Fixing the Mortgage DEBACLE

Earlier this year, when I was writing press releases on California's new home market for the CBIA while at Hanley Wood Market Intelligence, I was asked by the CBIA to soften the phrase "mortgage debacle" to something more neutral (such as "mortgage situation") that wouldn't alienate their builder members, who were already sensitive to the constant media reports of a rapidly slowing market. Since I understood the trade group's position and the wording itself wasn't that important to me I acquiesced, but I remember thinking that avoiding the truth would simply postpone the day of reckoning when the building industry risked seizing up due to lack of new credit, that some new solutions would be required and so planning far in advance of it was prudent.

Fast-forward six months later and with the lack of credit clearly having an enormous impact, the federal government's plan to freeze certain subprime loans at their teaser rates could certainly prevent foreclosures (and thereby help prop up property values, potentially helping the new home market), but it also has its critics, namely investors who hold these mortgages (and were soon hoping for greater returns) and analysts who claim that this is merely a political salvo that will postpone the inevitable foreclosure for homebuyers who simply bought more homes than they could afford.

Writing in the Financial Times, former Treasury Secretary Lawrence Summers opines that since the threat to the global economy is becoming worse, more concrete measures need to be taken now, including (1) fiscal stimuli (spending and tax cuts) that will necessarily postpone paying down the national debt; (2) maintaining the flow of credit through "super conduits" in which banks pool together to take on troubled investment vehicle assets to contain the damage; and (3) that the U.S. government, whether through the FHA, FNMA, FreddieMac or all three, keeps the credit spigot on to QUALIFIED BORROWERS while also blessing a template that would set up a comprehensive structure to modify large groups of sub-prime loan terms at risk of default instead of at the glacial pace of one at a time.

Inman News columnist Lou Barnes seconds this idea, arguing that waiting longer would simply continue to erode banks' capital requirements, making them technically insolvent (hence the recent investments in Countrywide, E-Trade and Citibank). While it does seem morally repugnant to bail out the pathologically greedy, Barnes makes a very good point:

Since it is beyond the power of the Fed to deal with capital and counterparty risks, we can't just sit here watching more capital evaporate as more and more assets cross the event horizon to black hole. Everybody wants bad actors punished, and nobody wants a bailout -- not taxpayers, and not the moral hazard police.

Get over it. Get on with it: firewall bad assets, give big banks and dealers get-out-of-jail capital cards, and restore the supply of new credit before this gets ugly.

And yet builders may need to take even faster action if they hope to continue selling homes (and generating cash). In his most recent newsletter, John Burns (yes, I'm a subscriber too!), suggests that builders not only continue to make mortgages, but actually plan to hold them in order to make the sale:

If you have information about your pricing, submarkets and buyer profiles that leads you to believe that there is very little chance that the homes you are selling will fall 20% in value, you might consider forming a venture to make piggyback loans or whole loans. While this is clearly not a preferred choice, it might be the only choice next year that allows you to continue selling homes at a reasonable sales pace.

If this idea seems absolutely absurd to you, ask some of the industry veterans how they survived the 1981-82 downturn. Most of them made the loans on the homes they sold. Today's environment is much different and the loan would be much riskier, but the key to survival is selling homes and recovering as much of the cash you have already invested as you can.

Very interesting idea. So how do you predict if new homes will not fall below 20% in value? I'd suggest micro-market studies, in which the analysis carefully considers the immediate neighborhood, locational advantages (access to freeways and mass transit, future development) and comprehensively argues why this particular project might be more immune from future price declines than elsewhere (a topic I'll be taking on later today for Builder/Developer magazine).

Because just because one WANTS their full piece of pie doesn't mean they'll get it!