By Matt Phillips, Damian Paletta, and Henry J. Pulizzi from the Wall Street Journal Online
President Bush and Treasury Secretary Henry Paulson began a full-court press to make the administration's case that it has the housing and credit situations well in hand.
Speaking to a Rotary Club meeting in Fredericksburg, Va., Mr. Bush reinforced his opposition to a federal bailout of lenders and real-estate speculators, but said administration initiatives will help still-creditworthy homeowners renegotiate their mortgages and remain in their homes.
"It's going to take a while to work through the housing bubble, but we can mitigate some of the issues," Mr. Bush said. "We've got a strategy."
Mr. Paulson told a town hall meeting on the outskirts of Orlando, Fla., that there was no "silver bullet" to solve the credit-market problems, though he expressed optimism about several programs designed to limit mortgage foreclosures and restore market stability. The meeting was the first of several in towns across the country this week to discuss White House efforts to minimize foreclosures.
"The magic here is investors and servicers coming together to deal with an unprecedented situation so we don't have perverse outcomes and so that we don't have a market failure," Mr. Paulson said. Mr. Paulson used the term "market failure" at least six times and "unprecedented" at least twice in less than two hours.
Mr. Paulson helped broker industry discussions that led to a new format announced two weeks ago to make it easier for many homeowners with subprime adjustable-rate mortgages to move toward more affordable refinanced loans. Many other borrowers could qualify to have their interest rates frozen for up to five years.
With record numbers of subprime adjustable-rate mortgages resetting into more expensive monthly requirements and housing prices falling in many parts of the country, foreclosure rates have risen sharply, putting pressure on the economy.
Mr. Paulson said he supported Citigroup Inc.'s decision last week to move its assets from its structured investment vehicles, or SIVs, onto its balance sheet. SIVs, which issue short-term debt to buy other, higher-yielding assets, have been struggling because of exposure to risky subprime-mortgage debt.
He spoke enthusiastically about supporting a legislative proposal to allow government-sponsored enterprises Fannie Mae and Freddie Mac to securitize more expensive mortgages to spread their liquidity function into a different part of the market, but signaled that the administration would condition its support on broader regulatory reform of the companies.
In Virginia, the president warned lawmakers not to raise taxes while the U.S. economy faces credit-market-related challenges, saying his administration has a good plan to deal with the turmoil in the housing market.
He touted the Federal Housing Administration's mortgage-renegotiation program, known as FHASecure, and the Treasury Department-led private-sector initiative for homeowners about to be stung by resetting mortgage rates.
"I am concerned, I know you're concerned, about the housing industry. We all should be," Mr. Bush said.
Democrats were quick to criticize Mr. Bush's remarks as overly optimistic on the economy and unrealistic on the effectiveness of the White House's housing policies.
"The Bush administration continues to see the economy through rose-colored glasses, whether it be the subprime crisis, the credit crisis, the energy crisis or the declining dollar, it blithely marches along without making any serious effort to solve these economic problems," said Sen. Charles Schumer (D., N.Y.)
Saturday, December 29, 2007
Thursday, December 27, 2007
Rental Corner: When to Repair Your Tenant's Property
Getting Your Fix: Renters' Rights to Minor Repairs
How to get landlords to keep their end of the maintenance bargain.
Renters often feel stuck with less-than-ideal living conditions. Maybe the drip, drip, drip of your leaking bathroom faucet is driving you insane. There's an unsightly stain in your living room carpet. Or the paint in your kitchen has gone from crisp white to the dingy yellow of spoiled milk. These aren't huge problems and don't justify a move. But you don't just have to live with them, right?
Landlords Must Fix Major Problems
Your landlord is responsible for keeping your unit in a habitable, or livable, condition. The landlord must keep the structure of the building sound, including stairways, floors, and roofs; keep electrical, heating, and plumbing systems operating safely; supply hot and cold water in reasonable amounts; and exterminate infestations of pests such as cockroaches.
Keep in mind, however, that if a problem is the result of your own carelessness -- such as a vermin infestation caused by your poor housekeeping -- the repair bill will properly be forwarded to you. If you don't pay it, the amount may be taken out of your security deposit.
Landlords May Have to Make Minor Repairs
What about the annoying problems most tenants face, like leaky faucets, old paint, torn screens, or worn flooring? While these types of problems can be unpleasant or inconvenient, they don't make the unit uninhabitable. Does the landlord have to repair them?
Whether your landlord must take care of a minor repair depends upon a number of factors, beginning with the nature of the problem. Purely cosmetic repairs are not legally required. Mildewed grout or worn carpet, for example, are less likely to require a landlord's attention than are loose tiles that make the shower unusable or holes in carpeting that could trip someone.
If you're not sure whether your landlord is legally required to make a repair, check to see if your specific complaint is addressed by:
the terms of your lease
any oral or written promises your landlord has made
state and local building codes, or
state landlord-tenant laws.
How to Get Your Landlord to Make Minor Repairs
It's often harder to enforce your rights to minor repairs than major ones. Tenants in an uninhabitable dwelling are often allowed by law to withhold rent or use "repair and deduct" procedures, but taking those actions for merely minor problems could get you evicted. There are, however, a number of proven strategies for getting landlords to take care of minor problems.
1. Write a repair request. Even if you've already asked your landlord to take care of a problem, a written request is almost always helpful. It gives you a chance to articulate the problem clearly and point out why it's in the landlord's best interest to have it fixed. A letter also allows a reluctant landlord to think it over without having to give you an immediate answer (which often results in a knee-jerk "no").
Try to develop a number of themes in your letter. One effective tactic is to explain that the problem might become worse -- and more costly to the landlord -- if it's not taken care of right away. A landlord might find it easy to ignore your drippy faucet until you point out the possibility of an overflowing sink and water damage to the floors.
Another theme that will grab your landlord's attention is the potential for injury. A hole in the stairway carpeting could cause someone to trip and fall, making the landlord liable for the injury. Landlords are also sensitive to security issues, so be sure to point out any security risks created by your problem, such as a broken lock or faulty hallway light. Finally, if the problem affects other tenants, be sure to emphasize that.
2. Propose mediation. If your oral and written requests are ignored, contact a mediation service, which will invite the landlord to meet with you and a trained mediator. The mediator will help the two of you reach a mutually-acceptable solution, but will not (unlike a judge) impose a solution. Many communities offer free or low-cost mediation services as an alternative to going to court.
3. Report your landlord to your local building or housing agency. Some minor problems may violate local building or housing codes. Call the agency that enforces these codes in your area to find out. (Look under the city or county government listings of your phone book.) Officials at the agency should be able to explain whether your problem violates local or state codes, and may be able to take action against your landlord.
Keep in mind that reporting your landlord won't likely improve your relationship, which may be important to you if you want to stay in your unit for some time. Even state "antiretaliation" laws, which prohibit rent hikes, terminations, or other adverse actions following a tenant's complaint to a government agency or exercise of a legal right, cannot forestall a sour relationship.
4. Sue your landlord in small claims court. If you can prove in court that the unaddressed problems decrease the value of your unit, a judge can award you the difference between what you've been paying in rent and the amount the unit is actually worth. Obviously, suing your landlord is not your best option if you want to salvage your landlord-tenant relationship. But if you've tried everything else and moving elsewhere is not feasible, taking your landlord to court might be the right remedy.
How to get landlords to keep their end of the maintenance bargain.
Renters often feel stuck with less-than-ideal living conditions. Maybe the drip, drip, drip of your leaking bathroom faucet is driving you insane. There's an unsightly stain in your living room carpet. Or the paint in your kitchen has gone from crisp white to the dingy yellow of spoiled milk. These aren't huge problems and don't justify a move. But you don't just have to live with them, right?
Landlords Must Fix Major Problems
Your landlord is responsible for keeping your unit in a habitable, or livable, condition. The landlord must keep the structure of the building sound, including stairways, floors, and roofs; keep electrical, heating, and plumbing systems operating safely; supply hot and cold water in reasonable amounts; and exterminate infestations of pests such as cockroaches.
Keep in mind, however, that if a problem is the result of your own carelessness -- such as a vermin infestation caused by your poor housekeeping -- the repair bill will properly be forwarded to you. If you don't pay it, the amount may be taken out of your security deposit.
Landlords May Have to Make Minor Repairs
What about the annoying problems most tenants face, like leaky faucets, old paint, torn screens, or worn flooring? While these types of problems can be unpleasant or inconvenient, they don't make the unit uninhabitable. Does the landlord have to repair them?
Whether your landlord must take care of a minor repair depends upon a number of factors, beginning with the nature of the problem. Purely cosmetic repairs are not legally required. Mildewed grout or worn carpet, for example, are less likely to require a landlord's attention than are loose tiles that make the shower unusable or holes in carpeting that could trip someone.
If you're not sure whether your landlord is legally required to make a repair, check to see if your specific complaint is addressed by:
the terms of your lease
any oral or written promises your landlord has made
state and local building codes, or
state landlord-tenant laws.
How to Get Your Landlord to Make Minor Repairs
It's often harder to enforce your rights to minor repairs than major ones. Tenants in an uninhabitable dwelling are often allowed by law to withhold rent or use "repair and deduct" procedures, but taking those actions for merely minor problems could get you evicted. There are, however, a number of proven strategies for getting landlords to take care of minor problems.
1. Write a repair request. Even if you've already asked your landlord to take care of a problem, a written request is almost always helpful. It gives you a chance to articulate the problem clearly and point out why it's in the landlord's best interest to have it fixed. A letter also allows a reluctant landlord to think it over without having to give you an immediate answer (which often results in a knee-jerk "no").
Try to develop a number of themes in your letter. One effective tactic is to explain that the problem might become worse -- and more costly to the landlord -- if it's not taken care of right away. A landlord might find it easy to ignore your drippy faucet until you point out the possibility of an overflowing sink and water damage to the floors.
Another theme that will grab your landlord's attention is the potential for injury. A hole in the stairway carpeting could cause someone to trip and fall, making the landlord liable for the injury. Landlords are also sensitive to security issues, so be sure to point out any security risks created by your problem, such as a broken lock or faulty hallway light. Finally, if the problem affects other tenants, be sure to emphasize that.
2. Propose mediation. If your oral and written requests are ignored, contact a mediation service, which will invite the landlord to meet with you and a trained mediator. The mediator will help the two of you reach a mutually-acceptable solution, but will not (unlike a judge) impose a solution. Many communities offer free or low-cost mediation services as an alternative to going to court.
3. Report your landlord to your local building or housing agency. Some minor problems may violate local building or housing codes. Call the agency that enforces these codes in your area to find out. (Look under the city or county government listings of your phone book.) Officials at the agency should be able to explain whether your problem violates local or state codes, and may be able to take action against your landlord.
Keep in mind that reporting your landlord won't likely improve your relationship, which may be important to you if you want to stay in your unit for some time. Even state "antiretaliation" laws, which prohibit rent hikes, terminations, or other adverse actions following a tenant's complaint to a government agency or exercise of a legal right, cannot forestall a sour relationship.
4. Sue your landlord in small claims court. If you can prove in court that the unaddressed problems decrease the value of your unit, a judge can award you the difference between what you've been paying in rent and the amount the unit is actually worth. Obviously, suing your landlord is not your best option if you want to salvage your landlord-tenant relationship. But if you've tried everything else and moving elsewhere is not feasible, taking your landlord to court might be the right remedy.
Wednesday, December 26, 2007
Looking for an End to the Housing Slump
By Amy Hoak From MarketWatch
CHICAGO -- After a year of falling house prices in numerous parts of the country and a meltdown in the mortgage market that affected borrowers regardless of their ZIP code, many hope that housing markets will finally start to get better next year.
But if there's any improvement in 2008, it may be relatively modest.
It's difficult to get a consensus on exactly when housing will turn the corner. Local markets will certainly vary, but at the least it's likely that some of the same problems that plagued 2007 will carry over into next year.
At best, market conditions could start to stabilize, with home sales regaining strength. If more buyers get back into the market, some of the huge inventories of new and existing homes for sale can begin to be worked off.
"The only reason why demand is finding a bottom is because sellers are cutting their prices," said Mark Zandi, chief economist of Moody's Economy.com. "There was a sense that the market would cool -- I don't think there was a sense it would crash. And it crashed."
The National Association of Realtors predicts a slight increase in existing-home sales next year but a decline in new-home sales. Others aren't as optimistic, including the Mortgage Bankers Association, which is predicting that sales won't pick up until 2009.
After the median price for existing homes dropped 1.9% in 2007 to a projected $217,600, NAR forecasts that the median price will rise 0.3% to $218,300 in 2008.
But the MBA is expecting prices of existing homes to decrease 2.93% in 2007 and 2.04% in 2008; new-home prices should decrease 2.72% in 2007 and 1.96% in 2008.
A recent Economy.com report, "Aftershock: Housing in the Wake of the Mortgage Meltdown," predicts home sales will hit bottom in early 2008, with housing starts hitting bottom mid-2008.
But prices will continue to drop, and by early 2009 home prices will have fallen about 13% nationally from their peaks, according to the report. Prices will have fallen more than 15% if nonprice discounts to buyers are taken into account.
Housing's ills
Housing's most fundamental problem, according to the Economy.com report, is the excess of unsold inventory lingering in many of the country's local markets. The supply of homes for sale hit its highest level in 22 years in October, according to NAR.
Overbuilding is a culprit in many markets, and investors who are unloading units bought during the boom are adding to the massive supply, the National Association of Home Builders pointed out in a recent forecast. In December, the group reported that single-family housing starts were down by about 50% from a record high at the beginning of 2006.
"Once we hit bottom ... we're going to stay there for awhile," at least in terms of new construction, predicted Richard F. Moody, chief economist of Mission Residential.
Adding to the already elevated inventories are foreclosures hitting the market. According to the MBA, 1.69% of first-lien mortgages were in the foreclosure process in the third quarter. The percentage was the highest in the survey's history, and the group expects high numbers of foreclosures to continue into next year.
Areas where overall economic conditions were weak, including Michigan and Ohio, drove up the national foreclosure numbers, as did areas where there was much investor speculation, including California, Nevada and Florida. Defaults on adjustable-rate loans -- especially subprime loans made to borrowers with weaker credit histories -- caused a lot of the strain; when the mortgage's teaser period was up, homeowners couldn't keep up with payments.
The mortgage meltdown this summer made it tougher for some borrowers to get a loan, another stumbling block in this housing market. In particular, nonconforming loans, which can't be bought by government-sponsored mortgage agencies Freddie Mac or Fannie Mae, were harder or more expensive to come by.
Many borrowers with good credit and a decent down payment were fine, but subprime loans, intended for borrowers with poor credit histories, became a thing of the past. Alt-A loans, which required little or no documentation, became a rarity. And rates on jumbo loans went through the roof, making it tougher for home buyers in expensive markets.
Some borrowers who could qualify for a Federal Housing Administration insured loan turned to those, and proposed FHA modernization may help some borrowers even more. But in the second half of the year, the credit disruptions slowed down an already sluggish market.
Waiting for the rebound
Rick Loughlin thought the Boston market appeared to be "really coming alive" this summer.
"Then we had the mortgage crisis," said Loughlin, chairman of the Greater Boston Real Estate Board and president of Coldwell Banker Residential Brokerage New England. The borrowing ability of many individuals took a hit, reducing the number of buyers able to enter the market and stranding homeowners looking to trade up.
The lending landscape isn't likely to change much in the near term, with no-documentation and low-down payment loans remaining harder to come by, Moody said.
Perhaps the only bright spot in the mortgage arena this year was low interest rates on conforming loans. The average rate on the 30-year fixed-rate mortgage fell below 6% at one point in December; NAR expects the 30-year to rise to about 6.4% by the end of 2008.
The low rates "should have provided a lift to home sales, but it has not," said Lawrence Yun, NAR's chief economist. That indicates to him that the elevated cost of jumbo loans is still taking a toll. If conforming loan limits were raised to accommodate expensive markets, it could have a greater impact on housing than the current low conforming rates have, he said.
Sitting on the sidelines
The home price drops encouraged a number of people to put home buying decisions on hold. In some of the most sluggish markets, sellers who don't absolutely need to sell aren't attempting to do so; those who do are offering price cuts and concessions to make the deal.
"A lot of buyers and investors are sitting on the sidelines. They feel unsure what is happening in the marketplace," said Devin Reiss, president of the Greater Las Vegas Association of Realtors. Some mistakenly think that it's impossible for anyone to get a mortgage nowadays, even with good credit, he said. Often, however, fears revolve around the undesirable scenario of buying a home only to watch it decrease in value a short time later.
His advice for bargain hunters: Don't wait too long.
"If we start to see demand go up and supply go down, prices will go (up) with it," he said.
But probably the best advice is to know your market before making any kind of move.
"A hallmark of the downturn is how broad it is across the country," said Economy.com's Zandi. But even in poor-performing markets there could be good neighborhoods, he said, adding that housing conditions vary "block to block."
NAR reported that 93 out of 150 metropolitan areas showed increases in median existing single-family home prices during the third quarter of 2007, compared with 2006, even though price drops in other areas brought down the national median price.
Still, Bob McNamera, a real-estate agent with Pasquesi Realty in Chicago, said that some people are staying out of the market based on what they hear about general trends.
"They hear it's a bad market, and don't do any more homework," he said. First-time buyers, however, with a down payment and decent credit, could find bargains, he added.
Even in Stockton, Calif., an area hard-hit by foreclosures, Renee Becker, a Realtor and vice president of Beck Realtors, has hope for next year. The deals in the foreclosure inventory might bring back more investors and help fuel a slow and gradual recovery, she said.
CHICAGO -- After a year of falling house prices in numerous parts of the country and a meltdown in the mortgage market that affected borrowers regardless of their ZIP code, many hope that housing markets will finally start to get better next year.
But if there's any improvement in 2008, it may be relatively modest.
It's difficult to get a consensus on exactly when housing will turn the corner. Local markets will certainly vary, but at the least it's likely that some of the same problems that plagued 2007 will carry over into next year.
At best, market conditions could start to stabilize, with home sales regaining strength. If more buyers get back into the market, some of the huge inventories of new and existing homes for sale can begin to be worked off.
"The only reason why demand is finding a bottom is because sellers are cutting their prices," said Mark Zandi, chief economist of Moody's Economy.com. "There was a sense that the market would cool -- I don't think there was a sense it would crash. And it crashed."
The National Association of Realtors predicts a slight increase in existing-home sales next year but a decline in new-home sales. Others aren't as optimistic, including the Mortgage Bankers Association, which is predicting that sales won't pick up until 2009.
After the median price for existing homes dropped 1.9% in 2007 to a projected $217,600, NAR forecasts that the median price will rise 0.3% to $218,300 in 2008.
But the MBA is expecting prices of existing homes to decrease 2.93% in 2007 and 2.04% in 2008; new-home prices should decrease 2.72% in 2007 and 1.96% in 2008.
A recent Economy.com report, "Aftershock: Housing in the Wake of the Mortgage Meltdown," predicts home sales will hit bottom in early 2008, with housing starts hitting bottom mid-2008.
But prices will continue to drop, and by early 2009 home prices will have fallen about 13% nationally from their peaks, according to the report. Prices will have fallen more than 15% if nonprice discounts to buyers are taken into account.
Housing's ills
Housing's most fundamental problem, according to the Economy.com report, is the excess of unsold inventory lingering in many of the country's local markets. The supply of homes for sale hit its highest level in 22 years in October, according to NAR.
Overbuilding is a culprit in many markets, and investors who are unloading units bought during the boom are adding to the massive supply, the National Association of Home Builders pointed out in a recent forecast. In December, the group reported that single-family housing starts were down by about 50% from a record high at the beginning of 2006.
"Once we hit bottom ... we're going to stay there for awhile," at least in terms of new construction, predicted Richard F. Moody, chief economist of Mission Residential.
Adding to the already elevated inventories are foreclosures hitting the market. According to the MBA, 1.69% of first-lien mortgages were in the foreclosure process in the third quarter. The percentage was the highest in the survey's history, and the group expects high numbers of foreclosures to continue into next year.
Areas where overall economic conditions were weak, including Michigan and Ohio, drove up the national foreclosure numbers, as did areas where there was much investor speculation, including California, Nevada and Florida. Defaults on adjustable-rate loans -- especially subprime loans made to borrowers with weaker credit histories -- caused a lot of the strain; when the mortgage's teaser period was up, homeowners couldn't keep up with payments.
The mortgage meltdown this summer made it tougher for some borrowers to get a loan, another stumbling block in this housing market. In particular, nonconforming loans, which can't be bought by government-sponsored mortgage agencies Freddie Mac or Fannie Mae, were harder or more expensive to come by.
Many borrowers with good credit and a decent down payment were fine, but subprime loans, intended for borrowers with poor credit histories, became a thing of the past. Alt-A loans, which required little or no documentation, became a rarity. And rates on jumbo loans went through the roof, making it tougher for home buyers in expensive markets.
Some borrowers who could qualify for a Federal Housing Administration insured loan turned to those, and proposed FHA modernization may help some borrowers even more. But in the second half of the year, the credit disruptions slowed down an already sluggish market.
Waiting for the rebound
Rick Loughlin thought the Boston market appeared to be "really coming alive" this summer.
"Then we had the mortgage crisis," said Loughlin, chairman of the Greater Boston Real Estate Board and president of Coldwell Banker Residential Brokerage New England. The borrowing ability of many individuals took a hit, reducing the number of buyers able to enter the market and stranding homeowners looking to trade up.
The lending landscape isn't likely to change much in the near term, with no-documentation and low-down payment loans remaining harder to come by, Moody said.
Perhaps the only bright spot in the mortgage arena this year was low interest rates on conforming loans. The average rate on the 30-year fixed-rate mortgage fell below 6% at one point in December; NAR expects the 30-year to rise to about 6.4% by the end of 2008.
The low rates "should have provided a lift to home sales, but it has not," said Lawrence Yun, NAR's chief economist. That indicates to him that the elevated cost of jumbo loans is still taking a toll. If conforming loan limits were raised to accommodate expensive markets, it could have a greater impact on housing than the current low conforming rates have, he said.
Sitting on the sidelines
The home price drops encouraged a number of people to put home buying decisions on hold. In some of the most sluggish markets, sellers who don't absolutely need to sell aren't attempting to do so; those who do are offering price cuts and concessions to make the deal.
"A lot of buyers and investors are sitting on the sidelines. They feel unsure what is happening in the marketplace," said Devin Reiss, president of the Greater Las Vegas Association of Realtors. Some mistakenly think that it's impossible for anyone to get a mortgage nowadays, even with good credit, he said. Often, however, fears revolve around the undesirable scenario of buying a home only to watch it decrease in value a short time later.
His advice for bargain hunters: Don't wait too long.
"If we start to see demand go up and supply go down, prices will go (up) with it," he said.
But probably the best advice is to know your market before making any kind of move.
"A hallmark of the downturn is how broad it is across the country," said Economy.com's Zandi. But even in poor-performing markets there could be good neighborhoods, he said, adding that housing conditions vary "block to block."
NAR reported that 93 out of 150 metropolitan areas showed increases in median existing single-family home prices during the third quarter of 2007, compared with 2006, even though price drops in other areas brought down the national median price.
Still, Bob McNamera, a real-estate agent with Pasquesi Realty in Chicago, said that some people are staying out of the market based on what they hear about general trends.
"They hear it's a bad market, and don't do any more homework," he said. First-time buyers, however, with a down payment and decent credit, could find bargains, he added.
Even in Stockton, Calif., an area hard-hit by foreclosures, Renee Becker, a Realtor and vice president of Beck Realtors, has hope for next year. The deals in the foreclosure inventory might bring back more investors and help fuel a slow and gradual recovery, she said.
Looking for an End to the Housing Slump
By Amy Hoak From MarketWatch
CHICAGO -- After a year of falling house prices in numerous parts of the country and a meltdown in the mortgage market that affected borrowers regardless of their ZIP code, many hope that housing markets will finally start to get better next year.
But if there's any improvement in 2008, it may be relatively modest.
It's difficult to get a consensus on exactly when housing will turn the corner. Local markets will certainly vary, but at the least it's likely that some of the same problems that plagued 2007 will carry over into next year.
At best, market conditions could start to stabilize, with home sales regaining strength. If more buyers get back into the market, some of the huge inventories of new and existing homes for sale can begin to be worked off.
"The only reason why demand is finding a bottom is because sellers are cutting their prices," said Mark Zandi, chief economist of Moody's Economy.com. "There was a sense that the market would cool -- I don't think there was a sense it would crash. And it crashed."
The National Association of Realtors predicts a slight increase in existing-home sales next year but a decline in new-home sales. Others aren't as optimistic, including the Mortgage Bankers Association, which is predicting that sales won't pick up until 2009.
After the median price for existing homes dropped 1.9% in 2007 to a projected $217,600, NAR forecasts that the median price will rise 0.3% to $218,300 in 2008.
But the MBA is expecting prices of existing homes to decrease 2.93% in 2007 and 2.04% in 2008; new-home prices should decrease 2.72% in 2007 and 1.96% in 2008.
A recent Economy.com report, "Aftershock: Housing in the Wake of the Mortgage Meltdown," predicts home sales will hit bottom in early 2008, with housing starts hitting bottom mid-2008.
But prices will continue to drop, and by early 2009 home prices will have fallen about 13% nationally from their peaks, according to the report. Prices will have fallen more than 15% if nonprice discounts to buyers are taken into account.
Housing's ills
Housing's most fundamental problem, according to the Economy.com report, is the excess of unsold inventory lingering in many of the country's local markets. The supply of homes for sale hit its highest level in 22 years in October, according to NAR.
Overbuilding is a culprit in many markets, and investors who are unloading units bought during the boom are adding to the massive supply, the National Association of Home Builders pointed out in a recent forecast. In December, the group reported that single-family housing starts were down by about 50% from a record high at the beginning of 2006.
"Once we hit bottom ... we're going to stay there for awhile," at least in terms of new construction, predicted Richard F. Moody, chief economist of Mission Residential.
Adding to the already elevated inventories are foreclosures hitting the market. According to the MBA, 1.69% of first-lien mortgages were in the foreclosure process in the third quarter. The percentage was the highest in the survey's history, and the group expects high numbers of foreclosures to continue into next year.
Areas where overall economic conditions were weak, including Michigan and Ohio, drove up the national foreclosure numbers, as did areas where there was much investor speculation, including California, Nevada and Florida. Defaults on adjustable-rate loans -- especially subprime loans made to borrowers with weaker credit histories -- caused a lot of the strain; when the mortgage's teaser period was up, homeowners couldn't keep up with payments.
The mortgage meltdown this summer made it tougher for some borrowers to get a loan, another stumbling block in this housing market. In particular, nonconforming loans, which can't be bought by government-sponsored mortgage agencies Freddie Mac or Fannie Mae, were harder or more expensive to come by.
Many borrowers with good credit and a decent down payment were fine, but subprime loans, intended for borrowers with poor credit histories, became a thing of the past. Alt-A loans, which required little or no documentation, became a rarity. And rates on jumbo loans went through the roof, making it tougher for home buyers in expensive markets.
Some borrowers who could qualify for a Federal Housing Administration insured loan turned to those, and proposed FHA modernization may help some borrowers even more. But in the second half of the year, the credit disruptions slowed down an already sluggish market.
Waiting for the rebound
Rick Loughlin thought the Boston market appeared to be "really coming alive" this summer.
"Then we had the mortgage crisis," said Loughlin, chairman of the Greater Boston Real Estate Board and president of Coldwell Banker Residential Brokerage New England. The borrowing ability of many individuals took a hit, reducing the number of buyers able to enter the market and stranding homeowners looking to trade up.
The lending landscape isn't likely to change much in the near term, with no-documentation and low-down payment loans remaining harder to come by, Moody said.
Perhaps the only bright spot in the mortgage arena this year was low interest rates on conforming loans. The average rate on the 30-year fixed-rate mortgage fell below 6% at one point in December; NAR expects the 30-year to rise to about 6.4% by the end of 2008.
The low rates "should have provided a lift to home sales, but it has not," said Lawrence Yun, NAR's chief economist. That indicates to him that the elevated cost of jumbo loans is still taking a toll. If conforming loan limits were raised to accommodate expensive markets, it could have a greater impact on housing than the current low conforming rates have, he said.
Sitting on the sidelines
The home price drops encouraged a number of people to put home buying decisions on hold. In some of the most sluggish markets, sellers who don't absolutely need to sell aren't attempting to do so; those who do are offering price cuts and concessions to make the deal.
"A lot of buyers and investors are sitting on the sidelines. They feel unsure what is happening in the marketplace," said Devin Reiss, president of the Greater Las Vegas Association of Realtors. Some mistakenly think that it's impossible for anyone to get a mortgage nowadays, even with good credit, he said. Often, however, fears revolve around the undesirable scenario of buying a home only to watch it decrease in value a short time later.
His advice for bargain hunters: Don't wait too long.
"If we start to see demand go up and supply go down, prices will go (up) with it," he said.
But probably the best advice is to know your market before making any kind of move.
"A hallmark of the downturn is how broad it is across the country," said Economy.com's Zandi. But even in poor-performing markets there could be good neighborhoods, he said, adding that housing conditions vary "block to block."
NAR reported that 93 out of 150 metropolitan areas showed increases in median existing single-family home prices during the third quarter of 2007, compared with 2006, even though price drops in other areas brought down the national median price.
Still, Bob McNamera, a real-estate agent with Pasquesi Realty in Chicago, said that some people are staying out of the market based on what they hear about general trends.
"They hear it's a bad market, and don't do any more homework," he said. First-time buyers, however, with a down payment and decent credit, could find bargains, he added.
Even in Stockton, Calif., an area hard-hit by foreclosures, Renee Becker, a Realtor and vice president of Beck Realtors, has hope for next year. The deals in the foreclosure inventory might bring back more investors and help fuel a slow and gradual recovery, she said.
CHICAGO -- After a year of falling house prices in numerous parts of the country and a meltdown in the mortgage market that affected borrowers regardless of their ZIP code, many hope that housing markets will finally start to get better next year.
But if there's any improvement in 2008, it may be relatively modest.
It's difficult to get a consensus on exactly when housing will turn the corner. Local markets will certainly vary, but at the least it's likely that some of the same problems that plagued 2007 will carry over into next year.
At best, market conditions could start to stabilize, with home sales regaining strength. If more buyers get back into the market, some of the huge inventories of new and existing homes for sale can begin to be worked off.
"The only reason why demand is finding a bottom is because sellers are cutting their prices," said Mark Zandi, chief economist of Moody's Economy.com. "There was a sense that the market would cool -- I don't think there was a sense it would crash. And it crashed."
The National Association of Realtors predicts a slight increase in existing-home sales next year but a decline in new-home sales. Others aren't as optimistic, including the Mortgage Bankers Association, which is predicting that sales won't pick up until 2009.
After the median price for existing homes dropped 1.9% in 2007 to a projected $217,600, NAR forecasts that the median price will rise 0.3% to $218,300 in 2008.
But the MBA is expecting prices of existing homes to decrease 2.93% in 2007 and 2.04% in 2008; new-home prices should decrease 2.72% in 2007 and 1.96% in 2008.
A recent Economy.com report, "Aftershock: Housing in the Wake of the Mortgage Meltdown," predicts home sales will hit bottom in early 2008, with housing starts hitting bottom mid-2008.
But prices will continue to drop, and by early 2009 home prices will have fallen about 13% nationally from their peaks, according to the report. Prices will have fallen more than 15% if nonprice discounts to buyers are taken into account.
Housing's ills
Housing's most fundamental problem, according to the Economy.com report, is the excess of unsold inventory lingering in many of the country's local markets. The supply of homes for sale hit its highest level in 22 years in October, according to NAR.
Overbuilding is a culprit in many markets, and investors who are unloading units bought during the boom are adding to the massive supply, the National Association of Home Builders pointed out in a recent forecast. In December, the group reported that single-family housing starts were down by about 50% from a record high at the beginning of 2006.
"Once we hit bottom ... we're going to stay there for awhile," at least in terms of new construction, predicted Richard F. Moody, chief economist of Mission Residential.
Adding to the already elevated inventories are foreclosures hitting the market. According to the MBA, 1.69% of first-lien mortgages were in the foreclosure process in the third quarter. The percentage was the highest in the survey's history, and the group expects high numbers of foreclosures to continue into next year.
Areas where overall economic conditions were weak, including Michigan and Ohio, drove up the national foreclosure numbers, as did areas where there was much investor speculation, including California, Nevada and Florida. Defaults on adjustable-rate loans -- especially subprime loans made to borrowers with weaker credit histories -- caused a lot of the strain; when the mortgage's teaser period was up, homeowners couldn't keep up with payments.
The mortgage meltdown this summer made it tougher for some borrowers to get a loan, another stumbling block in this housing market. In particular, nonconforming loans, which can't be bought by government-sponsored mortgage agencies Freddie Mac or Fannie Mae, were harder or more expensive to come by.
Many borrowers with good credit and a decent down payment were fine, but subprime loans, intended for borrowers with poor credit histories, became a thing of the past. Alt-A loans, which required little or no documentation, became a rarity. And rates on jumbo loans went through the roof, making it tougher for home buyers in expensive markets.
Some borrowers who could qualify for a Federal Housing Administration insured loan turned to those, and proposed FHA modernization may help some borrowers even more. But in the second half of the year, the credit disruptions slowed down an already sluggish market.
Waiting for the rebound
Rick Loughlin thought the Boston market appeared to be "really coming alive" this summer.
"Then we had the mortgage crisis," said Loughlin, chairman of the Greater Boston Real Estate Board and president of Coldwell Banker Residential Brokerage New England. The borrowing ability of many individuals took a hit, reducing the number of buyers able to enter the market and stranding homeowners looking to trade up.
The lending landscape isn't likely to change much in the near term, with no-documentation and low-down payment loans remaining harder to come by, Moody said.
Perhaps the only bright spot in the mortgage arena this year was low interest rates on conforming loans. The average rate on the 30-year fixed-rate mortgage fell below 6% at one point in December; NAR expects the 30-year to rise to about 6.4% by the end of 2008.
The low rates "should have provided a lift to home sales, but it has not," said Lawrence Yun, NAR's chief economist. That indicates to him that the elevated cost of jumbo loans is still taking a toll. If conforming loan limits were raised to accommodate expensive markets, it could have a greater impact on housing than the current low conforming rates have, he said.
Sitting on the sidelines
The home price drops encouraged a number of people to put home buying decisions on hold. In some of the most sluggish markets, sellers who don't absolutely need to sell aren't attempting to do so; those who do are offering price cuts and concessions to make the deal.
"A lot of buyers and investors are sitting on the sidelines. They feel unsure what is happening in the marketplace," said Devin Reiss, president of the Greater Las Vegas Association of Realtors. Some mistakenly think that it's impossible for anyone to get a mortgage nowadays, even with good credit, he said. Often, however, fears revolve around the undesirable scenario of buying a home only to watch it decrease in value a short time later.
His advice for bargain hunters: Don't wait too long.
"If we start to see demand go up and supply go down, prices will go (up) with it," he said.
But probably the best advice is to know your market before making any kind of move.
"A hallmark of the downturn is how broad it is across the country," said Economy.com's Zandi. But even in poor-performing markets there could be good neighborhoods, he said, adding that housing conditions vary "block to block."
NAR reported that 93 out of 150 metropolitan areas showed increases in median existing single-family home prices during the third quarter of 2007, compared with 2006, even though price drops in other areas brought down the national median price.
Still, Bob McNamera, a real-estate agent with Pasquesi Realty in Chicago, said that some people are staying out of the market based on what they hear about general trends.
"They hear it's a bad market, and don't do any more homework," he said. First-time buyers, however, with a down payment and decent credit, could find bargains, he added.
Even in Stockton, Calif., an area hard-hit by foreclosures, Renee Becker, a Realtor and vice president of Beck Realtors, has hope for next year. The deals in the foreclosure inventory might bring back more investors and help fuel a slow and gradual recovery, she said.
Saturday, November 24, 2007
Which is the Better Investment: A House or a Town Home?
By June Fletcher From The Wall Street Journal Online
Question: I can't decide whether I should buy a town house or a single-family home that's about the same size. Which appreciates faster?
June Fletcher: Pop quiz: What's the difference between a town house and a condominium?
Answer: The truth is, sometimes they're the same and sometimes not.
The answer matters because some local data collectors arbitrarily group price and sales statistics on town houses with those of single-family detached homes; others include them with condominiums. Either way, it's likely that at least some town-house developments in any city have been put into the wrong group.
The confusion comes because a town house, which is simply a multi-story, attached residence, can be owned one of two ways -- either with or without the lot. If the developer includes the town house's lot in the sale, ownership is "freehold" or "fee simple," just like most single-family detached homes. If the lot isn't included in the sale, the town-house development is considered either a condominium -- where owners own everything up to party (or shared) walls individually, but share ownership of the land and common elements like pools and swimming pools with other neighbors -- or a co-op, where individuals receive a fractional stake in buildings, land and common elements that are owned and controlled by an association.
The way a property is owned has a big impact on payments for insurance, maintenance and homeowners' association fees. So it doesn't make much sense to try to compare a condominium or co-op town house with a fee-simple single-family house merely on the base of purchase price.
Other factors, like finishes, location and demographics, muddy the comparison, too. For instance, will a 2,000-square-foot urban town house with granite countertops, crown molding and marble floors, targeted to empty-nesters, build up equity faster than a same-sized house with a big yard way out in the suburbs, built for young families? It depends on whether there are more empty-nesters in the area looking for homes at the time you want to sell, or more young families.
If you have already narrowed your search to a particular town house and single-family house, it may be worthwhile to check public records at your local municipality or online. But don't assume that these rates will be constant forever (even though some economists make that very assumption when they make their pricing prognostications). A change in traffic patterns that creates gridlock might make an urban town house more valuable to buyers in the future than a comparable suburban tract house; conversely, an uptick in crime in a neighborhood may cause buyers to flee to the 'burbs. Since such events are inherently unpredictable, you might as well just buy the house that you like best.
Question: I can't decide whether I should buy a town house or a single-family home that's about the same size. Which appreciates faster?
June Fletcher: Pop quiz: What's the difference between a town house and a condominium?
Answer: The truth is, sometimes they're the same and sometimes not.
The answer matters because some local data collectors arbitrarily group price and sales statistics on town houses with those of single-family detached homes; others include them with condominiums. Either way, it's likely that at least some town-house developments in any city have been put into the wrong group.
The confusion comes because a town house, which is simply a multi-story, attached residence, can be owned one of two ways -- either with or without the lot. If the developer includes the town house's lot in the sale, ownership is "freehold" or "fee simple," just like most single-family detached homes. If the lot isn't included in the sale, the town-house development is considered either a condominium -- where owners own everything up to party (or shared) walls individually, but share ownership of the land and common elements like pools and swimming pools with other neighbors -- or a co-op, where individuals receive a fractional stake in buildings, land and common elements that are owned and controlled by an association.
The way a property is owned has a big impact on payments for insurance, maintenance and homeowners' association fees. So it doesn't make much sense to try to compare a condominium or co-op town house with a fee-simple single-family house merely on the base of purchase price.
Other factors, like finishes, location and demographics, muddy the comparison, too. For instance, will a 2,000-square-foot urban town house with granite countertops, crown molding and marble floors, targeted to empty-nesters, build up equity faster than a same-sized house with a big yard way out in the suburbs, built for young families? It depends on whether there are more empty-nesters in the area looking for homes at the time you want to sell, or more young families.
If you have already narrowed your search to a particular town house and single-family house, it may be worthwhile to check public records at your local municipality or online. But don't assume that these rates will be constant forever (even though some economists make that very assumption when they make their pricing prognostications). A change in traffic patterns that creates gridlock might make an urban town house more valuable to buyers in the future than a comparable suburban tract house; conversely, an uptick in crime in a neighborhood may cause buyers to flee to the 'burbs. Since such events are inherently unpredictable, you might as well just buy the house that you like best.
Friday, November 23, 2007
Nearing Foreclosure? Chapter 13 Delivers Foreclosure Alternative
November 7, 2007 Rocky Mountain News
Facing rising mortgage payments and a weaker housing market, more Coloradans are turning to Chapter 13 bankruptcy to try to avoid losing their homes.
"Given the dramatic spike in foreclosures, we're seeing a lot more people coming in saying, 'I want to save my house, but my mortgage has adjusted, what can I do?' " Denver-based bankruptcy lawyer Tara Gaschler said.
In a year that could set a state record with more than 40,000 foreclosures, many people had mortgages with low introductory rates that are being reset higher.
"Now they're in over their heads," Gaschler said.
Chapter 13 can allow people to pay off mortgage and other debts over three to five years and to avert foreclosure. For those who have fallen behind because of sickness, job loss or a one-time setback but have steady income, Chapter 13 represents "a chance to get caught up and hold on to their property," she said.
Chapter 7, she said, means liquidation, and in many cases debtors can kiss their homes goodbye, even if a filing puts a temporary freeze on a foreclosure.
Still, many people across the state are in too deep of a hole to hold on to their residences, and a bankruptcy filing will be a stain on their records, affecting their ability to get financing.
Lawyer Larry Carroll said 20 percent of the cash- strapped Coloradans walking into his office end up entering Chapter 13 - double the traditional level - but many of them who are hoping to stave off foreclosure ultimately fail.
When monthly mortgage costs increase, clients usually cannot keep pace, he said. For primary residences, mortgage terms cannot be modified in bankruptcy, he noted.
"People expected an ever-appreciating home real estate market," the attorney said.
This year, Chapter 13 filings account for about 16 percent of all Colorado bankruptcy cases, up from 10 percent in 2003 and 2004, before new legislation sparked a frantic rush to the courthouse.
The number of bankruptcy cases in Colorado soared to 43,100 in 2005 as people raced to beat the deadline; the number fell sharply to roughly 9,700 in 2006. Many who would have waited to file in 2006 chose to do so earlier, and others may have been led to believe bankruptcy was no longer an option. Now the case load is increasing again, with the 2007 figure nearing 15,000, up 60 percent from last year.
Before long, the volume could return to the levels seen before the new law made headlines.
Grand Junction and the Western Slope - where the economy has flourished amid an energy boom - make up 4 percent of all the state's bankruptcy cases, down from about 9 percent in 2001.
The stricter bankruptcy law was designed to steer more people from Chapter 7 into Chapter 13. The former wipes out debts such as credit card and medical bills after certain assets have been forfeited, providing a "clean start." The latter requires debtors to adhere to a repayment schedule. Banks and credit card companies backed the law, arguing that people too often abused the system. Consumer advocates said those financial firms are to blame for Americans' huge debt.
The legislation also implemented a "means" test, gauging a consumer's ability to repay their obligations. Those deemed to have insufficient assets or income still can file for Chapter 7.
The law isn't as restrictive as many expected. More than 90 percent of the people who met the Chapter 7 criteria yesterday still do today, experts said.
"The 2005 media blitz created the perception that it was no longer available or only as a last extreme," said Brad Bolton, clerk of the Colorado bankruptcy court. "That's simply not true, and people are discovering that."
"Consumers ought to know it's still accessible," Bolton added. "It hasn't changed significantly or impacted most people, other than requiring a little more work up front."
Bankruptcy lawyer Gaschler said plenty of Coloradans looking at Chapter 13 as a way to stay off the long foreclosure line are bound to be disappointed.
"The real key to Chapter 13 is the ability to be able to have some sort of steady income," she said. "If you are $15,000 behind on your mortgage, and you can't make regular payments, it might be time to face the facts."
Facing rising mortgage payments and a weaker housing market, more Coloradans are turning to Chapter 13 bankruptcy to try to avoid losing their homes.
"Given the dramatic spike in foreclosures, we're seeing a lot more people coming in saying, 'I want to save my house, but my mortgage has adjusted, what can I do?' " Denver-based bankruptcy lawyer Tara Gaschler said.
In a year that could set a state record with more than 40,000 foreclosures, many people had mortgages with low introductory rates that are being reset higher.
"Now they're in over their heads," Gaschler said.
Chapter 13 can allow people to pay off mortgage and other debts over three to five years and to avert foreclosure. For those who have fallen behind because of sickness, job loss or a one-time setback but have steady income, Chapter 13 represents "a chance to get caught up and hold on to their property," she said.
Chapter 7, she said, means liquidation, and in many cases debtors can kiss their homes goodbye, even if a filing puts a temporary freeze on a foreclosure.
Still, many people across the state are in too deep of a hole to hold on to their residences, and a bankruptcy filing will be a stain on their records, affecting their ability to get financing.
Lawyer Larry Carroll said 20 percent of the cash- strapped Coloradans walking into his office end up entering Chapter 13 - double the traditional level - but many of them who are hoping to stave off foreclosure ultimately fail.
When monthly mortgage costs increase, clients usually cannot keep pace, he said. For primary residences, mortgage terms cannot be modified in bankruptcy, he noted.
"People expected an ever-appreciating home real estate market," the attorney said.
This year, Chapter 13 filings account for about 16 percent of all Colorado bankruptcy cases, up from 10 percent in 2003 and 2004, before new legislation sparked a frantic rush to the courthouse.
The number of bankruptcy cases in Colorado soared to 43,100 in 2005 as people raced to beat the deadline; the number fell sharply to roughly 9,700 in 2006. Many who would have waited to file in 2006 chose to do so earlier, and others may have been led to believe bankruptcy was no longer an option. Now the case load is increasing again, with the 2007 figure nearing 15,000, up 60 percent from last year.
Before long, the volume could return to the levels seen before the new law made headlines.
Grand Junction and the Western Slope - where the economy has flourished amid an energy boom - make up 4 percent of all the state's bankruptcy cases, down from about 9 percent in 2001.
The stricter bankruptcy law was designed to steer more people from Chapter 7 into Chapter 13. The former wipes out debts such as credit card and medical bills after certain assets have been forfeited, providing a "clean start." The latter requires debtors to adhere to a repayment schedule. Banks and credit card companies backed the law, arguing that people too often abused the system. Consumer advocates said those financial firms are to blame for Americans' huge debt.
The legislation also implemented a "means" test, gauging a consumer's ability to repay their obligations. Those deemed to have insufficient assets or income still can file for Chapter 7.
The law isn't as restrictive as many expected. More than 90 percent of the people who met the Chapter 7 criteria yesterday still do today, experts said.
"The 2005 media blitz created the perception that it was no longer available or only as a last extreme," said Brad Bolton, clerk of the Colorado bankruptcy court. "That's simply not true, and people are discovering that."
"Consumers ought to know it's still accessible," Bolton added. "It hasn't changed significantly or impacted most people, other than requiring a little more work up front."
Bankruptcy lawyer Gaschler said plenty of Coloradans looking at Chapter 13 as a way to stay off the long foreclosure line are bound to be disappointed.
"The real key to Chapter 13 is the ability to be able to have some sort of steady income," she said. "If you are $15,000 behind on your mortgage, and you can't make regular payments, it might be time to face the facts."
Thursday, October 04, 2007
Real Estate Woes Help Apartment REITS
By Alex Frangos From The Wall Street Journal
When the music stopped in the residential-real-estate market, speculators who got caught with unsold houses and condos began putting them on the market as rentals. This "shadow market" has made investors jittery about price-destroying competition for the real-estate investment trusts that own big apartment complexes.
For most of the country, though, it is a landlords' market, with vacancy rates falling and rents rising in many major cities. Despite a selloff in apartment REITs, the shadow market is really confined to real-estate disaster areas such as Florida, Las Vegas and Phoenix. That presents a buying opportunity for stock-market investors.
Figures scheduled to be released today by New York-based research firm Reis Inc. show that the nation's apartment-vacancy rate dropped 0.2 percentage point in the third quarter, while rents increased a healthy 1.4%.
Apartment owners in high-price cities such as San Francisco and New York seem to be benefiting from renters who are getting locked out of the for-sale market because of the lack of so-called jumbo mortgages, which are more than $417,000, says Sam Chandan, Reis chief economist. Rents in New York jumped 3.6% in the third quarter. In San Francisco, they were up 3.4%.
That is all good news for publicly traded REITs that specialize in apartments.
REITs are real-estate companies that pay no corporate income tax and distribute at least 90% of their earnings in dividends. Apartment-company stocks have suffered compared with their real-estate rivals. The Dow Jones Apartment REIT subindex is down 8.6% year-to-date, though the stocks have rallied in the past month. The overall Dow Jones Equity REIT index, which includes hotels, retail, self-storage and office properties, is down just 2.8%.
The stocks of apartment-owning REITs have a lot going for them. Nearly two million rental households have entered the market in the past two years, including buyers who have shied away from the for-sale housing market and those who defaulted on home mortgages.
"That's equivalent to filling up New York City," says Raymond Torto, principal of CBRE Torto Wheaton Research, a real-estate research firm.
Some companies say investors haven't recognized that apartments, in some cases, behave in opposition to single-family homes, absorbing the decline in home ownership and lack of affordability. "They clump it all together," says Richard Campo, chief executive of Camden Property Trust, a Houston-based apartment REIT. Camden's stock is down 11.5% this year, closing yesterday's session on the New York Stock Exchange at $65.35, up $1.55, or 2.4%.
The supply of apartment buildings has been constrained by below-average construction of units, less than 100,000 units a year in the past few years in the top markets, according to Reis. And the echo boom -- the demographic bulge made up of baby-boomer offspring -- is entering prime renting age.
"In our view, we will have more additional demand for renters than additional supply of rental property," says James Corl, chief investment officer at Cohen & Steers, a New York investment firm specializing in REITs. It has about $35 billion under management.
It is easy to understand why investors have been nervous about apartment REITs. For one, it is difficult to assess the impact of the shadow market because there isn't an accurate measure of the number of individual homes and condominiums that are on the rental market.
"It's my greatest frustration," says apartment analyst Craig Leupold of Green Street Advisors Inc., a Newport Beach, Calif., real-estate research firm. "I'd love to get better data on how many vacant single-family homes are for rent."
James Kammert, portfolio manager at Transwestern Securities Management, a Chicago-based asset manager with about $250 million in the REIT sector, says the discounts are "quite attractive in the apartment space." He says the value of apartment buildings may hold up because apartment REITs can access commercial-mortgage loans from Fannie Mae and Freddie Mac. Property owners in other sectors can't, and are thus more exposed to the recent credit crunch. Still, there clearly are risks for apartment REITs, the biggest being an economic slowdown that could reduce demand for apartments.
The most attractive REITs are trading below the total value of the apartment buildings they own and are cheaper than their competitors based on their projected funds from operations, which is essentially their profit excluding depreciation expenses.
For example, the share price of the largest apartment company, Denver-based Apartment Investment & Management Co., with 1,200 apartment complexes and 209,000 units, is down 15% this year and has been sold off to the point that it looks cheap. Aimco is trading at a 24% discount to its net asset value. What's more, it trades at 13.5 times its 2007 estimated funds from operations, compared with 21.2 times for the apartment sector. In 4 p.m. trading yesterday on the Big Board, Aimco's shares were up $1.05, or 2.3%, to $43.74.
Another to consider: AvalonBay Communities Inc., based in Alexandria, Va. With a high-end portfolio of buildings in hard-to-build urban markets, AvalonBay is trading at a 7.4% discount to net asset value, though its funds-from-operations multiple is an above-average 25.2. Its shares closed yesterday on the NYSE at $122.09, up $2.60, or 2.2%.
There are bargains throughout the sector. According to BMO Capital Markets, apartment REITs overall are trading at a 10% discount to net asset value. That discount would be even more but for the takeover of one of the largest apartment REITs, Archstone-Smith Operating Trust, whose stock price has stayed relatively high since it agreed to a buyout in May and closed yesterday at $59.95, down 23 cents on the Big Board. That deal is scheduled to close Friday.
Camden's Mr. Campo says the shadow market has had a sizable effect on his company's apartments. But there also is a flip side: Camden is recruiting failed homeowners to rent its apartments.
"They're pretty good renters," he says of foreclosed-upon homeowners. "But they didn't realize what the total cost of ownership really meant. We are marketing to those people as long as they have reasonable credit minus the foreclosure," he says.
- - Kemba J. Dunham contributed to this article.
When the music stopped in the residential-real-estate market, speculators who got caught with unsold houses and condos began putting them on the market as rentals. This "shadow market" has made investors jittery about price-destroying competition for the real-estate investment trusts that own big apartment complexes.
For most of the country, though, it is a landlords' market, with vacancy rates falling and rents rising in many major cities. Despite a selloff in apartment REITs, the shadow market is really confined to real-estate disaster areas such as Florida, Las Vegas and Phoenix. That presents a buying opportunity for stock-market investors.
Figures scheduled to be released today by New York-based research firm Reis Inc. show that the nation's apartment-vacancy rate dropped 0.2 percentage point in the third quarter, while rents increased a healthy 1.4%.
Apartment owners in high-price cities such as San Francisco and New York seem to be benefiting from renters who are getting locked out of the for-sale market because of the lack of so-called jumbo mortgages, which are more than $417,000, says Sam Chandan, Reis chief economist. Rents in New York jumped 3.6% in the third quarter. In San Francisco, they were up 3.4%.
That is all good news for publicly traded REITs that specialize in apartments.
REITs are real-estate companies that pay no corporate income tax and distribute at least 90% of their earnings in dividends. Apartment-company stocks have suffered compared with their real-estate rivals. The Dow Jones Apartment REIT subindex is down 8.6% year-to-date, though the stocks have rallied in the past month. The overall Dow Jones Equity REIT index, which includes hotels, retail, self-storage and office properties, is down just 2.8%.
The stocks of apartment-owning REITs have a lot going for them. Nearly two million rental households have entered the market in the past two years, including buyers who have shied away from the for-sale housing market and those who defaulted on home mortgages.
"That's equivalent to filling up New York City," says Raymond Torto, principal of CBRE Torto Wheaton Research, a real-estate research firm.
Some companies say investors haven't recognized that apartments, in some cases, behave in opposition to single-family homes, absorbing the decline in home ownership and lack of affordability. "They clump it all together," says Richard Campo, chief executive of Camden Property Trust, a Houston-based apartment REIT. Camden's stock is down 11.5% this year, closing yesterday's session on the New York Stock Exchange at $65.35, up $1.55, or 2.4%.
The supply of apartment buildings has been constrained by below-average construction of units, less than 100,000 units a year in the past few years in the top markets, according to Reis. And the echo boom -- the demographic bulge made up of baby-boomer offspring -- is entering prime renting age.
"In our view, we will have more additional demand for renters than additional supply of rental property," says James Corl, chief investment officer at Cohen & Steers, a New York investment firm specializing in REITs. It has about $35 billion under management.
It is easy to understand why investors have been nervous about apartment REITs. For one, it is difficult to assess the impact of the shadow market because there isn't an accurate measure of the number of individual homes and condominiums that are on the rental market.
"It's my greatest frustration," says apartment analyst Craig Leupold of Green Street Advisors Inc., a Newport Beach, Calif., real-estate research firm. "I'd love to get better data on how many vacant single-family homes are for rent."
James Kammert, portfolio manager at Transwestern Securities Management, a Chicago-based asset manager with about $250 million in the REIT sector, says the discounts are "quite attractive in the apartment space." He says the value of apartment buildings may hold up because apartment REITs can access commercial-mortgage loans from Fannie Mae and Freddie Mac. Property owners in other sectors can't, and are thus more exposed to the recent credit crunch. Still, there clearly are risks for apartment REITs, the biggest being an economic slowdown that could reduce demand for apartments.
The most attractive REITs are trading below the total value of the apartment buildings they own and are cheaper than their competitors based on their projected funds from operations, which is essentially their profit excluding depreciation expenses.
For example, the share price of the largest apartment company, Denver-based Apartment Investment & Management Co., with 1,200 apartment complexes and 209,000 units, is down 15% this year and has been sold off to the point that it looks cheap. Aimco is trading at a 24% discount to its net asset value. What's more, it trades at 13.5 times its 2007 estimated funds from operations, compared with 21.2 times for the apartment sector. In 4 p.m. trading yesterday on the Big Board, Aimco's shares were up $1.05, or 2.3%, to $43.74.
Another to consider: AvalonBay Communities Inc., based in Alexandria, Va. With a high-end portfolio of buildings in hard-to-build urban markets, AvalonBay is trading at a 7.4% discount to net asset value, though its funds-from-operations multiple is an above-average 25.2. Its shares closed yesterday on the NYSE at $122.09, up $2.60, or 2.2%.
There are bargains throughout the sector. According to BMO Capital Markets, apartment REITs overall are trading at a 10% discount to net asset value. That discount would be even more but for the takeover of one of the largest apartment REITs, Archstone-Smith Operating Trust, whose stock price has stayed relatively high since it agreed to a buyout in May and closed yesterday at $59.95, down 23 cents on the Big Board. That deal is scheduled to close Friday.
Camden's Mr. Campo says the shadow market has had a sizable effect on his company's apartments. But there also is a flip side: Camden is recruiting failed homeowners to rent its apartments.
"They're pretty good renters," he says of foreclosed-upon homeowners. "But they didn't realize what the total cost of ownership really meant. We are marketing to those people as long as they have reasonable credit minus the foreclosure," he says.
- - Kemba J. Dunham contributed to this article.
Wednesday, September 26, 2007
Sales of Existing Homes Slide, Median Price Rises Slightly
By Jeff Bater From The Wall Street Journal Online
Demand for previously owned homes tumbled in August to the lowest level in five years as mortgage market troubles hurt sales.
Separately, U.S. consumer confidence fell to a nearly two-year low in September, weighed down by a softening labor market and worries over volatility in financial markets and a weaker dollar, according to a report Tuesday from the Conference Board.
Home resales fell to a 5.50 million annual rate, a 4.3% decrease from July's unrevised 5.75 million annual pace, the National Association of Realtors said Tuesday.
The August resales level was in line with Wall Street expectations. It was the lowest pace since 5.36 million in August 2002. "The credit market freeze in August no doubt contributed to the sales decline," NAR senior economist Lawrence Yun said.
The median home price was $224,500 in August, up 0.2% from $224,000 in August 2006. The median price in July this year was $228,700.
In a separate report, Standard & Poor's S&P/Case-Shiller home price index fell in July as 16 of 20 major metropolitan areas saw a decline in annual growth rate.The 10-city composite index fell 4.5% in July from a year earlier, while the 20-city composite index was down 3.9%.
Mr. Yun said the unusual disruptions in the mortgage market, including a significant climb in jumbo loan rates resulted in a fairly high number of postponed or canceled sales. "Lower sales contributed to a buildup of unsold inventory," he said.
Inventories of homes rose 0.4% at the end of August to 4.58 million available for sale, which represented a 10.0-month supply at the current sales pace. There was a 9.5-month supply at the end of July, revised from a previously estimated 9.6 months.
Existing-home sales tumbled in all regions. Sales dropped 5.2% in the Midwest, 2.0% in the Northeast, 9.8% in the West, and 2.7% in the South.
The average 30-year mortgage rate was 6.57% in August, down from 6.70% in July, according to Freddie Mac.
Consumer Confidence Declines
The board's index slid to 99.8 from 105.6 in August, leaving it at its lowest mark since November 2005's 98.3.
Consumers' assessments of present-day conditions were also lower, dragging this index down to 121.7 in September from 130.1 in August.
The index measuring expectations for business conditions over the next six months also fell, to 85.2 in September from August's 89.2.
The confidence survey is based on polling of 5,000 U.S. households.
The cutoff date for the survey was Sept. 18, the day the Federal Reserve cut interest rates by surprising half-percentage point in an effort to rescue a sagging economy and restore confidence to shaky financial markets.
"Weaker business conditions combined with a less favorable job market continue to cast a cloud over consumers and heighten their sense of uncertainty and concern," said Lynn Franco, director of the Conference Board Consumer Research Center. "Looking ahead, little economic improvement is expected and with the holiday season right around the corner, this is not welcome news."
-- Dan Molinski contributed to this article.
Demand for previously owned homes tumbled in August to the lowest level in five years as mortgage market troubles hurt sales.
Separately, U.S. consumer confidence fell to a nearly two-year low in September, weighed down by a softening labor market and worries over volatility in financial markets and a weaker dollar, according to a report Tuesday from the Conference Board.
Home resales fell to a 5.50 million annual rate, a 4.3% decrease from July's unrevised 5.75 million annual pace, the National Association of Realtors said Tuesday.
The August resales level was in line with Wall Street expectations. It was the lowest pace since 5.36 million in August 2002. "The credit market freeze in August no doubt contributed to the sales decline," NAR senior economist Lawrence Yun said.
The median home price was $224,500 in August, up 0.2% from $224,000 in August 2006. The median price in July this year was $228,700.
In a separate report, Standard & Poor's S&P/Case-Shiller home price index fell in July as 16 of 20 major metropolitan areas saw a decline in annual growth rate.The 10-city composite index fell 4.5% in July from a year earlier, while the 20-city composite index was down 3.9%.
Mr. Yun said the unusual disruptions in the mortgage market, including a significant climb in jumbo loan rates resulted in a fairly high number of postponed or canceled sales. "Lower sales contributed to a buildup of unsold inventory," he said.
Inventories of homes rose 0.4% at the end of August to 4.58 million available for sale, which represented a 10.0-month supply at the current sales pace. There was a 9.5-month supply at the end of July, revised from a previously estimated 9.6 months.
Existing-home sales tumbled in all regions. Sales dropped 5.2% in the Midwest, 2.0% in the Northeast, 9.8% in the West, and 2.7% in the South.
The average 30-year mortgage rate was 6.57% in August, down from 6.70% in July, according to Freddie Mac.
Consumer Confidence Declines
The board's index slid to 99.8 from 105.6 in August, leaving it at its lowest mark since November 2005's 98.3.
Consumers' assessments of present-day conditions were also lower, dragging this index down to 121.7 in September from 130.1 in August.
The index measuring expectations for business conditions over the next six months also fell, to 85.2 in September from August's 89.2.
The confidence survey is based on polling of 5,000 U.S. households.
The cutoff date for the survey was Sept. 18, the day the Federal Reserve cut interest rates by surprising half-percentage point in an effort to rescue a sagging economy and restore confidence to shaky financial markets.
"Weaker business conditions combined with a less favorable job market continue to cast a cloud over consumers and heighten their sense of uncertainty and concern," said Lynn Franco, director of the Conference Board Consumer Research Center. "Looking ahead, little economic improvement is expected and with the holiday season right around the corner, this is not welcome news."
-- Dan Molinski contributed to this article.
Tuesday, September 25, 2007
Will The Sub-Prime Lending Problem Affect Your Home's Value?
Will The Sub-Prime Lending Problem Affect Your Home's Value?
By Marie de Espinosa
Easy Come, Easy Go?
RealtyTrac, a leading industry resource on foreclosure activity reports that one in every 316 homes in Colorado is now in foreclosure, up a whopping 11.25% in August from July 2007.
The supply of sub-prime easy money definitely helped to increase demand for housing here in Colorado: now that the faucet of easy credit is being turned down, the National Association of Realtors indicated in their latest report that pending home sales are down 20.7% in our sector of the country and predicts housing demand trends will continue.
The bottom line of slowdown in these lending practices— increased housing supply and reduced demand for homeownership— does not affect all Denver homeowners the same.
In fact, the more expensive your neighborhood, the better chance you have of not being affected at all.
It’s Still a Local Market
Premier Colorado Economist Tucker Hart Adams with US Bank expects that housing will continue to soften, a result of the number of new homes built exceeding demand. Adams notes that Denver’s “bubble” is “not nearly as large as it is nationally.”
A review of MLS statistics indicates that it is the homes closest to average home prices that are most affected by the increased supply and reduced demand. The Colorado Association of Realtors is reporting that median Colorado home price in the second quarter of 2007 fell to $225,000, down from $232,222 in 2006.
The good news for homeowners in this price range is that housing starts are down dramatically this year from their high in 2004 and the loan adjustments fueling mass foreclosures has a foreseeable end. According to the Adams Group, housing permits skyrocketed 17% in 2004 only to plunge 16% in 2006.
Furthermore, FHA limits are being reset in order to help those who want to keep or purchase homes. Conventional loan rates, including “jumbo” loan rates are still in the 6% range for those with good qualifications.
Your Personal Picture
If you are considering selling, buying or refinancing, take the time to get to know all the options available to you as far in advance as possible.
Sellers will want to be very sure of the lending position of anyone making an offer on their home.
The equity position of your home may have recently changed. Before you refinance, make sure you know the latest about home values in your neighborhood.
Buyers may spend more time negotiating with Lenders to ensure they are getting the best rates and fees available.
By Marie de Espinosa
Easy Come, Easy Go?
RealtyTrac, a leading industry resource on foreclosure activity reports that one in every 316 homes in Colorado is now in foreclosure, up a whopping 11.25% in August from July 2007.
The supply of sub-prime easy money definitely helped to increase demand for housing here in Colorado: now that the faucet of easy credit is being turned down, the National Association of Realtors indicated in their latest report that pending home sales are down 20.7% in our sector of the country and predicts housing demand trends will continue.
The bottom line of slowdown in these lending practices— increased housing supply and reduced demand for homeownership— does not affect all Denver homeowners the same.
In fact, the more expensive your neighborhood, the better chance you have of not being affected at all.
It’s Still a Local Market
Premier Colorado Economist Tucker Hart Adams with US Bank expects that housing will continue to soften, a result of the number of new homes built exceeding demand. Adams notes that Denver’s “bubble” is “not nearly as large as it is nationally.”
A review of MLS statistics indicates that it is the homes closest to average home prices that are most affected by the increased supply and reduced demand. The Colorado Association of Realtors is reporting that median Colorado home price in the second quarter of 2007 fell to $225,000, down from $232,222 in 2006.
The good news for homeowners in this price range is that housing starts are down dramatically this year from their high in 2004 and the loan adjustments fueling mass foreclosures has a foreseeable end. According to the Adams Group, housing permits skyrocketed 17% in 2004 only to plunge 16% in 2006.
Furthermore, FHA limits are being reset in order to help those who want to keep or purchase homes. Conventional loan rates, including “jumbo” loan rates are still in the 6% range for those with good qualifications.
Your Personal Picture
If you are considering selling, buying or refinancing, take the time to get to know all the options available to you as far in advance as possible.
Sellers will want to be very sure of the lending position of anyone making an offer on their home.
The equity position of your home may have recently changed. Before you refinance, make sure you know the latest about home values in your neighborhood.
Buyers may spend more time negotiating with Lenders to ensure they are getting the best rates and fees available.
Monday, September 24, 2007
Can't Get a Mortgage Loan? Try Your Credit Union.
Can't Get a Mortgage? Try Your Credit Union
By Amy Hoak From MarketWatch
As many mortgage lenders tighten loan underwriting standards and interest rates on jumbo mortgages rise, consumers may be able to find a friend in their credit union.
One reason: Many (although not all) of the mortgage loans made by credit unions are held in their own portfolios and therefore don't need to be sold to investors, said Bill Hampel, chief economist for the Credit Union National Association and Affiliates.
"A credit union considering a mortgage loan application doesn't have as many things to worry about as a mortgage banker that has to sell that to a secondary mortgage market," he said.
Selling nonconforming loans in the secondary market over the past few weeks has been a challenge, as the market has been repricing the risk associated with mortgage loans that aren't bought by Freddie Mac and Fannie Mae. As a result, some loan products have been removed from lenders' offerings, while lending standards have tightened on other products, perhaps requiring better credit scores or larger down payments from borrowers.
At credit unions, however, underwriting standards haven't needed to change, Hampel said.
And while the rates on jumbo loans offered by many lenders went "haywire" over the past couple of weeks, at credit unions the rates on those loans haven't experienced a jump, Hampel said. Jumbo loans are those that exceed the conforming loan limit of $417,000 in most states.
"Many borrowers will find a credit union an easier place to get a mortgage right now than other lenders," he said.
And consumers seem to be discovering this, according to Steve VanSickler, chief lending officer at Red Rocks Credit Union in Highlands Ranch, Colo.
"Without a doubt, we are seeing increased traffic," he said.
Credit union mission
Even if it's a good time to head to the credit union for a mortgage, it's important to point out that these institutions are far from being risk takers. They're not-for-profit, co-op organizations that were founded with a main mission to serve members.
It's not that they "cherry pick" borrowers who are approved for a mortgage, VanSickler said.
"Credit unions still have higher approval rates to lower income borrowers," he pointed out.
But there's a more measured approach to how that mortgage works with the member's overall financial picture, since the credit union is often that borrower's primary institution, he added.
Plus, the majority of mortgage products at credit unions don't tend to be risky -- regardless of what is going on in the rest of the lending market, said Jay Johnson, executive vice president of Callahan & Associates, a national credit union research and consulting firm.
"They're not likely to get into exotic products and jump on the bandwagon," Johnson said.
Subprime loans never thrived in credit unions, Hampel said. And the Alt-A mortgages that require little documentation are used sparingly, he added, usually with members who are well known to the credit union and have belonged for a long time. That way, the credit union can confirm that a borrower has a steady history of income into a savings or checking account, he said.
As a way to address high-cost housing markets, credit unions have also offered 40-year mortgages and interest-only loans, Hampel said. But only if they fit the borrower's needs.
"We don't want to get members into a deal where they will likely lose their home," he said.
The approach tends to work: Last year, the net charge-off rate for credit union mortgages was 0.02%, he said. The net charge-off rate is the amount lost in default minus the amount the credit union is able to recoup through the sale of the property.
If the borrower does see trouble coming around the bend regarding a mortgage, credit unions can often address it before the payments are late, Hampel said. Many of them also partner with credit-counseling agencies to help borrowers in a pinch, Johnson said.
How to find a credit union
One of the tricks for consumers interested in working with a credit union for a home loan is finding one that makes them. There are about 8,000 credit unions throughout the country, but only 3,500 of those do first-mortgage lending, Johnson said.
In order to join a credit union, individuals must meet the institution's criteria. A credit union's "field of membership" can be an employer, a church, a school, a community or another subset, according to the Credit Union National Association's Web site.
The Web site has a searchable directory for consumers to find credit unions throughout the country. Visit the credit union search tool.
By Amy Hoak From MarketWatch
As many mortgage lenders tighten loan underwriting standards and interest rates on jumbo mortgages rise, consumers may be able to find a friend in their credit union.
One reason: Many (although not all) of the mortgage loans made by credit unions are held in their own portfolios and therefore don't need to be sold to investors, said Bill Hampel, chief economist for the Credit Union National Association and Affiliates.
"A credit union considering a mortgage loan application doesn't have as many things to worry about as a mortgage banker that has to sell that to a secondary mortgage market," he said.
Selling nonconforming loans in the secondary market over the past few weeks has been a challenge, as the market has been repricing the risk associated with mortgage loans that aren't bought by Freddie Mac and Fannie Mae. As a result, some loan products have been removed from lenders' offerings, while lending standards have tightened on other products, perhaps requiring better credit scores or larger down payments from borrowers.
At credit unions, however, underwriting standards haven't needed to change, Hampel said.
And while the rates on jumbo loans offered by many lenders went "haywire" over the past couple of weeks, at credit unions the rates on those loans haven't experienced a jump, Hampel said. Jumbo loans are those that exceed the conforming loan limit of $417,000 in most states.
"Many borrowers will find a credit union an easier place to get a mortgage right now than other lenders," he said.
And consumers seem to be discovering this, according to Steve VanSickler, chief lending officer at Red Rocks Credit Union in Highlands Ranch, Colo.
"Without a doubt, we are seeing increased traffic," he said.
Credit union mission
Even if it's a good time to head to the credit union for a mortgage, it's important to point out that these institutions are far from being risk takers. They're not-for-profit, co-op organizations that were founded with a main mission to serve members.
It's not that they "cherry pick" borrowers who are approved for a mortgage, VanSickler said.
"Credit unions still have higher approval rates to lower income borrowers," he pointed out.
But there's a more measured approach to how that mortgage works with the member's overall financial picture, since the credit union is often that borrower's primary institution, he added.
Plus, the majority of mortgage products at credit unions don't tend to be risky -- regardless of what is going on in the rest of the lending market, said Jay Johnson, executive vice president of Callahan & Associates, a national credit union research and consulting firm.
"They're not likely to get into exotic products and jump on the bandwagon," Johnson said.
Subprime loans never thrived in credit unions, Hampel said. And the Alt-A mortgages that require little documentation are used sparingly, he added, usually with members who are well known to the credit union and have belonged for a long time. That way, the credit union can confirm that a borrower has a steady history of income into a savings or checking account, he said.
As a way to address high-cost housing markets, credit unions have also offered 40-year mortgages and interest-only loans, Hampel said. But only if they fit the borrower's needs.
"We don't want to get members into a deal where they will likely lose their home," he said.
The approach tends to work: Last year, the net charge-off rate for credit union mortgages was 0.02%, he said. The net charge-off rate is the amount lost in default minus the amount the credit union is able to recoup through the sale of the property.
If the borrower does see trouble coming around the bend regarding a mortgage, credit unions can often address it before the payments are late, Hampel said. Many of them also partner with credit-counseling agencies to help borrowers in a pinch, Johnson said.
How to find a credit union
One of the tricks for consumers interested in working with a credit union for a home loan is finding one that makes them. There are about 8,000 credit unions throughout the country, but only 3,500 of those do first-mortgage lending, Johnson said.
In order to join a credit union, individuals must meet the institution's criteria. A credit union's "field of membership" can be an employer, a church, a school, a community or another subset, according to the Credit Union National Association's Web site.
The Web site has a searchable directory for consumers to find credit unions throughout the country. Visit the credit union search tool.
Saturday, September 22, 2007
Top Five Mistakes Home Buyers Make
Top Five Mistakes Home Buyers Make
By Stacey L. Bradford, SmartMoney
Looking for a new home? Well, you're in luck? sort of. First, the good news: Home prices are falling and buyers have more negotiating power than ever before. Now, the not-so-good news: Lining up financing has become much more difficult as droves of current homeowners default on their existing mortgages. This isn't to say you won't be able to secure the home of your dreams, but you will need to be a bit more cautious and conservative with your purchase.
Here are five mistakes to avoid when looking for a home in today's real estate market.
1. Waiting to Sell Your Home
Now that the housing market is slowing it's more important than ever to sell your existing home before you commit to a new one. Here's why. In the current environment, it's going to take you longer to find a buyer than it would have just a year ago. If you don't start showing your home until after you've signed a contract for a new place, you're taking on the added risk of carrying two mortgages for an extended period of time, warns Elaine Clayman, a real estate broker with Brown Harris Stevens.
Also, the only accurate way to know how much your home is really worth is to see how much someone else is willing to pay for it. "If for some reason you've overpriced the property you already own?you'll know that after the first 30 to 45 days it's on the market," says Peter Comitini, a real estate broker with the Corcoran Group. Once you have a realistic picture of how much your home will fetch, then you can adjust your budget for a new home accordingly, he says.
2. Ignoring Your Credit Score
Get a copy of your credit report as soon as you decide it's time to move. Nearly 80% contain some type of error and 25% of those mistakes are serious enough to drag down your credit score, potentially disqualifying you for the most competitive interest rate on a mortgage, according to U.S. PIRG, the federation of state Public Interest Research Groups. How much can your credit score affect your loan? Someone with a score of 630, for example, would pay one interest point higher than another borrower with a score of 730, says Geoffrey Sheerar, a mortgage broker with Apple Mortgage, a New York City-based mortgage brokerage firm.
This is also your chance to discover and settle any delinquent accounts. "I've seen a client get a worse credit score than he should have over a $40 doctor bill that went to collection that the person didn't even know about," says Sheerar. Keep in mind, once you find a problem, it can take several weeks and a bit of leg work to have the black mark taken off of your credit report.
3. Skipping the Mortgage Preapproval Process
The days of easy money and low teaser rates are over. In this tight lending environment, it's important to shop around for a mortgage and get preapproved by a lender before you even start visiting open houses. While borrowers, even ones with very low credit scores, had hundreds of options just a couple of months ago, that's simply not the case today. Many lenders have stopped underwriting riskier loans in favor of more traditional fixed rate mortgages, says Keith Gumbinger, vice president with HSH Associates Financial Publishers, a Pompton Plains, N.J.-based mortgage research firm.
By getting preapproved, you'll not only get a realistic idea of the type of financing available to you, but you'll also have a better idea of what your interest rate will look like. Scanning the newspaper for prevailing rates isn't all that helpful since lenders will adjust your rate based on how risky a borrower they feel you are. At the moment, someone with excellent credit could qualify for a 7.5% interest rate on a $450,000 loan and another buyer with a closer to average credit score could get charged 8% or 9%, says Gumbinger. Rates are certain to fluctuate as you shop for the perfect home. But once you have a ball-park figure, you can plug it into a mortgage calculator to see how much home you can afford to buy.
4. Not Budging on Your Budget
As we mentioned earlier, buyers have more negotiating power than ever. So don't be afraid to make an offer that's well below the asking price. That said, once you find a home you really love and you're negotiating on price, you'd be foolish to walk away from that property over just a few thousand dollars, says Brown Harris Stevens' Clayman. That's especially important if you're borrowing the money to buy that home. Think of it this way: On a monthly basis, an extra $10,000 (on a loan valued less than $417,000) will cost you just $63.
5. Signing a Contract with Contingencies
Unfortunately, it isn't enough to secure financing and find a place that you're comfortable calling home. You also need to find a seller who's ready to move quickly. That means avoiding folks who want to include all sorts of onerous contingencies in the selling contract that would allow them to stay in their house for an extended period of time. One situation you want to avoid, for example, is when the sale is dependent on the seller finding a new home first, warns Corcoran's Comitini.
The risk here is that you wait around for months only to watch the interest rate lock on your mortgage expire, thus forcing you to spend more money for the same home. Or, the deal could fall apart entirely, putting you back at square one with the real estate listings spread out on the kitchen table.
By Stacey L. Bradford, SmartMoney
Looking for a new home? Well, you're in luck? sort of. First, the good news: Home prices are falling and buyers have more negotiating power than ever before. Now, the not-so-good news: Lining up financing has become much more difficult as droves of current homeowners default on their existing mortgages. This isn't to say you won't be able to secure the home of your dreams, but you will need to be a bit more cautious and conservative with your purchase.
Here are five mistakes to avoid when looking for a home in today's real estate market.
1. Waiting to Sell Your Home
Now that the housing market is slowing it's more important than ever to sell your existing home before you commit to a new one. Here's why. In the current environment, it's going to take you longer to find a buyer than it would have just a year ago. If you don't start showing your home until after you've signed a contract for a new place, you're taking on the added risk of carrying two mortgages for an extended period of time, warns Elaine Clayman, a real estate broker with Brown Harris Stevens.
Also, the only accurate way to know how much your home is really worth is to see how much someone else is willing to pay for it. "If for some reason you've overpriced the property you already own?you'll know that after the first 30 to 45 days it's on the market," says Peter Comitini, a real estate broker with the Corcoran Group. Once you have a realistic picture of how much your home will fetch, then you can adjust your budget for a new home accordingly, he says.
2. Ignoring Your Credit Score
Get a copy of your credit report as soon as you decide it's time to move. Nearly 80% contain some type of error and 25% of those mistakes are serious enough to drag down your credit score, potentially disqualifying you for the most competitive interest rate on a mortgage, according to U.S. PIRG, the federation of state Public Interest Research Groups. How much can your credit score affect your loan? Someone with a score of 630, for example, would pay one interest point higher than another borrower with a score of 730, says Geoffrey Sheerar, a mortgage broker with Apple Mortgage, a New York City-based mortgage brokerage firm.
This is also your chance to discover and settle any delinquent accounts. "I've seen a client get a worse credit score than he should have over a $40 doctor bill that went to collection that the person didn't even know about," says Sheerar. Keep in mind, once you find a problem, it can take several weeks and a bit of leg work to have the black mark taken off of your credit report.
3. Skipping the Mortgage Preapproval Process
The days of easy money and low teaser rates are over. In this tight lending environment, it's important to shop around for a mortgage and get preapproved by a lender before you even start visiting open houses. While borrowers, even ones with very low credit scores, had hundreds of options just a couple of months ago, that's simply not the case today. Many lenders have stopped underwriting riskier loans in favor of more traditional fixed rate mortgages, says Keith Gumbinger, vice president with HSH Associates Financial Publishers, a Pompton Plains, N.J.-based mortgage research firm.
By getting preapproved, you'll not only get a realistic idea of the type of financing available to you, but you'll also have a better idea of what your interest rate will look like. Scanning the newspaper for prevailing rates isn't all that helpful since lenders will adjust your rate based on how risky a borrower they feel you are. At the moment, someone with excellent credit could qualify for a 7.5% interest rate on a $450,000 loan and another buyer with a closer to average credit score could get charged 8% or 9%, says Gumbinger. Rates are certain to fluctuate as you shop for the perfect home. But once you have a ball-park figure, you can plug it into a mortgage calculator to see how much home you can afford to buy.
4. Not Budging on Your Budget
As we mentioned earlier, buyers have more negotiating power than ever. So don't be afraid to make an offer that's well below the asking price. That said, once you find a home you really love and you're negotiating on price, you'd be foolish to walk away from that property over just a few thousand dollars, says Brown Harris Stevens' Clayman. That's especially important if you're borrowing the money to buy that home. Think of it this way: On a monthly basis, an extra $10,000 (on a loan valued less than $417,000) will cost you just $63.
5. Signing a Contract with Contingencies
Unfortunately, it isn't enough to secure financing and find a place that you're comfortable calling home. You also need to find a seller who's ready to move quickly. That means avoiding folks who want to include all sorts of onerous contingencies in the selling contract that would allow them to stay in their house for an extended period of time. One situation you want to avoid, for example, is when the sale is dependent on the seller finding a new home first, warns Corcoran's Comitini.
The risk here is that you wait around for months only to watch the interest rate lock on your mortgage expire, thus forcing you to spend more money for the same home. Or, the deal could fall apart entirely, putting you back at square one with the real estate listings spread out on the kitchen table.
Tuesday, September 18, 2007
Credit (Only) Where Credit is Due
Credit (Only) Where Credit Is Due
By Terri Cullen WSJ Real Estate Writer
Mortgage-lending giant Countrywide Financial rattled Wall Street Wednesday by announcing it was bowing out of the subprime mortgage business. The move comes as dozens of lenders and mortgage companies have gone out of business or filed for bankruptcy amid the deepening credit crisis.
Many investors like me wondered what, if any, long-term damage this might inflict on their portfolios. But to homeowners and homebuyers, a more urgent question might be: What affect is the credit crunch going to have on my ability to get a mortgage or home-equity loan?
For now, it appears homeowners with good credit still have access to relatively low-cost financing. The average rate for a 30-year fixed rate mortgage stands at 6.27%, while the rate on a $50,000 home-equity line of credit averaged 6.52%, according to Bankrate.com.
If my experience is an indicator, lenders are becoming even more aggressive in seeking out homeowners with good credit and substantial home equity. Lately my husband Gerry and I have been bombarded with home-equity loan and line of credit offers from our bank ("Get $40,000 for as little as $283 a month") and our credit-card company ("As low as 6.84%, guaranteed for life!"). Our credit union sent a letter recently noting that we hadn't borrowed on the account recently and offering a lower rate of interest if we borrowed a minimum of $25,000.
And if my neighborhood is an indicator, we're not alone. As I mentioned in a past column, home construction in my neck of the woods is booming. New homes are being built and McMansions are rising where small bungalows once stood. The renovations are so extensive it's unlikely they're being paid for with cash savings, so clearly the credit spigot hasn't been turned off.
So who's in trouble if they need to get a mortgage? Borrowers with bad credit will find it extremely difficult to get a loan right now, says Fritz Elmendorf, spokesman for the Consumer Bankers Association. "Unless you're looking for a conventional loan with good credit there aren't too many out there willing to lend right now," he says. And, needless to say, anyone walking in with no documentation expecting to get a loan will be out of luck, he says.
Another casualty of the credit crunch? "Piggyback" loans. "This type of loan has almost completely disappeared," Mr. Elmendorf says. Piggybacks combine a first mortgage that covers 80% of the home's price and a second mortgage to cover the remaining 20%. The loans came into favor in the last decade as a way for borrowers to avoid paying for private mortgage insurance (PMI), which protects lenders in the event of a default. Going forward, he says, homebuyers will need to come up with at least some portion of the 20% downpayment in cash and pay PMI.
My sister Melissa and her husband Joe got their piggyback just before lenders soured on the loans. The couple purchased their first home this spring for $270,000. Eighty percent of the home's price was covered by their low-rate first mortgage, and the remaining 20% on a higher-rate 15-year balloon loan. Melissa says they're managing the monthly payments and since they have a cushion of savings she's not worried about making the mortgage.
What's keeping her up at night is home prices. She's become addicted to monitoring the same real-estate and foreclosure sites she used to find her home. She estimates home prices in her area are down about 10% from where they were just six months ago. More troubling: The number of foreclosures is up, which means price are likely to sink even lower.
The couple had hoped that in a few years their home would appreciate enough to allow them to refinance the two loans into a single lower-rate mortgage, but that scenario now seems highly unlikely. They'll need to stay in their home and continue paying the two loans for at least five years, though likely more. If they get into a financial crisis anytime soon, it's very possible they won't be able to refinance because they'll have negative equity, meaning their mortgage will be greater than the value of their home.
Anyone in the market for a home with no downpayment will need to rent a little longer to build up their savings. Homeowners looking to refinance and would-be home buyers will need to work at boosting their credit scores before applying for a loan. Homeowners who are in my sister's situation -- underwater on their mortgages -- should cut back on spending as soon as possible and start funding a rainy day account to provide a cushion in the event of a financial emergency.
If you're already experiencing one, your options are limited. Some lenders are helping borrowers modify their loans to prevent them from defaulting. But financially distressed homeowners are often paralyzed by fears of losing their home, and wait until the last minute to try and work something out with the lender. At that point, the loan is so delinquent that lenders are unwilling to negotiate. So if you're in trouble, contact your lender as soon as possible and try to work something out.
The pendulum has definitely swung hard to more conservative lending practices -- and ultimately that's a good thing for borrowers who won't be allowed to get themselves too deeply in debt.
By Terri Cullen WSJ Real Estate Writer
Mortgage-lending giant Countrywide Financial rattled Wall Street Wednesday by announcing it was bowing out of the subprime mortgage business. The move comes as dozens of lenders and mortgage companies have gone out of business or filed for bankruptcy amid the deepening credit crisis.
Many investors like me wondered what, if any, long-term damage this might inflict on their portfolios. But to homeowners and homebuyers, a more urgent question might be: What affect is the credit crunch going to have on my ability to get a mortgage or home-equity loan?
For now, it appears homeowners with good credit still have access to relatively low-cost financing. The average rate for a 30-year fixed rate mortgage stands at 6.27%, while the rate on a $50,000 home-equity line of credit averaged 6.52%, according to Bankrate.com.
If my experience is an indicator, lenders are becoming even more aggressive in seeking out homeowners with good credit and substantial home equity. Lately my husband Gerry and I have been bombarded with home-equity loan and line of credit offers from our bank ("Get $40,000 for as little as $283 a month") and our credit-card company ("As low as 6.84%, guaranteed for life!"). Our credit union sent a letter recently noting that we hadn't borrowed on the account recently and offering a lower rate of interest if we borrowed a minimum of $25,000.
And if my neighborhood is an indicator, we're not alone. As I mentioned in a past column, home construction in my neck of the woods is booming. New homes are being built and McMansions are rising where small bungalows once stood. The renovations are so extensive it's unlikely they're being paid for with cash savings, so clearly the credit spigot hasn't been turned off.
So who's in trouble if they need to get a mortgage? Borrowers with bad credit will find it extremely difficult to get a loan right now, says Fritz Elmendorf, spokesman for the Consumer Bankers Association. "Unless you're looking for a conventional loan with good credit there aren't too many out there willing to lend right now," he says. And, needless to say, anyone walking in with no documentation expecting to get a loan will be out of luck, he says.
Another casualty of the credit crunch? "Piggyback" loans. "This type of loan has almost completely disappeared," Mr. Elmendorf says. Piggybacks combine a first mortgage that covers 80% of the home's price and a second mortgage to cover the remaining 20%. The loans came into favor in the last decade as a way for borrowers to avoid paying for private mortgage insurance (PMI), which protects lenders in the event of a default. Going forward, he says, homebuyers will need to come up with at least some portion of the 20% downpayment in cash and pay PMI.
My sister Melissa and her husband Joe got their piggyback just before lenders soured on the loans. The couple purchased their first home this spring for $270,000. Eighty percent of the home's price was covered by their low-rate first mortgage, and the remaining 20% on a higher-rate 15-year balloon loan. Melissa says they're managing the monthly payments and since they have a cushion of savings she's not worried about making the mortgage.
What's keeping her up at night is home prices. She's become addicted to monitoring the same real-estate and foreclosure sites she used to find her home. She estimates home prices in her area are down about 10% from where they were just six months ago. More troubling: The number of foreclosures is up, which means price are likely to sink even lower.
The couple had hoped that in a few years their home would appreciate enough to allow them to refinance the two loans into a single lower-rate mortgage, but that scenario now seems highly unlikely. They'll need to stay in their home and continue paying the two loans for at least five years, though likely more. If they get into a financial crisis anytime soon, it's very possible they won't be able to refinance because they'll have negative equity, meaning their mortgage will be greater than the value of their home.
Anyone in the market for a home with no downpayment will need to rent a little longer to build up their savings. Homeowners looking to refinance and would-be home buyers will need to work at boosting their credit scores before applying for a loan. Homeowners who are in my sister's situation -- underwater on their mortgages -- should cut back on spending as soon as possible and start funding a rainy day account to provide a cushion in the event of a financial emergency.
If you're already experiencing one, your options are limited. Some lenders are helping borrowers modify their loans to prevent them from defaulting. But financially distressed homeowners are often paralyzed by fears of losing their home, and wait until the last minute to try and work something out with the lender. At that point, the loan is so delinquent that lenders are unwilling to negotiate. So if you're in trouble, contact your lender as soon as possible and try to work something out.
The pendulum has definitely swung hard to more conservative lending practices -- and ultimately that's a good thing for borrowers who won't be allowed to get themselves too deeply in debt.
Sunday, September 16, 2007
Investor's Rental Home Soars In Value to Over $1 Million
Investor's Rental Home Soars In Value to Over $1 Million
By Jane Hodges
The investor: Jacqueline Janssen, 61, began investing in real estate in 2000 to reduce her holdings in the stock market. The executive recruiter has purchased eight properties in northern California and Hawaii over the years. She lives in Marin County, Calif.
The property: The octagonal home is in Dillon Beach, Calif., and was built in 1976. It's on a bluff with ocean views. The residence has three bedrooms, three bathrooms and a fireplace. The house includes a 400-square-foot garage for two small cars. Dillon Beach overlooks Tomales Bay and is popular with seasonal and full-time renters. The community is about 30 miles from Petaluma, Calif.
Purchase price: $450,000. Ms. Janssen bought the property with her son, Evan Blacksea, now 25, in 2000. She placed a 20% down payment and financed the purchase with a 30-year fixed-rate mortgage.
Additional investment: $150,000. Ms. Janssen "totally gutted" the property immediately after buying it and tacked on an 800-square-foot addition with two bedrooms and two bathrooms. The property has new plumbing, electrical systems and walls, and expanded window and deck space with views of Tomales Bay.
The strategy: "I try to make sure my properties break even," says Ms. Janssen, referring to her average yearly cash flow (the profit from rental income after factoring in mortgage payments, mortgage interest, taxes and insurance). She alternates between renting the property out monthly and leasing it to vacationers on an even more short-term basis. She made a monthly profit of $800 (after paying her mortgage, taxes and insurance) during a two-year period when the home was fully rented and broke even during intermittent periods of short-term rental, she says.
Pitfalls: Renting to both short-term vacationers (typically with a three-night minimum) and long-term tenants was a strategy that worked for a while for Ms. Janssen, but she shifted her focus in 2005 to mostly annual renters. Using her home as a short-term vacation rental seemed potentially more profitable, but she found that overseeing the property (and hiring maid service, etc.) was more time intensive. "Short-term renting can be more lucrative if you have the time to stay on top of it," she says.
The transaction: Ms. Janssen plans to keep the home, even though its market value has surpassed $1 million -- a bench mark at which she'd consider selling in the past. The combination of cash flow and her home's price appreciation make the property a solid investment, she says. The house is now worth $1.2 million (or 166.7% more than its value at the time of her purchase) per a local real-estate agent, and is valued at $1.05 million, or 133% more than its value at purchase, per Zillow.com. Marin County water-view property is popular, and her house's proximity to a deer nature preserve would hinder additional residential construction that would obstruct the home's view, Ms. Janssen says. Despite some price fluctuations, home values in Marin County have steadily increased over the past year -- even now when California's housing market is seeing volatility.
By Jane Hodges
The investor: Jacqueline Janssen, 61, began investing in real estate in 2000 to reduce her holdings in the stock market. The executive recruiter has purchased eight properties in northern California and Hawaii over the years. She lives in Marin County, Calif.
The property: The octagonal home is in Dillon Beach, Calif., and was built in 1976. It's on a bluff with ocean views. The residence has three bedrooms, three bathrooms and a fireplace. The house includes a 400-square-foot garage for two small cars. Dillon Beach overlooks Tomales Bay and is popular with seasonal and full-time renters. The community is about 30 miles from Petaluma, Calif.
Purchase price: $450,000. Ms. Janssen bought the property with her son, Evan Blacksea, now 25, in 2000. She placed a 20% down payment and financed the purchase with a 30-year fixed-rate mortgage.
Additional investment: $150,000. Ms. Janssen "totally gutted" the property immediately after buying it and tacked on an 800-square-foot addition with two bedrooms and two bathrooms. The property has new plumbing, electrical systems and walls, and expanded window and deck space with views of Tomales Bay.
The strategy: "I try to make sure my properties break even," says Ms. Janssen, referring to her average yearly cash flow (the profit from rental income after factoring in mortgage payments, mortgage interest, taxes and insurance). She alternates between renting the property out monthly and leasing it to vacationers on an even more short-term basis. She made a monthly profit of $800 (after paying her mortgage, taxes and insurance) during a two-year period when the home was fully rented and broke even during intermittent periods of short-term rental, she says.
Pitfalls: Renting to both short-term vacationers (typically with a three-night minimum) and long-term tenants was a strategy that worked for a while for Ms. Janssen, but she shifted her focus in 2005 to mostly annual renters. Using her home as a short-term vacation rental seemed potentially more profitable, but she found that overseeing the property (and hiring maid service, etc.) was more time intensive. "Short-term renting can be more lucrative if you have the time to stay on top of it," she says.
The transaction: Ms. Janssen plans to keep the home, even though its market value has surpassed $1 million -- a bench mark at which she'd consider selling in the past. The combination of cash flow and her home's price appreciation make the property a solid investment, she says. The house is now worth $1.2 million (or 166.7% more than its value at the time of her purchase) per a local real-estate agent, and is valued at $1.05 million, or 133% more than its value at purchase, per Zillow.com. Marin County water-view property is popular, and her house's proximity to a deer nature preserve would hinder additional residential construction that would obstruct the home's view, Ms. Janssen says. Despite some price fluctuations, home values in Marin County have steadily increased over the past year -- even now when California's housing market is seeing volatility.
Investor's Rental Home Soars In Value to Over $1 Million
Investor's Rental Home Soars In Value to Over $1 Million
By Jane Hodges
The investor: Jacqueline Janssen, 61, began investing in real estate in 2000 to reduce her holdings in the stock market. The executive recruiter has purchased eight properties in northern California and Hawaii over the years. She lives in Marin County, Calif.
The property: The octagonal home is in Dillon Beach, Calif., and was built in 1976. It's on a bluff with ocean views. The residence has three bedrooms, three bathrooms and a fireplace. The house includes a 400-square-foot garage for two small cars. Dillon Beach overlooks Tomales Bay and is popular with seasonal and full-time renters. The community is about 30 miles from Petaluma, Calif.
Purchase price: $450,000. Ms. Janssen bought the property with her son, Evan Blacksea, now 25, in 2000. She placed a 20% down payment and financed the purchase with a 30-year fixed-rate mortgage.
Additional investment: $150,000. Ms. Janssen "totally gutted" the property immediately after buying it and tacked on an 800-square-foot addition with two bedrooms and two bathrooms. The property has new plumbing, electrical systems and walls, and expanded window and deck space with views of Tomales Bay.
The strategy: "I try to make sure my properties break even," says Ms. Janssen, referring to her average yearly cash flow (the profit from rental income after factoring in mortgage payments, mortgage interest, taxes and insurance). She alternates between renting the property out monthly and leasing it to vacationers on an even more short-term basis. She made a monthly profit of $800 (after paying her mortgage, taxes and insurance) during a two-year period when the home was fully rented and broke even during intermittent periods of short-term rental, she says.
Pitfalls: Renting to both short-term vacationers (typically with a three-night minimum) and long-term tenants was a strategy that worked for a while for Ms. Janssen, but she shifted her focus in 2005 to mostly annual renters. Using her home as a short-term vacation rental seemed potentially more profitable, but she found that overseeing the property (and hiring maid service, etc.) was more time intensive. "Short-term renting can be more lucrative if you have the time to stay on top of it," she says.
The transaction: Ms. Janssen plans to keep the home, even though its market value has surpassed $1 million -- a bench mark at which she'd consider selling in the past. The combination of cash flow and her home's price appreciation make the property a solid investment, she says. The house is now worth $1.2 million (or 166.7% more than its value at the time of her purchase) per a local real-estate agent, and is valued at $1.05 million, or 133% more than its value at purchase, per Zillow.com. Marin County water-view property is popular, and her house's proximity to a deer nature preserve would hinder additional residential construction that would obstruct the home's view, Ms. Janssen says. Despite some price fluctuations, home values in Marin County have steadily increased over the past year -- even now when California's housing market is seeing volatility.
By Jane Hodges
The investor: Jacqueline Janssen, 61, began investing in real estate in 2000 to reduce her holdings in the stock market. The executive recruiter has purchased eight properties in northern California and Hawaii over the years. She lives in Marin County, Calif.
The property: The octagonal home is in Dillon Beach, Calif., and was built in 1976. It's on a bluff with ocean views. The residence has three bedrooms, three bathrooms and a fireplace. The house includes a 400-square-foot garage for two small cars. Dillon Beach overlooks Tomales Bay and is popular with seasonal and full-time renters. The community is about 30 miles from Petaluma, Calif.
Purchase price: $450,000. Ms. Janssen bought the property with her son, Evan Blacksea, now 25, in 2000. She placed a 20% down payment and financed the purchase with a 30-year fixed-rate mortgage.
Additional investment: $150,000. Ms. Janssen "totally gutted" the property immediately after buying it and tacked on an 800-square-foot addition with two bedrooms and two bathrooms. The property has new plumbing, electrical systems and walls, and expanded window and deck space with views of Tomales Bay.
The strategy: "I try to make sure my properties break even," says Ms. Janssen, referring to her average yearly cash flow (the profit from rental income after factoring in mortgage payments, mortgage interest, taxes and insurance). She alternates between renting the property out monthly and leasing it to vacationers on an even more short-term basis. She made a monthly profit of $800 (after paying her mortgage, taxes and insurance) during a two-year period when the home was fully rented and broke even during intermittent periods of short-term rental, she says.
Pitfalls: Renting to both short-term vacationers (typically with a three-night minimum) and long-term tenants was a strategy that worked for a while for Ms. Janssen, but she shifted her focus in 2005 to mostly annual renters. Using her home as a short-term vacation rental seemed potentially more profitable, but she found that overseeing the property (and hiring maid service, etc.) was more time intensive. "Short-term renting can be more lucrative if you have the time to stay on top of it," she says.
The transaction: Ms. Janssen plans to keep the home, even though its market value has surpassed $1 million -- a bench mark at which she'd consider selling in the past. The combination of cash flow and her home's price appreciation make the property a solid investment, she says. The house is now worth $1.2 million (or 166.7% more than its value at the time of her purchase) per a local real-estate agent, and is valued at $1.05 million, or 133% more than its value at purchase, per Zillow.com. Marin County water-view property is popular, and her house's proximity to a deer nature preserve would hinder additional residential construction that would obstruct the home's view, Ms. Janssen says. Despite some price fluctuations, home values in Marin County have steadily increased over the past year -- even now when California's housing market is seeing volatility.
Saturday, September 15, 2007
1/3 of Purchase Loans Originated by Mortgage Brokers Failed to Close Last Month - National Realty News
1/3 of Purchase Loans Originated by Mortgage Brokers Failed to Close Last Month Says Survey
Thursday, September 13, 2007 - By Staff Writer, The National Realty News
WASHINGTON, DC – About 33% of home purchase closings of loans originated by mortgage brokers were canceled during August, according to a new national survey, which also found that 57% of brokers’ customers could not refinance adjustable rate mortgages (ARMs) that had resetting interest rates.
The survey of 1,744 brokers, conducted August 23-31, provides one of the first quantitative measures of the major disruptions in the mortgage originations market which started in early August. The survey was conducted by Campbell Communications of Washington.
The survey found that home purchase closings were more often canceled for homebuyers with subprime credit. Fifty-six percent of subprime homebuyers in August had canceled closings while 21% of homebuyers seeking prime conforming mortgages had canceled closings. In another survey of real estate agents taken by Campbell Communications back in 2004, respondents indicated that only 4% of home purchase closings failed in that timeframe for mortgage-related reasons.
Thomas Popik, designer of the survey, noted that the reasons for canceled closings were different depending on credit class and product category. Prime conforming homebuyers were more likely to withdraw from the transaction while subprime homebuyers were more likely to have problems getting mortgage approval, he said.
“The survey found that both prime and subprime homeowners are having trouble refinancing adjustable rate mortgages,” Popik said. “Sixty-four percent of subprime homeowners could not refinance while 50% of homeowners seeking prime conforming mortgages could not refinance. Subprime homeowners most commonly had issues with subprime loan programs no longer being offered and FICO scores. Those seeking prime conforming mortgages most commonly found appraised property values and loan-to-value (LTV) ratios as impediments.”
Other product categories covered in the survey were Alt A loans and prime jumbo loans. Alt A loans have lower documentation requirements for borrower income and assets. Jumbo loans have a loan amount greater than the Fannie Mae and Freddie Mac conforming limit of $417,000. Throughout the tabulated survey results, prime conforming, prime jumbo, Alt A, and subprime product categories are separately presented.
Mortgage broker survey respondents indicated that the maximum acceptable LTV for prime jumbo production has tightened substantially and now averages 90%, the lowest of any of the four product categories surveyed. For prime jumbo loans, the minimum acceptable FICO score now averages 679, the highest of the four product categories surveyed.
The survey found substantially reduced mortgage broker production in the month of August 2007 as compared to August of last year. Production of prime conforming loans was down approximately 20% while production of Alt A loans was down nearly 50%.
Survey results indicated that a substantial number of commitments by lenders to fund loans are not being met. Another common term for funding commitment is “fully-approved loan.” Twenty percent of commitments to fund subprime loans through mortgage brokers were not met during the month of August.
The survey asked mortgage brokers for their most frequently used lenders for prime conforming, prime jumbo, Alt A, and subprime production during the month of August. Survey respondents indicated that one-third of their most frequently used subprime lenders in August are no longer accepting applications or funding loans. For prime jumbo lenders, approximately 15% are no longer accepting applications or funding loans.
The survey also asked mortgage brokers to specify the lenders they are most likely to use going forward. For prime conforming production, Countrywide was most often selected as the most likely lender going forward. For subprime production, First Franklin, a unit of Merrill Lynch, was most often selected.
The survey found that mortgage brokers are submitting identical applications for the same borrower to multiple lenders. Reasons for submitting multiple identical applications include rate shopping, uncertainty regarding mortgage approval, uncertainty regarding prevailing underwriting guidelines, and concern that lenders will not honor funding commitments. While mortgage brokers more often submit multiple applications for subprime and Alt A borrowers, this practice has become more prevalent for prime credit applicants as well. On average, mortgage brokers are currently submitting 1.7 applications for prime conforming loans; another Campbell Communications survey of mortgage brokers in 2006 found only 1.2 applications submitted on average for prime conforming loans.
“There is very little hard data available about what is currently going on in the mortgage originations and home sales markets,” Popik noted. “The Mortgage Bankers Association weekly application index is likely being skewed by mortgage brokers submitting multiple applications.
The National Association of Realtors Pending Home Sales Index does not account for sales that will fall through because of mortgage issues. Our survey shows that the number of home purchase transactions falling through due to the mortgage market disruption was substantial for the month of August. Mortgage originations statistics for the month of August from government registries of deed and industry surveys will not become available for another 60-90 days. To the best of my knowledge, we have the most current and actionable data available on the wholesale mortgage market and on homebuyers served by mortgage brokers.”
Thursday, September 13, 2007 - By Staff Writer, The National Realty News
WASHINGTON, DC – About 33% of home purchase closings of loans originated by mortgage brokers were canceled during August, according to a new national survey, which also found that 57% of brokers’ customers could not refinance adjustable rate mortgages (ARMs) that had resetting interest rates.
The survey of 1,744 brokers, conducted August 23-31, provides one of the first quantitative measures of the major disruptions in the mortgage originations market which started in early August. The survey was conducted by Campbell Communications of Washington.
The survey found that home purchase closings were more often canceled for homebuyers with subprime credit. Fifty-six percent of subprime homebuyers in August had canceled closings while 21% of homebuyers seeking prime conforming mortgages had canceled closings. In another survey of real estate agents taken by Campbell Communications back in 2004, respondents indicated that only 4% of home purchase closings failed in that timeframe for mortgage-related reasons.
Thomas Popik, designer of the survey, noted that the reasons for canceled closings were different depending on credit class and product category. Prime conforming homebuyers were more likely to withdraw from the transaction while subprime homebuyers were more likely to have problems getting mortgage approval, he said.
“The survey found that both prime and subprime homeowners are having trouble refinancing adjustable rate mortgages,” Popik said. “Sixty-four percent of subprime homeowners could not refinance while 50% of homeowners seeking prime conforming mortgages could not refinance. Subprime homeowners most commonly had issues with subprime loan programs no longer being offered and FICO scores. Those seeking prime conforming mortgages most commonly found appraised property values and loan-to-value (LTV) ratios as impediments.”
Other product categories covered in the survey were Alt A loans and prime jumbo loans. Alt A loans have lower documentation requirements for borrower income and assets. Jumbo loans have a loan amount greater than the Fannie Mae and Freddie Mac conforming limit of $417,000. Throughout the tabulated survey results, prime conforming, prime jumbo, Alt A, and subprime product categories are separately presented.
Mortgage broker survey respondents indicated that the maximum acceptable LTV for prime jumbo production has tightened substantially and now averages 90%, the lowest of any of the four product categories surveyed. For prime jumbo loans, the minimum acceptable FICO score now averages 679, the highest of the four product categories surveyed.
The survey found substantially reduced mortgage broker production in the month of August 2007 as compared to August of last year. Production of prime conforming loans was down approximately 20% while production of Alt A loans was down nearly 50%.
Survey results indicated that a substantial number of commitments by lenders to fund loans are not being met. Another common term for funding commitment is “fully-approved loan.” Twenty percent of commitments to fund subprime loans through mortgage brokers were not met during the month of August.
The survey asked mortgage brokers for their most frequently used lenders for prime conforming, prime jumbo, Alt A, and subprime production during the month of August. Survey respondents indicated that one-third of their most frequently used subprime lenders in August are no longer accepting applications or funding loans. For prime jumbo lenders, approximately 15% are no longer accepting applications or funding loans.
The survey also asked mortgage brokers to specify the lenders they are most likely to use going forward. For prime conforming production, Countrywide was most often selected as the most likely lender going forward. For subprime production, First Franklin, a unit of Merrill Lynch, was most often selected.
The survey found that mortgage brokers are submitting identical applications for the same borrower to multiple lenders. Reasons for submitting multiple identical applications include rate shopping, uncertainty regarding mortgage approval, uncertainty regarding prevailing underwriting guidelines, and concern that lenders will not honor funding commitments. While mortgage brokers more often submit multiple applications for subprime and Alt A borrowers, this practice has become more prevalent for prime credit applicants as well. On average, mortgage brokers are currently submitting 1.7 applications for prime conforming loans; another Campbell Communications survey of mortgage brokers in 2006 found only 1.2 applications submitted on average for prime conforming loans.
“There is very little hard data available about what is currently going on in the mortgage originations and home sales markets,” Popik noted. “The Mortgage Bankers Association weekly application index is likely being skewed by mortgage brokers submitting multiple applications.
The National Association of Realtors Pending Home Sales Index does not account for sales that will fall through because of mortgage issues. Our survey shows that the number of home purchase transactions falling through due to the mortgage market disruption was substantial for the month of August. Mortgage originations statistics for the month of August from government registries of deed and industry surveys will not become available for another 60-90 days. To the best of my knowledge, we have the most current and actionable data available on the wholesale mortgage market and on homebuyers served by mortgage brokers.”
Thursday, September 13, 2007
NAR: Mortgage Problems to Dampen Home Sales in the Short Term
Mortgage Problems to Dampen Home Sales in The Short Term
WASHINGTON, September 11, 2007
Tighter credit for home mortgages will measurably dampen home sales in the short term and postpone an expected recovery for existing-home sales until 2008, according to the latest forecast by the National Association of Realtors®.
Lawrence Yun, NAR senior economist, said unusual disruptions in the mortgage market are dampening the outlook for home sales, notably for August and September. “There’s been an unusual hit to home sales, starting in March when subprime problems emerged and more recently when problems spread to jumbo loans, with many potential buyers on the sidelines.
“However, the jumbo loan market is now beginning to settle, and FHA-insured loans are helping to fill the subprime vacuum. The volume of existing-home sales this year will be better than 2002, which was the second year of the housing boom.”
Existing-home sales are projected at 5.92 million this year and then rise to 6.27 million in 2008, compared with 6.48 million in 2006. New-home sales should total 801,000 in 2007 and 741,000 next year, below the 1.05 million in 2006.
“A sharp production pullback by homebuilders deep into 2008 is a healthy trend that will help trim down housing inventory,” Yun said. Housing starts, including multifamily units, are expected to total 1.37 million this year and 1.26 million in 2008, compared with 1.80 million in 2006.
“The mortgage markets will calm further in the months ahead, but it’s important to underscore the fact that conventional loans – the vast majority of available financing – are available to creditworthy borrowers,” Yun said. “Patient buyers in most areas who do their homework will recognize that housing remains a good long-term investment.”
Existing-home prices are likely to slip 1.7 percent to a median of $218,200 this year before rising 2.2 percent in 2008 to $223,000. The median new-home price is estimated to drop 2.2 percent to $241,100 in 2007, and then increase 1.7 percent next year to $245,100.
The 30-year fixed-rate mortgage is projected to average 6.4 percent for the balance of the year and then edge up to the 6.5 percent range in 2008. “We expect the Fed to cut rates two times before the end of the year, which will lower interest rates for prime borrowers and FHA-insured loans,” Yun said. “FHA modernization could buffer the fallout of subprime loans, which would raise our sales forecast in the future.”
Growth in the U.S. gross domestic product (GDP) is forecast at 2.0 percent in 2007, below the 2.9 percent growth rate last year; GDP will probably grow 2.7 percent in 2008.
The unemployment rate should average 4.6 percent for 2007, unchanged from last year.
Inflation, as measured by the Consumer Price Index, is estimated to be 2.8 percent in 2007, compared with 3.2 percent last year. Inflation-adjusted disposable personal income is likely to increase 3.6 percent this year, up from 3.1 percent in 2006.
The National Association of Realtors®, “The Voice for Real Estate,” is America’s largest trade association, representing more than 1.3 million members involved in all aspects of the residential and commercial real estate industries.
WASHINGTON, September 11, 2007
Tighter credit for home mortgages will measurably dampen home sales in the short term and postpone an expected recovery for existing-home sales until 2008, according to the latest forecast by the National Association of Realtors®.
Lawrence Yun, NAR senior economist, said unusual disruptions in the mortgage market are dampening the outlook for home sales, notably for August and September. “There’s been an unusual hit to home sales, starting in March when subprime problems emerged and more recently when problems spread to jumbo loans, with many potential buyers on the sidelines.
“However, the jumbo loan market is now beginning to settle, and FHA-insured loans are helping to fill the subprime vacuum. The volume of existing-home sales this year will be better than 2002, which was the second year of the housing boom.”
Existing-home sales are projected at 5.92 million this year and then rise to 6.27 million in 2008, compared with 6.48 million in 2006. New-home sales should total 801,000 in 2007 and 741,000 next year, below the 1.05 million in 2006.
“A sharp production pullback by homebuilders deep into 2008 is a healthy trend that will help trim down housing inventory,” Yun said. Housing starts, including multifamily units, are expected to total 1.37 million this year and 1.26 million in 2008, compared with 1.80 million in 2006.
“The mortgage markets will calm further in the months ahead, but it’s important to underscore the fact that conventional loans – the vast majority of available financing – are available to creditworthy borrowers,” Yun said. “Patient buyers in most areas who do their homework will recognize that housing remains a good long-term investment.”
Existing-home prices are likely to slip 1.7 percent to a median of $218,200 this year before rising 2.2 percent in 2008 to $223,000. The median new-home price is estimated to drop 2.2 percent to $241,100 in 2007, and then increase 1.7 percent next year to $245,100.
The 30-year fixed-rate mortgage is projected to average 6.4 percent for the balance of the year and then edge up to the 6.5 percent range in 2008. “We expect the Fed to cut rates two times before the end of the year, which will lower interest rates for prime borrowers and FHA-insured loans,” Yun said. “FHA modernization could buffer the fallout of subprime loans, which would raise our sales forecast in the future.”
Growth in the U.S. gross domestic product (GDP) is forecast at 2.0 percent in 2007, below the 2.9 percent growth rate last year; GDP will probably grow 2.7 percent in 2008.
The unemployment rate should average 4.6 percent for 2007, unchanged from last year.
Inflation, as measured by the Consumer Price Index, is estimated to be 2.8 percent in 2007, compared with 3.2 percent last year. Inflation-adjusted disposable personal income is likely to increase 3.6 percent this year, up from 3.1 percent in 2006.
The National Association of Realtors®, “The Voice for Real Estate,” is America’s largest trade association, representing more than 1.3 million members involved in all aspects of the residential and commercial real estate industries.
Wednesday, September 12, 2007
Housing Market Poised for Steep Downturn
Housing Market Poised For Steep Downturn
By Rex Nutting From MarketWatch
The U.S. housing industry is in for a much deeper downturn, the National Association of Realtors said Tuesday as it slashed its forecasts for home sales and construction for this year and next.
Tighter credit conditions will likely postpone the recovery even further, said Lawrence Yun, senior economist for the real estate trade group.
In their monthly forecast, the realtors cut their estimates for all housing-related indicators for this year and next year compared with last month's forecast. The group expects housing starts and sales of new homes to continue falling through 2008, but forecasts a mild recovery in sales of existing homes next year.
Housing starts are now expected to fall 24% this year and an additional 8% next year to 1.26 million, about 10% less than the realtors' forecast from just a month ago. That would be the lowest since 1992.
Starts of single-family homes are projected to fall 26.5% this year and an additional 11% next year to 954,000, about 11% less than last month's forecast. It would be the lowest total since 1991.
New home sales are projected to fall 24% this year and an additional 7.4% next year to 741,000, about 13% less than the forecast a month ago. That would the lowest since 1995.
Existing-home sales are projected to fall 8.6% this year and rise 5.8% next year to 6.28 million, about 2% less than last month's forecast.
The median price for existing-homes is expected to fall 1.7% this year to $218,200 and rise 2.2% next year to $223,000.
By Rex Nutting From MarketWatch
The U.S. housing industry is in for a much deeper downturn, the National Association of Realtors said Tuesday as it slashed its forecasts for home sales and construction for this year and next.
Tighter credit conditions will likely postpone the recovery even further, said Lawrence Yun, senior economist for the real estate trade group.
In their monthly forecast, the realtors cut their estimates for all housing-related indicators for this year and next year compared with last month's forecast. The group expects housing starts and sales of new homes to continue falling through 2008, but forecasts a mild recovery in sales of existing homes next year.
Housing starts are now expected to fall 24% this year and an additional 8% next year to 1.26 million, about 10% less than the realtors' forecast from just a month ago. That would be the lowest since 1992.
Starts of single-family homes are projected to fall 26.5% this year and an additional 11% next year to 954,000, about 11% less than last month's forecast. It would be the lowest total since 1991.
New home sales are projected to fall 24% this year and an additional 7.4% next year to 741,000, about 13% less than the forecast a month ago. That would the lowest since 1995.
Existing-home sales are projected to fall 8.6% this year and rise 5.8% next year to 6.28 million, about 2% less than last month's forecast.
The median price for existing-homes is expected to fall 1.7% this year to $218,200 and rise 2.2% next year to $223,000.
Tuesday, September 11, 2007
Schumer to Seek Boost In Mortgage Funding
Schumer to Seek Boost In Mortgage Funding
By Damian Paletta From The Wall Street Journal Online
Amid a worrisome slump in the U.S. housing market, Democrats are stepping up efforts to increase the flow of funds into home mortgages by expanding the authority of Fannie Mae and Freddie Mac, despite White House efforts to limit the companies' roles.
The latest move comes today, as Sen. Charles Schumer plans to introduce a bill that would temporarily loosen growth constraints on the two government-sponsored investors and increase the size of mortgages they can purchase in high-cost areas.
"This is what Fannie and Freddie were designed for," the New York Democrat said. "To have the public purpose and use private-sector knowledge and dollars."
Prospects for Mr. Schumer's bill would have been slim several months ago, but credit-market turmoil has led many Democrats and some Republicans to call for the companies to step up their activities as worries about defaults and a weak housing market keep other investors on the sidelines. Fannie and Freddie buy mortgages and repackage them as investment securities, but are bound by limits on size and types.
The Bush administration has opposed changes similar to those proposed by Mr. Schumer, but White House and Treasury officials have been under growing pressure to address the market turbulence. Last week at a hearing in the House of Representatives, Democrats repeatedly challenged the Treasury undersecretary for domestic finance, Robert K. Steel, to reverse the administration's stance regarding the companies.
Mr. Schumer's bill would raise the portfolio caps at each company by at least 10% for one year, while requiring Fannie and Freddie to devote half of that increase -- roughly $73 billion combined -- to helping borrowers with certain high-risk adjustable-rate mortgages refinance into more-affordable products.
Because of past accounting problems, Fannie and Freddie aren't allowed to expand their portfolios beyond strict limits set by their regulator, the Office of Federal Housing Enterprise Oversight, until they finish overhauling internal controls. Fannie's portfolio is capped at $727 billion, and Freddie's at $728 billion, though Freddie Mac can increase its portfolio 2% a year.
Mr. Schumer's bill would also allow the companies for one year to purchase loans of as much as $625,000 in high-cost areas. Currently, they aren't allowed to purchase mortgages above $417,000. Democrats have argued that Fannie and Freddie should be allowed to purchase more-expensive mortgages to provide liquidity to a broader group of housing markets.
It is unclear how Senate Banking Committee Chairman Christopher Dodd (D., Conn.), and House Financial Services Committee Chairman Barney Frank (D., Mass.) feel about Mr. Schumer's proposal. But the two chairmen have argued that Fannie and Freddie should begin playing an expanded role in mortgage markets immediately.
Last week, Mr. Frank said he planned to introduce an amendment that would also dramatically raise the loan limit. He said the amendment would be attached to a bill, supported by the White House, that would give the Federal Housing Administration more flexibility as an insurer of mortgage loans.
Some Republicans argue that allowing Fannie and Freddie to purchase high-cost mortgages would distract them from their mission to support affordable housing.
The House passed a bill earlier this year that would revamp oversight of both companies. It would also allow the companies to purchase more expensive mortgages in high-cost areas of the country, though not by as much as Mr. Schumer has proposed.
By Damian Paletta From The Wall Street Journal Online
Amid a worrisome slump in the U.S. housing market, Democrats are stepping up efforts to increase the flow of funds into home mortgages by expanding the authority of Fannie Mae and Freddie Mac, despite White House efforts to limit the companies' roles.
The latest move comes today, as Sen. Charles Schumer plans to introduce a bill that would temporarily loosen growth constraints on the two government-sponsored investors and increase the size of mortgages they can purchase in high-cost areas.
"This is what Fannie and Freddie were designed for," the New York Democrat said. "To have the public purpose and use private-sector knowledge and dollars."
Prospects for Mr. Schumer's bill would have been slim several months ago, but credit-market turmoil has led many Democrats and some Republicans to call for the companies to step up their activities as worries about defaults and a weak housing market keep other investors on the sidelines. Fannie and Freddie buy mortgages and repackage them as investment securities, but are bound by limits on size and types.
The Bush administration has opposed changes similar to those proposed by Mr. Schumer, but White House and Treasury officials have been under growing pressure to address the market turbulence. Last week at a hearing in the House of Representatives, Democrats repeatedly challenged the Treasury undersecretary for domestic finance, Robert K. Steel, to reverse the administration's stance regarding the companies.
Mr. Schumer's bill would raise the portfolio caps at each company by at least 10% for one year, while requiring Fannie and Freddie to devote half of that increase -- roughly $73 billion combined -- to helping borrowers with certain high-risk adjustable-rate mortgages refinance into more-affordable products.
Because of past accounting problems, Fannie and Freddie aren't allowed to expand their portfolios beyond strict limits set by their regulator, the Office of Federal Housing Enterprise Oversight, until they finish overhauling internal controls. Fannie's portfolio is capped at $727 billion, and Freddie's at $728 billion, though Freddie Mac can increase its portfolio 2% a year.
Mr. Schumer's bill would also allow the companies for one year to purchase loans of as much as $625,000 in high-cost areas. Currently, they aren't allowed to purchase mortgages above $417,000. Democrats have argued that Fannie and Freddie should be allowed to purchase more-expensive mortgages to provide liquidity to a broader group of housing markets.
It is unclear how Senate Banking Committee Chairman Christopher Dodd (D., Conn.), and House Financial Services Committee Chairman Barney Frank (D., Mass.) feel about Mr. Schumer's proposal. But the two chairmen have argued that Fannie and Freddie should begin playing an expanded role in mortgage markets immediately.
Last week, Mr. Frank said he planned to introduce an amendment that would also dramatically raise the loan limit. He said the amendment would be attached to a bill, supported by the White House, that would give the Federal Housing Administration more flexibility as an insurer of mortgage loans.
Some Republicans argue that allowing Fannie and Freddie to purchase high-cost mortgages would distract them from their mission to support affordable housing.
The House passed a bill earlier this year that would revamp oversight of both companies. It would also allow the companies to purchase more expensive mortgages in high-cost areas of the country, though not by as much as Mr. Schumer has proposed.
Wednesday, August 08, 2007
How Credit Got So Easy and Why It's Tightening
How Credit Got So EasyAnd Why It's Tightening
By Greg Ip and Jon E. Hilsenrath From The Wall Street Journal Online
An extraordinary credit boom that created many first-time homeowners and financed a wave of corporate takeovers seems to be waning. Home buyers with poor credit are having trouble borrowing. Institutional investors from Milwaukee to Düsseldorf to Sydney are reporting losses.
Banks are stuck with corporate debt that investors won't buy. Stocks are on a roller coaster, with financial powerhouses like Bear Stearns Cos. and Blackstone Group coming under intense pressure.
The origins of the boom and this unfolding reversal predate last year's mistakes. They trace to changes in the banking system provoked by the collapse of the savings-and-loan industry in the 1980s, the reaction of governments to the Asian financial crisis of the late 1990s, and the Federal Reserve's response to the 2000-01 bursting of the tech-stock bubble.
When the Fed cut interest rates to the lowest level in a generation to avoid a severe downturn, then-Chairman Alan Greenspan anticipated that making short-term credit so cheap would have unintended consequences. "I don't know what it is, but we're doing some damage because this is not the way credit markets should operate," he and a colleague recall him saying at the time.
Now the consequences of moves the Fed and others made are becoming clearer.
Low interest rates engineered by central banks and reinforced by a tidal wave of overseas savings fueled home prices and leveraged buyouts. Pension funds and endowments, unhappy with skimpy returns, shoved cash at hedge funds and private-equity firms, which borrowed heavily to make big bets. The investments of choice were opaque financial instruments that shifted default risk from lenders to global investors. The question now: When the dust settles, will the world be better off?
"These adverse periods are very painful, but they're inevitable if we choose to maintain a system in which people are free to take risks, a necessary condition for maximum sustainable economic growth," Mr. Greenspan says today. The evolving financial architecture is distributing risks away from highly leveraged banks toward investors better able to handle them, keeping the banks and economy more stable than in the past, he says. Economic growth, particularly outside the U.S., is strong, and even in the U.S., unemployment remains low. The financial system has absorbed the latest shock.
So far. But credit problems once seen as isolated to a few subprime-mortgage lenders are beginning to propagate across markets and borders in unpredicted ways and degrees. A system designed to distribute and absorb risk might, instead, have bred it, by making it so easy for investors to buy complex securities they didn't fully understand. And the interconnectedness of markets could mean that a sudden change in sentiment by investors in all sorts of markets could destabilize the financial system and hurt economic growth.
Side Effects of Deflation Fight
When a technology stock and investment plunge and the Sept. 11 terrorist attacks pushed the economy into recession in 2001, the Fed slashed interest rates. But even by mid-2003, job creation and business investment were still anemic, and the inflation rate was slipping toward 1%. The Fed began to study Japan's unhappy bout with deflation -- generally declining prices -- which made it harder to repay debts and left the central bank seemingly powerless to stimulate growth.
"Even though we perceive the risks [of deflation] as minor, the potential consequences are very substantial and could be quite negative," Mr. Greenspan said in May 2003. A month later, the Fed cut the target for its key federal-funds interest rate, a benchmark for all short-term rates, to 1%. It said the rate would stay there as long as necessary, figuring low rates would bolster housing and consumer spending until business investment and exports recovered. The rate stayed at 1% for a year.
Mr. Greenspan raised vague fears with colleagues over the possibility this policy could create distortions in the economy, but he says today that such risks were an acceptable price for insuring against deflation. "Central banks cannot avoid taking risks. Such trade-offs are an integral part of policy. We were always confronted with choices."
Fed officials who were there at the time generally maintain their policy was right, even in hindsight. The economy has grown steadily, avoiding both deflation and serious inflation. Yet some say they may have planted seeds of excess in the housing and subprime-loan markets.
Robert Eisenbeis, retired research director at the Federal Reserve Bank of Atlanta, says the Fed overreacted to the threat of deflation and kept rates low for too long. As a result, it "overstimulated the housing market, and now we're dealing with the consequences."
Edward Gramlich, a Fed governor in Washington from 1997 to 2005, says he failed to realize at the time that low rates were making it so easy for lenders to market subprime mortgages with low introductory rates. The Fed and other regulators could have prevented some of the resulting pain with more rigorous supervision of mortgage lenders besides banks, he says. "We didn't have that, and we're paying for it now." In June 2004, the Fed began to raise the short-term target rate, eventually taking it to 5.25%, where it has been for the past year. Such a boost usually leads to a rise, as well, in long-term rates, which are important to rates on 30-year conventional mortgages and corporate bonds. This time, it didn't. Mr. Greenspan expressed concern that investors were willing to accept low returns for taking on risk. "What they perceive as newly abundant liquidity can readily disappear," he said in August 2005, six months before retiring. "History has not dealt kindly with the aftermath of protracted periods of low risk premiums."
Looking back, he says today: "We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed."
Something besides Fed policy was at work. Both Mr. Greenspan and his successor, Ben Bernanke, point to an unanticipated surge in capital pouring into the U.S. from overseas.
'Global Saving Glut'
In June 1998, U.S. Treasury officials made a plea to China that they would be reminded of repeatedly in the following years. Thailand had devalued its currency in 1997, touching off a crisis in the region that led other countries to devalue and in some cases default on foreign debt. The yen was sliding. Chinese officials, who pegged their currency to the U.S. dollar, "let it be known...that if things kept going this way they'd have no choice but to devalue," recalls Ted Truman, a Treasury official at the time. The U.S., fearing such a move would trigger another round of devaluations, urged the Chinese to hold their peg, and praised them when they did so.
But times changed. As recessions and depressed currencies held down imports and goosed exports in other Asian countries, the countries ran trade surpluses that replenished foreign-exchange reserves. Determined never to be so tied to the onerous conditions of the International Monetary Fund, they have kept those policies in place. Thai reserves, effectively exhausted in 1997, now stand at $73 billion.
Long after the crisis passed, China's economic fundamentals suggested its currency should rise against the dollar. China let it rise only slowly, continuing to juice exports and produce trade surpluses that pushed China's foreign-exchange reserves above $1 trillion. When the U.S. pressed China to let its currency float, China reminded the U.S. of the fixed exchange rate's stabilizing role in 1998. China put much of its cash -- part of what Mr. Bernanke has called a "global saving glut" -- into U.S. Treasurys, helping hold down long-term U.S. interest rates.
Chinese government entities also recently poured $3 billion into U.S. private-equity firm Blackstone.
Mortgages for All
Lou Barnes, co-owner of a small Colorado mortgage bank called Boulder West Inc., has been in the mortgage business since the late 1970s. For most of that time, a borrower had to fully document his income. Lenders offered the first no-documentation loans in the mid-1990s, but for no more than 70% of the value of the house being purchased. A few years back, he says, that began to change as Wall Street investment banks and wholesalers demanded ever more mortgages from even the least creditworthy -- or "subprime" -- customers.
"All of us felt the suction from Wall Street. One day you would get an email saying, 'We will buy no-doc loans at 95% loan-to-value,' and an old-timer like me had never seen one," says Mr. Barnes. "It wasn't long before the no-doc emails said 100%."
Until the late 1990s, the subprime market was dominated by home-equity lines used by borrowers to consolidate debt and by loans on mobile homes. But when the Fed held rates down after 2001, lenders could offer borrowers with sketchy credit histories adjustable-rate mortgages with introductory rates that seemed affordable. Mr. Barnes says customers were asking about "2/28" subprime loans. These offered a low starter rate for two years, then adjusted for the remaining 28 to a rate that was often three percentage points higher than a prime customer normally paid. Customers, he says, seldom appreciated how high that rate could be once the Fed returned rates to normal levels.
Demand from consumers, on one side, and Wall Street and its customers on the other side prompted lenders to make more and more subprime loans. Originations rose to $600 billion or more in both 2005 and 2006 from $160 billion in 2001, according to Inside Mortgage Finance, an industry publication.
At first, delinquencies were surprisingly low. As a result, the credit ratings for bonds backed by the mortgages assumed a modest default rate. Standards for getting a mortgage fell. About 45% of all subprime loans in 2006 went to borrowers who didn't fully document their income, making it easier for them to overstate their creditworthiness.
The delinquency rate was a mirage: It was low mainly because home prices were rising so much that borrowers who fell behind could easily refinance. When home prices stopped rising in 2006, and fell in some regions, that game ended. Borrowers with subprime loans made in 2006 fell behind on monthly payments much more quickly than mortgages made a year or two earlier.
When banks get in trouble, federal deposit insurance encourages depositors not to flee, and in extreme circumstances, banks can borrow directly from the Fed. But banks are no longer the dominant lenders. After the S&L crisis in the 1980s and early 1990s, regulators insisted banks and thrifts hold more capital against risky loans. This tipped the playing field in favor of unregulated lenders. They financed themselves not by deposits but by Wall Street credit lines and by "securitization" of their loans -- in effect, the sale of the loans to investors.
The consequences proved painful. New Century Financial Corp., founded in 1995 by three former S&L executives, was the nation's second largest subprime lender by 2006. When its borrowers began falling behind, Wall Street cut off its lines of credit and forced it to buy back some of its poorly performing loans. New Century couldn't fall back on deposit insurance or the Fed. It filed for bankruptcy protection in April, wiping out shareholders and triggering market-wide fears about the health of the subprime business.
LBO Boom
Home buyers were not alone. In August 2002, Qwest Communications International Inc. -- heavily indebted, beaten down by the telecom bust and under investigation by the Securities and Exchange Commission -- decided to sell its Yellow Pages business. Private-equity firms Carlyle Group and Welsh, Carson, Anderson & Stowe agreed to buy it for $7 billion, about $5.5 billion of it borrowed. The business produced steady cash flow that could be used to pay down the debt.
The buyers were worried they might not be able to borrow as much as they needed. "We were coming out of a pretty bad credit cycle," says Daniel Toscano, managing director at Deutsche Bank, which helped to manage the fund-raising. Instead, they tapped into a gusher. Within a year, Dex Media Inc., as the business became known, was back in the market. It borrowed $889 million to pay a dividend to Carlyle and Welsh Carson, and then $250 million more to pay another dividend. In just 15 months, the private-equity buyers made back most of their investment and still owned the company.
By 2006, the volume of such leveraged buyouts was smashing records from the 1980s. Generous credit markets enabled private-equity firms to do larger deals and pay themselves bigger dividends. They boosted returns -- and attracted more investors, which enabled even bigger deals.
As in subprime mortgages, lenders began to ease borrowing requirements. They agreed, for instance, to "covenant-lite debt," which dropped once-standard performance requirements, and "PIK-toggle" notes, which allowed borrowers to toggle interest payments on and off like a faucet.
Bankers began marketing debt deals for companies that, unlike Yellow Pages, didn't have comfortable cash flow. There was Chrysler, burning cash rather than producing it. And there was First Data Corp., whose post-takeover cash flow would barely cover interest payments and capital spending, according to Standard & Poor's LCD, a unit of S&P which tracks the high-yield market.
Last month, investors began to balk. Now many banks find themselves having committed to lend about $200 billion that they had intended to turn over to investors, but can't.
Let's All Look Like Yale
The subprime and LBO booms required willing lenders. The stock-market collapse and low interest rates of 2001 to 2004 nurtured a class of investors and products to fill that role. Managers of pension and endowment funds long had divided their assets among domestic stocks, bonds and cash. The funds saw their performance suffer when the stock market and then bond yields tumbled.
A few endowments, most notably at Yale and Harvard, had for years been spreading their investments more broadly, going into hedge funds, real estate, foreign stocks, even timberland. The goal was holdings that wouldn't suffer in sync with stocks in a bear market. Sure enough, in 2000 and 2001, even as stocks tumbled, Harvard Management Co. earned returns of 32.2% and -2.7% respectively. Yale's returns were 41% and 9.2%.
Other institutions wanted their money managed the same way, seeding a flood of hedge funds that bought other untraditional investments such as credit derivatives. University endowments poured roughly $40 billion into hedge funds between 2000 and 2006, according to Hedge Fund Intelligence, a newsletter. "I call it the 'Let's all look like Yale effect,'" says Jeremy Grantham, chairman of Boston money manager GMO LLC.
Low interest rates made many investors willing to buy exotic securities in an effort to boost returns. Wall Street had just the vehicle: securitization, or turning loans that once sat quietly on banks' books into securities that can be sold in global markets.
Securitization, long common in conventional mortgages, had been supercharged in the early 1990s when the federal Resolution Trust Corp. took over S&Ls that held more than $400 billion of assets. Though some thought it would take the RTC a century to unload them, it took only a few years. The agency successfully securitized new classes of assets, such as delinquent home loans or commercial loans.
In the late 1990s, Wall Street went a step further, packaging bigger pools of securities into collateralized debt obligations, or CDOs, and carving them into "tranches," each with a different level of risk and return. Riskier tranches suffered the first losses if some underlying loans defaulted. Other tranches offered lower returns because riskier tranches would take the first hits if the business went sour.
Because of the way they were structured, some CDO tranches got triple-A ratings from Moody's Investors Service and Standard & Poor's even though they contained subprime loans. That lured traditionally conservative investors such as commercial banks, insurance companies and pension funds.
The upside was evident: Many borrowers got loans they wouldn't otherwise have had. The taxpayer-backed deposit fund was less likely to bear the cost of sloppy lending practices. Banks shifted risks to investors more willing to bear them -- leaving the banks able to make more loans. Investors could pick either more-risky or less-risky slices. And Wall Street middlemen made handsome profits.
Now the downside, too, is painfully evident. Final investors were so many steps removed from the original loans that it became hard for them to know the true value and risk of securities they bought. Some were satisfied with a triple-A rating on a CDO -- seemingly as safe as a U.S. Treasury bond but with more yield. Yet as defaults ate through the cushion of lower-rated tranches with unexpected speed, rating agencies were forced to rethink their models -- and lower the ratings on many of these investments.
Some structures were so opaque that markets couldn't value them. But ratings cuts sometimes forced an acknowledgment that securities owned weren't worth as much as thought. In May, Swiss bank UBS AG shut down a hedge fund after a $124 million loss. In June, two Bear Stearns hedge funds saw as much as $1.6 billion of investor capital wiped out by bad mortgage bets and pulled credit lines. The trouble spread to hedge funds in Sydney, Australia, a mortgage insurer in Milwaukee and a bank in Düsseldorf, Germany.
Even Harvard has been hit. The university lost about $350 million through an investment in Sowood Capital Management, a hedge-fund firm founded by one of the university's former in-house money managers.
Casino Night
Recent events show that financial innovations meant to distribute risk can end up multiplying it instead, in ways neither regulators nor investors fully understand. Mr. Grantham, the Boston money manager, says his portfolios are behaving in ways he hadn't expected.
Fed officials believe that even if their policies led to housing and debt bubbles, the strength of the overall economy shows that the policy was, on balance, the right one. Of course, that assumes the current problems don't culminate in a recession.
Market veterans predict the most egregious underwriting practices and products will disappear, but the benefits of innovation will continue.
Lessons have been learned -- the hard way. "The structures are here to stay," says Glenn Reynolds, chief executive of research firm CreditSights. "But you have to run it like a prudent risk-taking venture, not like it's casino night and you're on a bender."
By Greg Ip and Jon E. Hilsenrath From The Wall Street Journal Online
An extraordinary credit boom that created many first-time homeowners and financed a wave of corporate takeovers seems to be waning. Home buyers with poor credit are having trouble borrowing. Institutional investors from Milwaukee to Düsseldorf to Sydney are reporting losses.
Banks are stuck with corporate debt that investors won't buy. Stocks are on a roller coaster, with financial powerhouses like Bear Stearns Cos. and Blackstone Group coming under intense pressure.
The origins of the boom and this unfolding reversal predate last year's mistakes. They trace to changes in the banking system provoked by the collapse of the savings-and-loan industry in the 1980s, the reaction of governments to the Asian financial crisis of the late 1990s, and the Federal Reserve's response to the 2000-01 bursting of the tech-stock bubble.
When the Fed cut interest rates to the lowest level in a generation to avoid a severe downturn, then-Chairman Alan Greenspan anticipated that making short-term credit so cheap would have unintended consequences. "I don't know what it is, but we're doing some damage because this is not the way credit markets should operate," he and a colleague recall him saying at the time.
Now the consequences of moves the Fed and others made are becoming clearer.
Low interest rates engineered by central banks and reinforced by a tidal wave of overseas savings fueled home prices and leveraged buyouts. Pension funds and endowments, unhappy with skimpy returns, shoved cash at hedge funds and private-equity firms, which borrowed heavily to make big bets. The investments of choice were opaque financial instruments that shifted default risk from lenders to global investors. The question now: When the dust settles, will the world be better off?
"These adverse periods are very painful, but they're inevitable if we choose to maintain a system in which people are free to take risks, a necessary condition for maximum sustainable economic growth," Mr. Greenspan says today. The evolving financial architecture is distributing risks away from highly leveraged banks toward investors better able to handle them, keeping the banks and economy more stable than in the past, he says. Economic growth, particularly outside the U.S., is strong, and even in the U.S., unemployment remains low. The financial system has absorbed the latest shock.
So far. But credit problems once seen as isolated to a few subprime-mortgage lenders are beginning to propagate across markets and borders in unpredicted ways and degrees. A system designed to distribute and absorb risk might, instead, have bred it, by making it so easy for investors to buy complex securities they didn't fully understand. And the interconnectedness of markets could mean that a sudden change in sentiment by investors in all sorts of markets could destabilize the financial system and hurt economic growth.
Side Effects of Deflation Fight
When a technology stock and investment plunge and the Sept. 11 terrorist attacks pushed the economy into recession in 2001, the Fed slashed interest rates. But even by mid-2003, job creation and business investment were still anemic, and the inflation rate was slipping toward 1%. The Fed began to study Japan's unhappy bout with deflation -- generally declining prices -- which made it harder to repay debts and left the central bank seemingly powerless to stimulate growth.
"Even though we perceive the risks [of deflation] as minor, the potential consequences are very substantial and could be quite negative," Mr. Greenspan said in May 2003. A month later, the Fed cut the target for its key federal-funds interest rate, a benchmark for all short-term rates, to 1%. It said the rate would stay there as long as necessary, figuring low rates would bolster housing and consumer spending until business investment and exports recovered. The rate stayed at 1% for a year.
Mr. Greenspan raised vague fears with colleagues over the possibility this policy could create distortions in the economy, but he says today that such risks were an acceptable price for insuring against deflation. "Central banks cannot avoid taking risks. Such trade-offs are an integral part of policy. We were always confronted with choices."
Fed officials who were there at the time generally maintain their policy was right, even in hindsight. The economy has grown steadily, avoiding both deflation and serious inflation. Yet some say they may have planted seeds of excess in the housing and subprime-loan markets.
Robert Eisenbeis, retired research director at the Federal Reserve Bank of Atlanta, says the Fed overreacted to the threat of deflation and kept rates low for too long. As a result, it "overstimulated the housing market, and now we're dealing with the consequences."
Edward Gramlich, a Fed governor in Washington from 1997 to 2005, says he failed to realize at the time that low rates were making it so easy for lenders to market subprime mortgages with low introductory rates. The Fed and other regulators could have prevented some of the resulting pain with more rigorous supervision of mortgage lenders besides banks, he says. "We didn't have that, and we're paying for it now." In June 2004, the Fed began to raise the short-term target rate, eventually taking it to 5.25%, where it has been for the past year. Such a boost usually leads to a rise, as well, in long-term rates, which are important to rates on 30-year conventional mortgages and corporate bonds. This time, it didn't. Mr. Greenspan expressed concern that investors were willing to accept low returns for taking on risk. "What they perceive as newly abundant liquidity can readily disappear," he said in August 2005, six months before retiring. "History has not dealt kindly with the aftermath of protracted periods of low risk premiums."
Looking back, he says today: "We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed."
Something besides Fed policy was at work. Both Mr. Greenspan and his successor, Ben Bernanke, point to an unanticipated surge in capital pouring into the U.S. from overseas.
'Global Saving Glut'
In June 1998, U.S. Treasury officials made a plea to China that they would be reminded of repeatedly in the following years. Thailand had devalued its currency in 1997, touching off a crisis in the region that led other countries to devalue and in some cases default on foreign debt. The yen was sliding. Chinese officials, who pegged their currency to the U.S. dollar, "let it be known...that if things kept going this way they'd have no choice but to devalue," recalls Ted Truman, a Treasury official at the time. The U.S., fearing such a move would trigger another round of devaluations, urged the Chinese to hold their peg, and praised them when they did so.
But times changed. As recessions and depressed currencies held down imports and goosed exports in other Asian countries, the countries ran trade surpluses that replenished foreign-exchange reserves. Determined never to be so tied to the onerous conditions of the International Monetary Fund, they have kept those policies in place. Thai reserves, effectively exhausted in 1997, now stand at $73 billion.
Long after the crisis passed, China's economic fundamentals suggested its currency should rise against the dollar. China let it rise only slowly, continuing to juice exports and produce trade surpluses that pushed China's foreign-exchange reserves above $1 trillion. When the U.S. pressed China to let its currency float, China reminded the U.S. of the fixed exchange rate's stabilizing role in 1998. China put much of its cash -- part of what Mr. Bernanke has called a "global saving glut" -- into U.S. Treasurys, helping hold down long-term U.S. interest rates.
Chinese government entities also recently poured $3 billion into U.S. private-equity firm Blackstone.
Mortgages for All
Lou Barnes, co-owner of a small Colorado mortgage bank called Boulder West Inc., has been in the mortgage business since the late 1970s. For most of that time, a borrower had to fully document his income. Lenders offered the first no-documentation loans in the mid-1990s, but for no more than 70% of the value of the house being purchased. A few years back, he says, that began to change as Wall Street investment banks and wholesalers demanded ever more mortgages from even the least creditworthy -- or "subprime" -- customers.
"All of us felt the suction from Wall Street. One day you would get an email saying, 'We will buy no-doc loans at 95% loan-to-value,' and an old-timer like me had never seen one," says Mr. Barnes. "It wasn't long before the no-doc emails said 100%."
Until the late 1990s, the subprime market was dominated by home-equity lines used by borrowers to consolidate debt and by loans on mobile homes. But when the Fed held rates down after 2001, lenders could offer borrowers with sketchy credit histories adjustable-rate mortgages with introductory rates that seemed affordable. Mr. Barnes says customers were asking about "2/28" subprime loans. These offered a low starter rate for two years, then adjusted for the remaining 28 to a rate that was often three percentage points higher than a prime customer normally paid. Customers, he says, seldom appreciated how high that rate could be once the Fed returned rates to normal levels.
Demand from consumers, on one side, and Wall Street and its customers on the other side prompted lenders to make more and more subprime loans. Originations rose to $600 billion or more in both 2005 and 2006 from $160 billion in 2001, according to Inside Mortgage Finance, an industry publication.
At first, delinquencies were surprisingly low. As a result, the credit ratings for bonds backed by the mortgages assumed a modest default rate. Standards for getting a mortgage fell. About 45% of all subprime loans in 2006 went to borrowers who didn't fully document their income, making it easier for them to overstate their creditworthiness.
The delinquency rate was a mirage: It was low mainly because home prices were rising so much that borrowers who fell behind could easily refinance. When home prices stopped rising in 2006, and fell in some regions, that game ended. Borrowers with subprime loans made in 2006 fell behind on monthly payments much more quickly than mortgages made a year or two earlier.
When banks get in trouble, federal deposit insurance encourages depositors not to flee, and in extreme circumstances, banks can borrow directly from the Fed. But banks are no longer the dominant lenders. After the S&L crisis in the 1980s and early 1990s, regulators insisted banks and thrifts hold more capital against risky loans. This tipped the playing field in favor of unregulated lenders. They financed themselves not by deposits but by Wall Street credit lines and by "securitization" of their loans -- in effect, the sale of the loans to investors.
The consequences proved painful. New Century Financial Corp., founded in 1995 by three former S&L executives, was the nation's second largest subprime lender by 2006. When its borrowers began falling behind, Wall Street cut off its lines of credit and forced it to buy back some of its poorly performing loans. New Century couldn't fall back on deposit insurance or the Fed. It filed for bankruptcy protection in April, wiping out shareholders and triggering market-wide fears about the health of the subprime business.
LBO Boom
Home buyers were not alone. In August 2002, Qwest Communications International Inc. -- heavily indebted, beaten down by the telecom bust and under investigation by the Securities and Exchange Commission -- decided to sell its Yellow Pages business. Private-equity firms Carlyle Group and Welsh, Carson, Anderson & Stowe agreed to buy it for $7 billion, about $5.5 billion of it borrowed. The business produced steady cash flow that could be used to pay down the debt.
The buyers were worried they might not be able to borrow as much as they needed. "We were coming out of a pretty bad credit cycle," says Daniel Toscano, managing director at Deutsche Bank, which helped to manage the fund-raising. Instead, they tapped into a gusher. Within a year, Dex Media Inc., as the business became known, was back in the market. It borrowed $889 million to pay a dividend to Carlyle and Welsh Carson, and then $250 million more to pay another dividend. In just 15 months, the private-equity buyers made back most of their investment and still owned the company.
By 2006, the volume of such leveraged buyouts was smashing records from the 1980s. Generous credit markets enabled private-equity firms to do larger deals and pay themselves bigger dividends. They boosted returns -- and attracted more investors, which enabled even bigger deals.
As in subprime mortgages, lenders began to ease borrowing requirements. They agreed, for instance, to "covenant-lite debt," which dropped once-standard performance requirements, and "PIK-toggle" notes, which allowed borrowers to toggle interest payments on and off like a faucet.
Bankers began marketing debt deals for companies that, unlike Yellow Pages, didn't have comfortable cash flow. There was Chrysler, burning cash rather than producing it. And there was First Data Corp., whose post-takeover cash flow would barely cover interest payments and capital spending, according to Standard & Poor's LCD, a unit of S&P which tracks the high-yield market.
Last month, investors began to balk. Now many banks find themselves having committed to lend about $200 billion that they had intended to turn over to investors, but can't.
Let's All Look Like Yale
The subprime and LBO booms required willing lenders. The stock-market collapse and low interest rates of 2001 to 2004 nurtured a class of investors and products to fill that role. Managers of pension and endowment funds long had divided their assets among domestic stocks, bonds and cash. The funds saw their performance suffer when the stock market and then bond yields tumbled.
A few endowments, most notably at Yale and Harvard, had for years been spreading their investments more broadly, going into hedge funds, real estate, foreign stocks, even timberland. The goal was holdings that wouldn't suffer in sync with stocks in a bear market. Sure enough, in 2000 and 2001, even as stocks tumbled, Harvard Management Co. earned returns of 32.2% and -2.7% respectively. Yale's returns were 41% and 9.2%.
Other institutions wanted their money managed the same way, seeding a flood of hedge funds that bought other untraditional investments such as credit derivatives. University endowments poured roughly $40 billion into hedge funds between 2000 and 2006, according to Hedge Fund Intelligence, a newsletter. "I call it the 'Let's all look like Yale effect,'" says Jeremy Grantham, chairman of Boston money manager GMO LLC.
Low interest rates made many investors willing to buy exotic securities in an effort to boost returns. Wall Street had just the vehicle: securitization, or turning loans that once sat quietly on banks' books into securities that can be sold in global markets.
Securitization, long common in conventional mortgages, had been supercharged in the early 1990s when the federal Resolution Trust Corp. took over S&Ls that held more than $400 billion of assets. Though some thought it would take the RTC a century to unload them, it took only a few years. The agency successfully securitized new classes of assets, such as delinquent home loans or commercial loans.
In the late 1990s, Wall Street went a step further, packaging bigger pools of securities into collateralized debt obligations, or CDOs, and carving them into "tranches," each with a different level of risk and return. Riskier tranches suffered the first losses if some underlying loans defaulted. Other tranches offered lower returns because riskier tranches would take the first hits if the business went sour.
Because of the way they were structured, some CDO tranches got triple-A ratings from Moody's Investors Service and Standard & Poor's even though they contained subprime loans. That lured traditionally conservative investors such as commercial banks, insurance companies and pension funds.
The upside was evident: Many borrowers got loans they wouldn't otherwise have had. The taxpayer-backed deposit fund was less likely to bear the cost of sloppy lending practices. Banks shifted risks to investors more willing to bear them -- leaving the banks able to make more loans. Investors could pick either more-risky or less-risky slices. And Wall Street middlemen made handsome profits.
Now the downside, too, is painfully evident. Final investors were so many steps removed from the original loans that it became hard for them to know the true value and risk of securities they bought. Some were satisfied with a triple-A rating on a CDO -- seemingly as safe as a U.S. Treasury bond but with more yield. Yet as defaults ate through the cushion of lower-rated tranches with unexpected speed, rating agencies were forced to rethink their models -- and lower the ratings on many of these investments.
Some structures were so opaque that markets couldn't value them. But ratings cuts sometimes forced an acknowledgment that securities owned weren't worth as much as thought. In May, Swiss bank UBS AG shut down a hedge fund after a $124 million loss. In June, two Bear Stearns hedge funds saw as much as $1.6 billion of investor capital wiped out by bad mortgage bets and pulled credit lines. The trouble spread to hedge funds in Sydney, Australia, a mortgage insurer in Milwaukee and a bank in Düsseldorf, Germany.
Even Harvard has been hit. The university lost about $350 million through an investment in Sowood Capital Management, a hedge-fund firm founded by one of the university's former in-house money managers.
Casino Night
Recent events show that financial innovations meant to distribute risk can end up multiplying it instead, in ways neither regulators nor investors fully understand. Mr. Grantham, the Boston money manager, says his portfolios are behaving in ways he hadn't expected.
Fed officials believe that even if their policies led to housing and debt bubbles, the strength of the overall economy shows that the policy was, on balance, the right one. Of course, that assumes the current problems don't culminate in a recession.
Market veterans predict the most egregious underwriting practices and products will disappear, but the benefits of innovation will continue.
Lessons have been learned -- the hard way. "The structures are here to stay," says Glenn Reynolds, chief executive of research firm CreditSights. "But you have to run it like a prudent risk-taking venture, not like it's casino night and you're on a bender."
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