certainly, the number of short sales (e.g., the sale of a home prior to foreclosure at less than the loan payoff with Lender approval) will continue to increase. If you or someone you know has suffered a financial hardship and has little or no equity, give us a call and we can discuss this option. This option can be good for both sellers and buyers.
6. The need for Owner Financed Homes will continue to increase. While many owners don’t typically think of this as a great option, it can be a great investment opportunity. Normally, a larger down payment is required and the buyer pays a higher interest rate. It’s still a Win/Win for many buyers and sellers. If you are interested in finding out more about this option or would like to be made aware when of these come available, let us know.
7. Larger Demand for Rentals. With fewer able to get a mortgage, more rentals will need to be available. It’s a great opportunity for Landlords. If you are interested in building an inventory of rental homes, let’s talk strategy.
8. Need for Private Lenders. With less mortgage money available, the need for private individuals or private partnership lenders will be in greater demand. Again, if you would like to find more about this option, let’s discuss the opportunities.
9. Ultimately, prices will recover. See my article entitled, The 2nd Half of 2008 & Beyond: Speculations About Inflation and Housing Prices (www.MoovingThoughts.com).
The Bailout Plan (likely to be passed is some fashion) certainly will bring with it BOTH consequences and opportunities! With things changing daily, we’re here to help you stay informed: Buyer, Seller, Renter, or Investor. Please feel free to comment below on our website or give us a call and let us know how we can further help you!
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