Getting Out of the Housing Mess

05/22/2008 12:00 am EST


Howard Gold

Founder & President, GoldenEgg Investing

Everybody agrees that the housing market is in terrible shape, with steep price declines nationwide for the first time since the Great Depression.

And it's hard to quantify the misery and anxiety of many of our fellow citizens as they struggle to keep their homes while the prices of food and gasoline go through the roof.

But as Congress moves to offer $300 billion in loan guarantees to desperate borrowers, we need to know what the real problem is and how we got here.

My take: This housing crisis, while nationwide, is most acute in several states. Predatory lending played a big role, but so did speculative building and buying. And although housing prices nationwide should stabilize over the next year or so, some overbuilt markets may take much longer to recover.

First, the bad news.

Home foreclosures more than doubled in the first quarter from the same period in 2007, and some estimate that more than two million people may eventually lose their homes.

Foreclosures also could cause 40 million neighboring homes to lose as much as $356 billion in value-which also would hit state and local governments' property tax base by a similar amount, according to the Pew Center on the States.

The problem, as we all know, is that tens of billions of dollars of adjustable rate mortgages (ARMs) with "teaser" rates underwritten at the top of the housing bubble are now resetting when home values are much lower.

That makes it harder-in some cases, impossible-for borrowers to either refinance their mortgages or meet much higher monthly payments. That could lead to foreclosure.

And we're probably in the eye of the storm right now. Interest-rate resets on subprime mortgages will peak this year at over $30 billion a month, then drop dramatically in 2009, according to Credit Suisse.

But resets on Alt-A loans, given to somewhat more creditworthy borrowers, will continue to climb well into 2011 (presumably when five-year ARMs expire), and resets on prime ARMs will pick up a bit next year and then remain stable.

That means we'll likely be out of the acute phase of the crisis by year-end, but we'll probably have a higher than average default rate well into the next president's term.

And yet if you examine the numbers carefully, the crisis has hit some places-and populations-particularly hard. If you're white and affluent and live in a desirable northern city, you're probably OK. If you're of modest income, African-American or Hispanic and live in an exurb of Atlanta or Detroit, well, you may have big problems.

"It's a very concentrated phenomenon," say Peter T. Chinloy, professor of finance and real estate at American University in Washington, DC.

Subprime loans, which accounted for 28% of all mortgages originated in the bubble peak of 2006, comprised more than half of all home loans taken out by African-American families and 40% of all mortgages given to Hispanics that year.

That's why the crisis has hit particularly hard in minority communities, upon which unscrupulous lenders descended like locusts during the boom, giving homeowners the hard sell to refinance.

"Ninety percent of the people who got these [subprime] loans lived in their homes," says Kathleen Day, a spokesperson for the Center for Responsible Lending, a lobbying and advocacy group. "They were duped."

But others-a good many others-were trying to make a killing.

According to RealtyTrac, a California-based online real estate marketplace, 17 of the 20 metropolitan areas that had the highest foreclosure rates in the first quarter were in California, Florida, Nevada, Arizona, Ohio, and Michigan.

Subtract Ohio and Michigan, which have suffered from big manufacturing job losses, and you have what were some of the most speculative housing markets in America.

Phoenix. Las Vegas. Riverside/San Bernardino. Miami. Not so long ago these places were the glittering heart of a new Gold Rush. And now parts of them are becoming ghost towns.

How much of the boom was due to speculation? "About one-third of the [housing] price run-up between 2000 and the end of 2005 was due to people expecting prices to go up," says Todd Sinai, associate professor of real estate at The Wharton School of the University of Pennsylvania. And the other two-thirds? That came from "cheap capital" in its many forms, Sinai says.

RealtyTrac's data back that up: As much as 30% to 35% of the foreclosures the company tracks had a different tax filing address than the address of the property itself, suggesting they were investor-owned or speculative.

It's clear to me that many investors who were burned in the dot-com meltdown of 2000-2001 now found another outlet for their animal spirits-real estate.

"People were looking for a safer place to put their money than stocks," explains Rick Sharga, vice president of marketing of RealtyTrac. "You're looking at a property not as a place to park your car, but as a place to park your money."

But like so many other "sure things," it turned out not to be so safe.

There's plenty of blame to go around. "There were excesses throughout, from buyers to the realtors to the mortgage brokers to the underwriters to Wall Street fueling the fire to regulators being asleep at the switch," says Sharga.

A widely reported criminal investigation into this mess by the Federal Bureau of Investigation may bring some of these miscreants to justice. We can only hope it's as thorough and comprehensive as possible.

And if the new housing bill passes and is signed by President Bush, it may put a "floor" under the housing market and help prop up the economy.

But it probably won't get the nation's housing market out of the doldrums for another couple of years. And the hardest hit areas may take even longer to come back, although there are scattered signs of bottom fishing.

Developers put up so much speculative housing during the boom that it may take years to work off the huge oversupply. Heck, in Miami, where there's 4 ? years' worth of supply on the market, they're still building condos!

The only thing that might work in some markets, says Professor Chinloy, is to bulldoze some of the most troubled developments to bring supply closer to demand. Give the residents a moving allowance, let the builders go bankrupt, and give the land back to the desert or swamp.

It's not totally wacky: When I was real estate editor at a South Florida business newspaper in the late 1980s, Miami had just experienced a huge condo boom and bust. The market languished throughout the decade, but it was only after Hurricane Andrew destroyed tens of thousands of homes in 1992 that housing prices began to recover.

I wouldn't wish a hurricane on anybody, of course, but it's likely to take a lot of time and pain to work through this man-made disaster.

Howard R. Gold is executive editor of The opinions expressed here are his own and do not necessarily reflect the views of InterShow or

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