Housing Woes Have Gone From Main Street To Wall Street
There are many factors that played into how the housing bubble was created… and how the market has fallen. There’s quite a few factors, so let’s look at a few of them.
The federal government, in all their infinite wisdom, uses the tax code to reward and punish behavior. When they want more of something - they subsidize it; when they want less - they tax it. It’s a well-known fact of economics. Of course, using that logic, one might believe that the government wants more poor people and fewer wealthy ones… and after transferring $5 trillion in wealth, a good argument can be made based upon that premise. We have as many poor people now as ever.
One of these governmental beneficiaries has been Fannie Mae and Freddie Mac, whose mandate has been to provide liquidity in the mortgage markets. By obtaining funds at lower rates than other entities that were not Government Sponsored Entities (GSE’s) ostensibly in part to help minorities and the poor to obtain mortgages, Fannie and Freddie have enjoyed preferential treatment by investors, as they operated with some level of implied support from the federal government.
While the goal may have been admirable, the spread that these entities enjoyed because of their "GSE" status did not really benefit anyone other than those who were running these firms - as well as their political operatives in Washington.
During the Clinton Administration, there was a big push to increase home ownership - particularly minority and low-income home ownership - and that push continued right on through the Bush Administration. It was known back then that making these home loans to less-than-qualified individuals woud result in higher default rates, but as Fannie and Freddie seemed to be doing well financially, HUD continued the push towards higher minority participation.
In 1996, Bill Clinton brought Franklin Raines on as his Director of the US Office of Management and Budget. Raines had been the Vice Chairman of Fannie Mae since 1991, and left the Clinton Administration in 1998 to rejoin Fannie Mae as the CEO in 1999.
In 2004, Raines left Fannie Mae on what he referred to as "early retirement" while the US Securities and Exchange was busy investigating accounting irregularities at the mortgage giant. In a nutshell, Raines and company were "cooking the books" by overstating earnings by $9 billion (later revised to $6.3 billion), and the Office of Federal Housing Enterprise Oversight (OFHEO) filed civil charges against Raines and two other former Fannie Mae execs seeking $110 million in penalties and $115 million in returned bonuses. You can read the short story HERE. In the final analysis, Fannie Mae paid a record $400 million in fines for the fraud and abuse that Raines and company had perpetrated.
Although the US Congress was aware of the problems with Fannie and Freddie as early as 2002, they did nothing to stop the fundamental problems with these so-called "private" companies. John McCain tried to do something about these abuses in the summer of 2006, but his efforts were blocked by Chris Dodd, Chairman of the Senate Banking, Housing, and Urban Affairs Committee, and Barney Frank, Chairman of the House Financial Services Committee - both beneficiaries of big campaign contributions from Fannie and Freddie. In all fairness, there were Republicans who didn’t want to reform them, either… but the thrust of opposition has been by Democrats. It should also be noted that Chris Dodd has received more money from Fannie and Freddie since 1989 than any other member of Congress.
Meanwhile, the federal tax laws were changed that allowed mortgage interest deductions on their second homes, and after the terrorist attacks of 9/11/01, real estate became a logical place for investment, as the stock markets no longer appeared to be a "safe" place for the average investor. With housing demand rising - and housing prices rising right along with it - real estate speculation became the investment vehicle of choice. Low interest rates and new loan products allowed people to buy with no money down fueled the surge. Many were able to buy properties using "negative amortization" loans that provide for artificially low loan payments during the first few years of the loan.
But we knew it wouldn’t last forever.
People who had no business getting a loan were getting financed - and many of these loans were in turn sold to Fannie Mae and Freddie Mac, who in turn, bundled these loans into "pools" that were resold to investors so that the cycle could continue. Many of these loans should never have been bought, and the eventual tide of foreclosures is the evidence. Like any Ponzi scheme, everything is okay until the cookie crumbles.
Many homeowners tapped their newfound "wealth" by pulling the equity out of their homes with home equity loans and lines of credit. Once again, the lenders were only too happy to lend, as the collateral was increasing in value. At one point, there were lenders loaning 125% of the value of the property - even for initial home purchases.
So what kind of oversight did Congress provide? Well, there were hearings about baseball and steroids… and hearings with oil executives explaining to Congress for the third time in recent years that high gasoline prices are a direct result of high crude oil prices… but we saw no hearings about the continued problems with Fannie and Freddie. Not even after the housing market was collapsing.
Congress did nothing. Well, almost nothing.
They did pass a housing bill that eliminated down payment assistance programs that allowed home sellers to pay the buyer’s down payment. At the end of this month, buyers and sellers will no longer have that option - and since such a large percentage of loans are using these types of programs, the real estate market is about to get another smack-down. Just when the market needed any shot in the arm it could get - millions of buyers were taken out with that one bill. And it doesn’t just affect buyers, as sellers have lost a sales tool, as well. What hurts the buyers ability to buy also hurts a sellers ability to sell.
The tax laws that allow an individual to shelter $250,000 in capital gains on the sale of their home as long as they lived in the home for two of the past five years will no longer be the law of the land at the end of the year. To be eligible for that exclusion, individuals will need to live in the property for all five years; anything short of that will lose a proportionate shelter from capital gains taxes. In other words - Congress raised taxes on the sale of a great deal of real estate, thus further harming the market. President Bush, in the waning months of his presidency, signed the bill into law.
Also on the chopping block is the HUD100 program that allows certain HUD homes to be sold for only $100 down. This program benefits both the first-time home buyer as well as the taxpayer, and was implemented last year to help HUD move their mounting foreclosure inventory. Elimination of this program will do nothing to help first-time home buyers find home ownership - especially with the elimination of down payment assistance programs - nor will it help HUD get top dollar for their inventory.
The ramifications of these decisions will likely be a prolonged real estate recession, which is not in the best interest of the country. It also isn’t in the best interest of the taxpayer.
The tentacles of Fannie and Freddie are rooted deeply in other financial institutions - and we are witnessing the financial difficulties that those relationships have caused. The impact of this situation will be better known in the future - but it is likely that credit markets will shrink and buyers will not only have difficulty in obtaining home mortgages - they are likely to have difficulty obtaining credit in all sectors.
It is with a heavy heart that I write this article. The picture I paint is not a rosy one. I invite everyone to get educated about these issues that Congress has been involved in, and determine if their Senators and Congressmen and Congresswomen have been working on our behalf to improve our economy - or if they have been willing accomplices in the decisions to harm it for political gain.
As always, if you have any questions regarding real estate in the greater Atlanta area, feel free to contact me here.
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