Tuesday, November 20, 2007

Housing Market Crisis Tied to Speculation, 'Predatory' Lending

As the crisis stemming from high-risk sub-prime mortgage lenders' collapse in the US spreads, the real estate market beyond US borders is being hit by what observers are calling the 'credit crunch', taking for granted this will affect all international financial endeavors, such is the situation. The governor of the Bank of England has now warned that the United Kindom is facing what should be its tightest economic year in a decade, warning that the slowdown could last into 2009.

As such, it's worth rehashing a story published by Sentido.tv in January 2006, on the coming crisis in housing markets, as a result of overpricing and over-exuberant speculation. The Economist magazine had in June 2005 published an article on the unprecedented bubble of the global housing boom. The boom in developed economies amounted to a value increase of 100% of combined GDP, a figure whose trajectory could not be maintained by existing wealth or regular economic growth.

Sentido's reporting took into account "outlyer" values —cases where cost per property had literally gone of all charts— like the town house renting for £23,000 per week in Knightsbridge, the high-rent corner of the Royal Borough of Kensington and Chelsea in central London. The mood was that expanding prices were so inherently good, they would somehow generate the wealth necessary to feed the boom.

The problem, obviously, is that this is not how economic growth occurs. Mystical presumptions do not a prolonged expansion make, and at some point the biggest boom markets, like Ireland, Spain and the UK, would have to reach a maximum of capital available, at which point, cost of use could not justify cost of purchase for most properties at then current —or feasible— growth rates.

The Sentido report reads as follows: According to [The Economist's reporting], property values in South Africa increased by 244% between the first quarters of 2004 and 2005. Ireland's expanded by 192%, Britain by 154% and Spain by 145%. The piece also warned that like Germany, Japan and Hong Kong, some major markets were beginning to "fizzle out" and enter a period of likely decline.

The Economist proposed the possibility that the global economy, not just that of one nation or one region, had become too dependent on the untenable expansion of property values and profit from real estate sales. If the bubble were to burst, it could be the trigger event for the most severe and widespread economic downturn —potentially, a worldwide depression, in technical terms— yet seen in modern times and measured.

It's a sticky problem, because preventing such an event means first of all identifying the aspects of any given real estate market which contribute to overvaluation and to growth beyond real market potential. Then, it means persuading those with most direct invovlement in that aspect of the market to act to reform their methods or their outlook, to reign in a new kind of "irrational exuberance".

One worry is that as property values soar, many people will be forced to abandon neighborhoods they have largely built and maintained, possibly stripping the community fabric and undermining the inherent value of a given urban area. That flight would also mean average incomes reach too high a range, and basic services become less widely available and cost of living continues to escalate, further pushing community breakdown and/or flight.

A big part of the secret to the record boom in housing markets was lending practices, which were significantly liberalized to allow 'new money' —as if materializing out of nowhere— to flow into the home-buying markets, which in and of itself artificially inflates speculative earning potential for resale over the short term. The added value is 'artificial' because this new money depends heavily on the lending practices themselves, and represents theoretical wealth which may not actually be available to flow into those purchases.

Sentido pointed out in January 2006 that "The solution to the problem could be linked to lending; if banks are aware of the bubble risk, then they might take a more thoughtful approach to planning for lending for long-term buys, considering the sustainability of property values or the risks posed by increased volatility from excessive financing of 'flipping' schemes."

They did not. The thinking that prevailed across financial markets tended toward the boom-time logic: there's money to be made, and the way to make it is to invest in markets ripe for growth. That logic was not in itself inaccurate, but by the nature of the moment, it was applied to situations where the money to be made would stem in many cases from sales which could only occur with the help of risky mortgage schemes.

The lack of proper adjustment to lending policies and lack of assistance to borrowers overburdened by adjustable mortgage rates has led to the failure of many of those mortage accounts and the collapse of many smaller lending institutions. At present, economists predict this crisis is just the beginning of a serious credit shortfall, in which no less than 2.5 million American families may face losing their homes, further affecting equity valuations, lending practices and saleability of properties internationally.

Legislation is pending in the US to ban "predatory lending", but the nature of such practices is that they are tied to the logic of the demand for low-interest loans, provided with highly adjustable rates whose incremental rise in cost is justified by the notion of further borrowing power (assuming property values continue a steep rise, even where many are tied to risky loans).

Among the side-effects of sub-prime mortgages is the resulting upward price pressure on markets that require sustainable cost-to-funding ratios to be fruitful. Homes are bought for living in, in most cases, and require a sustainable local economic picture to be used as intended.

As overextended buyers find themselves priced out of communities they've just moved into, other areas of economic measurement slow accordingly, undercutting the very loans that in theory were to help create new wealth. This is part of the ripple effect now slowing world markets already affected by disappearing credit.

1 comment:

Xóu said...

Paulson Bond Proposal Aims to Stave Off Foreclosures

The Secretary of the US Treasury Dept., Henry Paulson, has proposed a plan whereby Congress would approve new legislation allowing state and local governments to issue tax-exempt bonds to homeowners with adjustable rate mortgages who need to refinance in order not to suffer foreclosure. The plan would allow "innovative mortgage programs" to be kept at lower cost, allowing affected borrowers to keep their homes while they pay down potentially crippling loans.

Agence France Presse reports "Paulson has also been working with banks to set up a 'superfund' to buy up distressed mortgage securities hurting the balance sheets of major finance institutions." This is partly due to the feeling that lending institutions and major investment houses have driven the crisis due to their attitude toward the long-term value of high-risk mortgage schemes.

The Chicago Tribune reports economic analysis citing the current housing and mortgage crisis as "the most serious housing downturn since the Great Depression". Sec. Paulson has also pushed for a freeze on adjustable rates, in an effort to prevent a widespread sudden rise that could lead to hundreds of thousands of foreclosures in a short span of time.

Democratic presidential candidate, and New York senator, Hillary Rodham Clinton, has urged Paulson to place a moratorium on foreclosures, for at least 90 days, on occupied homes. The senator is also calling for rates on all sub-prime loans to be frozen, then transformed into "affordable, fixed-rate" mortgages. The stakes are high, as analysts and policy-makers agree, the efficacy of steps taken could determine whether the US enters a prolonged recession.

AFP: "Paulson proposes tax-exempt bonds for mortgage aid"
Chicago Tribune: "U.S. puts heat on lenders to freeze rates"