JUST ONE MORE THING YOU SHOULD KNOW ABOUT THE REAL ESTATE BUBBLE

I think I've made this clear before - this wasn't because of the current administration. It takes a Village, and in this case, we'll now be thinking of them all as Village Idiots.

We've talked about predatory lenders, greedy Wall Street brokers, and loose lending regulations. How about the tax code? For a truly perfect bubble, you need favorable tax treatment OR loose regulations - and we had them both.

If you've always loved Ayn Rand's philosophy as expressed in "Atlas Shrugged," you should consider this a full refutement of that philosophy by its grandest champion:

"I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms."

Alan Greenspan, former Federal Reserve chairman

Big changes on the horizon

The Federal legislation that gives us SAFE (National Mortgage originator licensing) is going to go into effect on January 20, 2010. If you're one of those who won't be able to retain or be licensed after that date, now is the time to start planning your new career.

Virtually everyone who has a license now will have to re-test, re-qualify and be certified under the new standards, even though they are not as stringent as the Texas standards were already. Anyone who was grandfathered in at the beginning of Texas licensing will now have to pass the state exam for the first time.

These standards will apply to EVERYONE, whether employed by a Federally chartered bank, mortgage bank or mortgage broker. After January 20, 2010, anyone that's working with you originating a loan will be licensed to the uniform standard.

Can I have just one more hit off the credit bong, please?

Well, the Fed has thrown up their hands and said "Here, just take the damned money!" They've depressed interest rates again to a level that is almost as low as what we were seeing three and four years ago.

How low? Try an average of 5.19% 30 year fixed. That means that some lenders are offering 30 year fixed loans in the high 4% range.

Well, whoop it up, right?

Not exactly.

Here is a short list of people/scenarios which can no longer get loans:

* Stated income
* More than four mortgages including husband and wife together
* Non-warrantable condos
* Condos that are not FNMA/FHA compliant
* Neighborhoods with more than 10% foreclosed units
* Credit scores under 680 (FNMA) or 580 (FHA)

I'll tell you, this list is going to have people bellowing "oh, but I know I can do such and such."

And, they may be right. They could have very well done so. However, it's going to take the right borrower, the right property and the right lender to get those things done. If you're looking at a scenario where the proposed borrower is one of these things, get a back up contract at the very least. If you're a borrower with one of these situations, find a TERRIFIC mortgage broker and get fully approved FIRST.

It's nice to get one right -

A few years ago, I predicted that mortgage rates had fallen about as low as they could go - at the time, they were slightly below where we find them today - about 6.00% 30 year fixed.

I didn't realize at the time that the dedicated Ayn Rand supporter Alan Greenspan would push interest rates down further and keep them there for several years - creating an environment we now call the "real estate bubble."

So, I was right that interest rates in 1998 were about as low as they could go - naturally. It was an artificial push to move them lower. Still, I was wrong that "now is the time to buy or refinance, as rates won't go any lower."

Last I checked, 4% is lower than 6%. I blew that one.

However, a few weeks ago, I suggested that the end of consumer or non-owner occupied loans for high rise condos would put an end to the projects that had not yet come out of the ground.

I shared that opinion with a few Realtors and other friends, and they all nodded and rather gave me that "you're thinking too much again" look.

This morning, on the front page of the Houston Chronicle, we have validation de-lux.

When will all of the anti-Ashby high rise signs come down?

Whither the market goest

I watch with amusement the new lenders entering the market as the old reliables vanish. Every few weeks, another new mortgage banker steps forward and says that they can lend to those with sub-580 credit scores, or that they can do "liar" loans - stated income or no income documentation.

A few weeks later, that new mortgage banker sends out an announcement that they're no longer taking new files.

Any efforts to recreate the E-Z credit atmosphere of the past is doomed to fail. There just are no investors willing to take the risk. For the next several years, if not decade or more, loans will be made to those who can prove their income and credit quality.

Incoming regulations to ensure against identity theft, to use only third party automated documentation of income and bank deposits, and further restrictions on access to consumer credit will soon produce a totally new way of taking a loan application - you'll swipe your driver license.

The revisions to the Patriot Act plus other legislation mandate standardized state driver license record keeping and forms, and over the next few years, your driver license will be replaced with one that's just a little chunkier - it will contain an RFID chip - meaning that someone with an RFID reader could examine your name, address, driver license records, etc. It also means that your driver license will carry access to all kinds of secure databases. IRS records. Credit bureau records. Criminal background history. Voting records. Bank records. State unemployment/income records (which are updated weekly or quarterly and provide instant access to exactly how much you do earn).

Taking out a mortgage will instantly become instantaneous, as all of these databases populate into mortgage software, drive through the FNMA/Freddie Mac automated underwriting system and "presto!" You're nearly done.

This is going to make the private mortgage broker about as modern as the dodo bird. The analogy there is quite apt, only those that move quickly and strongly toward adopting these expensive technological changes will be able to compete with the new Super Banks - Chase, Wells, BofA. The private mortgage broker will only be able to work on self-employed persons and credit tiers that are beneath FNMA/FHA/VA standards - and then only with a handful of mortgage banks.

Choices will be extremely limited, and consumers shopping around will find it much harder to compare.

If you're in the mortgage business now, and you're committed to staying in the mortgage business, I suggest you start setting aside capital to secure access to this developing technology and data subscriptions, or start planning your early retirement.

Fannie and Freddie, and nationalized housing lending

I think that a great number of people have no earthly idea who or what Fannie Mae and Freddie Mac are, or how that affects our national housing market, the economy, nor the national debt and our economy's relationship to other countries.

"Oh, Fannie Mae was bailed out? What is that.. " and then, cease reading after the first or second paragraph.

Our national debt just doubled.

So, two pieces here - first, a very well written discussion of how Fannie and Freddie got to where they are; compare this to earlier discussions of the housing bubble and how it was created.

A quick excerpt:

The accounting scandal was so large that even Fannie and Freddie didn't know what was in their portfolio. They failed to register with the SEC for at least eight quarters.

If you're at all curious about what that means for you, I recommend you read the article.

What does this move hold for the future, though? My good friend Jillian Sorensen of Franklin American must have arisen before the roosters this morning to put together a marvelous synopsis of what may be coming. It is designed for mortgage professionals to read, but it gives a clear picture of what we don't know but may expect:

As you know, in a truly historic event yesterday, Treasury Secretary Paulson and Federal Housing Finance Agency Director Lockhart announced that “FHFA has placed Fannie Mae and Freddie Mac into conservatorship.” The government (FHFA) will now be managing Fannie Mae and Freddie Mac for the foreseeable future.


Below are some thoughts on this historic event…..


Overview


To stabilize and to stimulate the housing and financial markets, the Federal Government is taking the following key steps.

· The GSEs will be allowed to increase their MBS portfolios through the end of 2009
· Treasury will be initiating a program to purchase GSE mortgage-backed securities (through December 31, 2009)
· Treasury has established a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac and the Federal Home Loan Banks


We believe that Treasury Secretary Paulson and the Bush Administration determined Fannie Mae and Freddie Mac were unable to perform their housing missions at a time when they were most needed because the GSEs were trying (unsuccessfully) to address safety and soundness issues associated with raising capital. As a result of this plan, Treasury has indicated that the GSEs will now not be under any pressure to sell assets.


In the short-term, we expect mortgage liquidity should improve. Rates should decline as the risk spreads built into the GSE pricing (due, in part, to fear of potential GSE failure) should be reduced if not eliminated. The extent of the decline will depend on what happens to Treasury yields in the coming days.


Without capital constraints in the near term and based on Secretary Paulson’s comments (see below), we believe the new Fannie and Freddie will likely rollback at least some of their price increases and loosen underwriting requirements to some extent. It will be curious to see the MI reaction to this government intervention as their tightening of guidelines will now be “front and center” in the effort to expand mortgage financing availability.


We also believe Secretary Paulson’s call to examine the guaranty fee structure could lower those fees across-the-board. It will be interesting to see if the government-controlled GSEs will implement a Ginnie Mae-type flat fee structure and at what level.


On a longer term basis, there will be a “heavyweight” debate next year and beyond about the future size and structure of the GSEs (e.g. public or private entities). That debate will not occur until the new Congress and Administration take office next year.


Why did Treasury/FHFA take this action?


It appears to us that Treasury/FHFA lost confidence in Fannie Mae and Freddie’s Mac’s ability to support the housing recovery while, at the same time, addressing their safety and soundness responsibilities by preserving and raising capital. Below are some of Secretary Paulson and Director Lockhart’s remarks which lead us to this conclusion.


Director Lockhart said:

(bold and italics added)


“Their market share of all new mortgages reached over 80 percent earlier this year, but it is now falling. During the turmoil last year, they (the GSEs) played a very important role in providing liquidity to the conforming mortgage market. That has required a very careful and delicate balance of mission and safety and soundness. A key component of this balance has been their ability to raise and maintain capital. Given recent market conditions, the balance has been lost. Unfortunately, as house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated. In particular, the capacity of their capital to absorb further losses while supporting new business activity is in doubt. Today’s action addresses safety and soundness concerns. The result has been that they have been unable to provide needed stability to the market. They also find themselves unable to meet their affordable housing mission. Rather than letting these conditions fester and worsen and put our markets in jeopardy, FHFA, after painstaking review, has decided to take action now.“


Secretary Paulson said:


“I attribute the need for today’s action primarily to the inherent conflict and the flawed business model embedded in the GSE structure and the ongoing housing correction”. He added that he has “long said, the housing correction poses the biggest risk to the economy”.


“Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner” and that “the primary mission of these enterprises will now be to proactively work to increase the availability of mortgage finance including by examining the guaranty fee structure with an eye toward mortgage affordability”.

Comment

We have all seen the steps that Fannie Mae and Freddie Mac have taken to preserve and raise capital throughout this year. These measures have included raising prices on mortgages and tightening underwriting guidelines. As everyone is also aware, they have been aggressively trying to put back loans to seller-servicers who, in turn, are going back to originators.


Secretary Paulson in particular appeared to conclude that GSEs cannot serve two masters (i.e. its housing mission and its shareholders) during the housing crisis.


What does this mean?

To state the obvious, we are in uncharted waters. This plan is not a “silver bullet” that will address the underlying problems (i.e. record mortgage delinquency and foreclosures) that caused the need for this unprecedented action. MBA’s National Delinquency Survey last week indicated that over 9% of all mortgages are either delinquent or in the foreclosure process. While the new GSE approach to mortgage availability will increase the number of potentially eligible borrowers, it will likely not have any significant impact on affordability (borrowers must still qualify and make downpayments) in those markets where house prices increased the most during the “housing bubble” until house prices and borrower incomes are in line. With this as a caveat, below are our immediate thoughts.


· Short term goals

Two of the immediate goals of this action are: 1) “to increase the availability of mortgage finance” as Secretary Paulson said and 2) to lower mortgage interest rates through the Government guarantee of GSE debt.

· Long term objectives


On a longer term basis, the Government’s action yesterday raises the fundamental question about the government’s role in housing going forward. Secretary Paulson deferred the discussion of this question and the “flawed GSE business model” ( i.e. serving two masters ---public and private objectives) to the next Administration and Congress.

In this update, we will focus on short-term impact since the debate about the GSEs’ future structure and size will depend on who wins the election and the make-up of the Congress.

Short term Impact

For the housing industry, the short-term impact of the Government takeover appears to be positive.


* Mortgage rates should decline
* Liquidity should be increased
* GSEs should loosen standards (somewhat)
* GSEs should reduce fees including guaranty fees
* Some housing experts feel house price may stabilize sooner and the level of further house price decline will be moderated as a result


Potential Impact

* There could be a mini-refinance boom if the rate decline materializes.
* Hedging of servicing portfolios and pipeline problems will have to be addressed


There are many questions to be answered in the coming days and weeks:
(Here are a couple)

* How will the MIs react (mortgage insurance companies)?
* Their underwriting and pricing policies will be “front and center” if the GSEs take the actions we expect
* What will the new Fannie/Freddie management’s policy be on buybacks? Will they be more reasonable? If so, credit policies may relax!
* On g-fees, will the GSEs pursue the Ginnie Mae approach (uniform g-fees across the board)?
* What will be the new GSEs do with respect to lender relationships (preferential pricing, etc.)?

So, now all loans that aren't held in portfolio are either directly funded or directly guaranteed by the US government.

It CAN be done!!

Contract effective date - August 4, 2008
Full loan application date - August 5, 2008
Contract closing date - September 3, 2008
Actual closing date - August 22, 2008
Actual funding date - August 22, 2008

New construction, inner loop, FHA purchase.