This is the second in a two-part series of articles introducing my new “Secondary Market Overview” column for National Mortgage Professional Magazine. The goal of this column is to provide some perspective on how the secondary markets played a role in what has happened in the rise and fall of the real estate markets over the past 10 years. We left off in the September 2009 edition with the end of the Savings and Loan (S&L) crisis in the late 1980s. We moved from the S&L-dominated portfolio lending industry to one which was dominated by banks and the sale of mortgages on the secondary markets. The banks became stronger, and in an era of “deregulation,” they were able to make some major gains, easing and eliminating restrictions that were laid down in the wake of the banking crisis that occurred as part of the Great Depression earlier in the century. This culminated with the passage of the Financial Services Modernization Act of 1999. Remember that banks had to expand because they were called upon the talk over many of the assets of the failed S&Ls, and this expansion fueled a major merger and acquisition frenzy.
The 1990s was a decade of healing for the real estate industry. After another recession early in the decade, home prices stabilized and started recovering and the secondary markets were gaining steam. This recovery gained momentum towards the end of the decade.
There was a convergence of factors heading into the new decade:
► Early in the decade, the stock market crash brought the technology boom stocks to a halt. This means that investors were looking for “safer” investments.
► Despite the stock market crash, we had a strong economy, with plenty of cash out there—and real estate was seen as that “safe” investment.
► We also experienced an immigration boom, raising the demand for housing significantly.
► Sept. 11 hit, and though this caused a major disruption in the economy, a sharp downturn was avoided because the Fed drove rates down and turned on the spigot for credit.
All the while, the secondary market was evolving—in an era of deregulation. What did that mean? It meant the development of new products we had never seen before. No money down, stated-income, low credit score, multiple investors, unapproved condos and more. We had actually seen many of these before—but not in a combination like this. When I entered in the mortgage business 30 years ago, even when rates were a relatively low eight percent, if you had bad credit, you borrowed from a finance company at a rate of 18 percent or more. Now “sub-prime” was 0.5 percent above prime. How could that happen?
Well, combine the real estate boom that was taking place with these new products. These new products grew up in a time of a boom. They had never been tested in a bad real estate market. There are apparently no regulations requiring this. The pricing and guidelines were built only for prices of real estate going up. And not only did the price of real estate go up, but the availability of these products caused them to go up even faster. It was a feeding frenzy. The banks wanted even more product to sell and they made it ever so easy for mortgage brokers to get approved, and all of a sudden, we had a huge sales force—one that was new, inexperience and untrained. Why not? There were gobs of fees to be made and if the loans were “sold” there was no risk. The brokers and the bankers both felt invincible. Well, you all know what happened.
Seems like someone should have said, “What happens when the price of real estate goes down?” It certainly did during the late 1980s. It was like everyone lost their memory. The bigger they are, the harder they fall. And that’s exactly what happened—the biggest rise we ever saw and the biggest fall we ever saw. And the secondary market was in the “thick” of things.
The pendulum has swung—especially the credit pendulum. We have moved from the easiest credit environment to one in which it is very hard to get the average American approved. Equity is gone for many and credit scores are down. Foreclosures are soaring. The next year will be interesting. We have been “healing” for at least a year and the scars are so bad, it will take more than one year. The wild card? The government. Our healing process may have never have started if the government did not intervene. The government is purchasing Treasuries to keep rates down. They are purchasing mortgages to keep them priced reasonably. They have raised the conforming limits because the jumbo markets were in disarray. The tax credit has been absolutely essential to support the housing markets. The Federal Housing Administration (FHA) has become the hottest program in the nation. This all comes behind the fact that the industry already enjoys the single biggest tax break in America.
But the government cannot support us forever. They have spent hundreds of billions of dollars supporting the banks that make the loans, those who purchase homes and more. Granted, some of this money will come back when the banks purchase back their shares and securities are sold, but if the government withdraws from the markets too quickly, this will be as bad as rates going up quickly and choking off the recovery. As a matter of fact, we are in a Catch-22 situation. The more the government spends, the more likely rates will rise some time in the future. If the government stops spending, there is a chance that the markets will collapse again and we have to work our way out of a hole. So during the coming months and throughout the next year, the government will move from a full scale stimulus mode to an important balancing act mode. Our industry and our economy hang in this balance. Our technical advisor, Eric Holloman, chief executive officer of RateLink, tells us to expect the next year to be interesting and the months ahead to be volatile as these conflicting forces fight to prevail.
Dave Hershman is a leading author for the mortgage industry with eight books and several hundred articles to his credit. He is also head of OriginationPro Mortgage School and a top industry speaker.