A. What really caused the real estate market to collapse?
While much has been written about the multitude of complex reasons behind the collapse of the real estate market in 2007, it is the opinion of this writer that there is one primary reason for the collapse. Simply stated, banks loaned money to borrowers who lacked the ability to pay back the loan. That’s it, pure and simple. If you loan money to someone who has no resources to pay back your loan, you will lose money almost every time and it matters very little if you have any collateral for the loan. This should be known as the prime directive: “Thou shall not loan money to someone who cannot pay you back.” There certainly are many other reasons behind the collapse, but if the “system” had not violated the prime directive the collapse would not have been so sudden, so precipitous, and so prolonged
If it makes you feel any better, the list of characters that also deserve some of the blame is as long as my arm (34” sleeves). This list includes, in no particular order:
· Elected officials who thought the banking system should loan money to anyone who wanted to buy a house plus many who did not. Some of the housing bills passed by our elected “leaders” were tantamount to acts of treason.
· Greedy bankers who wrongly assumed they could find a seat when the game of musical chairs (a.k.a. loan aggregation and securitization) ended. Boy, were they ever wrong. Can you say WAMU, IndyMac, et al.?
· Borrowers who risked little, if any, real cash equity when buying a home. This is kind of like playing cards in Las Vegas with “house” money – pun intended. How bad can it hurt to lose everything if you start with nothing?
· Sellers who cashed in at sale prices resembling a lottery win and then turned right around, defying all logic, and used all of their winnings to buy more lottery tickets.
· Commission and/or fee driven providers of services who had no exposure to loan losses and only focused on making a quick buck. This group knew the “house of cards” we were building would collapse and never really did anything to stop the collapse.
· Home builders who actually believed that if they built it, buyers would come. Talk about a field of dreams. When have home builders ever thought there was any over-building?
· Everyone who thought no documentation and no income verification loans would work out well. Even a loan shark knows where his customers work and live.
· Blind regulators who ignored the red warning lights and alarm bells going off as early as 2005 and buried their heads in the sand like ostriches. If you stick your head in the sand, your butt is straight up in the air, and when the market collapsed, the regulators all got their butts kicked . . . hard.
· Flippers who tied up condos or homes and then tried to sell their purchase contracts to someone else without ever even closing on the property they tied up. This little gambit pretty much killed condos and condo conversions. Too bad it didn’t kill off the flippers.
· Morons (a.k.a. investment bankers) who decided that if they could package and sell securities backed by A and alt-A mortgage loans at huge profits, then it would surely be OK to do the same with sub-prime loans. Can you say “first payment default?”
However, at the end of the day, all we needed to do to avoid or at least mitigate the collapse was to follow the prime directive and not loan money to someone who had no way to pay us back.
B. What can be done to avoid another collapse?
I have a friend who is a judge and one of her favorite sayings was and still is “even a flatworm can learn.” The point is that unless we do something different this time around, we are condemned to repeat our past. This is essentially the definition of insanity. . . doing the same thing over and over again and expecting a different outcome. So, if even the lowly flatworm can learn, we should be able to exercise our big brains with millions of cells and come up with at least a few new ideas so we do not have to experience another real estate collapse like this latest one. Here are few ideas to consider:
· Do not violate the prime directive ever again. It’s time to limit the use of leverage by the uninformed. You wouldn’t let a baby play with razor blades, so don’t loan money to someone who can’t spell “budget” and cannot pay it back.
· Home ownership is not for everyone, no matter what the home builders or politicians tell you. Some people are born to be renters and that is OK. Owning a home may not be the American dream for everyone so let’s stop pretending it is.
· Require loan originators to retain and hold a piece of every loan they fund and sell. Even 1-2% would be enough to dramatically improve underwriting and reduce default risk. Require the same of every party up the chain that buys a loan and then resells it later. It’s always good to have skin in the game.
· Require real cash down payments by borrowers and, other than in loan programs designed specifically for groups like veterans, prohibit loans in excess of 90% of cost and/or value from being sold. In other words, you can loan 100%, but you have to retain the whole loan on your balance sheet if you do.
· Require updated due diligence (credit report, appraisal, etc.) by a loan buyer whenever a loan more than 3 years old is sold, and continue this requirement for the life of the loan. Nobody buys a used car without having a mechanic check it out thoroughly, so why do we allow “used” loans to be sold with the mere click of a button?
· Ban anyone caught committing fraud in a real estate transaction from obtaining a license in the real estate industry ever again. I know of an appraiser who pled guilty to mortgage fraud and then had his appraisal license renewed by the state. Really? Are the inmates in charge of this asylum?
· Put just a few bankers in jail. It won’t take many to have an impact, but if you think fining the banks millions or billions bothers these greedy bastards, remember they are paying the fine with your money, not theirs. Even a long weekend at Rikers Island would do wonders for some of this gang.
So, there you have it -- a nice short summary of how it happened and how we can avoid it from happening again. I like to call it Real Estate 101, but you can call it whatever you want as long as you remember the prime directive.
Written by Brian L. Trotier, JD, the Executive Vice President and Chief Operating Officer of FREA and a former practicing attorney with more than 30 years experience in real estate and risk management.