Real Estate – Fixing what went wrong

Real estate prices have been battered during the recession, and have dropped nearly continuously, with only a few brief pauses.  Government at all levels (federal, state, and city) has no idea what to do, so they throw various rescue programs at the problem that are expensive and completely ineffective.  Certain economists and real estate “experts” have called the bottom of the market several times, only to be shown wrong yet again.

WHAT GOT US INTO THIS SITUATION

1. Politicians, especially at the federal level, decided that everyone should own a house.  This started with the Community Reinvestment Act of 1977 launched during the Carter administration, then picked up again by Clinton, and that has continued to be a goal under Bush and Obama.
2. Bankers on Wall Street and mortgage brokers across the nation pushed idiotic financing schemes like option ARMs, which only work in a market of escalating prices and stable employment.  The banks securitized many of the loans without regard to loan quality.
3.  Government entities got in over their heads and acted in the best interests of their management.  Fannie and Freddie have required over $100 billion of taxpayer bailout money so far, and they are nowhere near done.  FHA continues to back up loans with down payments of only 3.5%, which only extends the problem.
4. Ratings agencies got too involved in the excitement of what was going on and neglected to do their jobs.  Groups (tranches) of garbage mortgages garnered the highest ratings of those agencies.
5. Consumers, through ignorance or outright fraud, took out mortgages that they had no chance of repaying unless all of the stars aligned perfectly.

We’re now at a point, I think, where prices will continue to decline in most areas for at least the next couple of years.  If you doubt this, look at the price to income ratios of many major markets, especially in California.  Household incomes are too low to justify even current valuations in these places.

IDEAS FOR FIXING THE PROBLEM

1. Politicians need to lose the idea that everyone should own a house.  There is nothing wrong with renting, and that is where people without the financial wherewithal to afford a house should stay.
2. Tightly regulate banks (and ratings agencies) and the financial instruments that they use.  Get rid of option ARMs and restrict interest-only loans to experts who know what they are doing.  All new ideas cooked up by bankers must get a thorough government review before they can be implemented.  Banks should mark to market the properties that they own, meaning that they recognize the true value of their inventories.  Yes, this will render some banks insolvent, but at least we take care of the problem now rather than later.
3. Get rid of Fannie and Freddie, though they may have to be wound down gradually over five years or so.  FHA should only insure loans in which the down payment is at least 10% of the purchase price.

Essentially, government needs to get out of the picture and banks have to act like responsible adults.  Owner financing, in which a real estate note is created between a willing buyer and seller, provides a good model for transparency and making good decisions.  Banks need to hold on to large parts of their loans, thus incenting them to maintain good lending practices.

Nothing will save the real estate market in the short term, as it needs to run its course and correct from past mistakes.  However, following the above recommendations rids us of the “extend and pretend” scenarios currently in play, and will lead us at least back to stability within a few years.

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