bring the market back up to speed

Recession and the reality of real estate

Here’s what’s going on to bring the market back up to speed


As one would expect over a problem that's already sent nearly 2 million American homeowners into foreclosure and threatens to drag the economy into recession, the federal government is beside itself trying to bring the ongoing mortgage crisis under control.

That's proving a particularly tough challenge for numerous reasons, not the least of which being that no one really knows just how deep is the hole in which we find ourselves. Aside from the financial exposure already incurred by the mortgage industry -- The Economist magazine in December estimated sub-prime borrowers alone may ultimately default on as much as $300 billion in loans -- the potential losses as the crisis bleeds into other areas of the economy are incalculable. But that hasn't stopped the U.S. government from trying to fix the mess anyway.

Since the sub-prime debacle first came to the fore in July 2007, an increasingly desperate Federal Reserve has tried to shore up the economy through interest-rate cuts four times -- in August, October, December and January. More cuts are almost certainly on the way. In March, the Reserve and the central banks of four foreign countries announced they would pump $200 billion of Treasury securities into financial institutions that have seen their liquid assets dry up as a result of the crisis.

In December, President Bush announced the creation of the "Hope Now Alliance," in which lenders would be encouraged to temporarily freeze the mortgages of some homeowners with adjustable-rate loans. The Treasury Department has been working with banks to try to modify loans facing adjustable-rate increases. For its part, Congress in February pushed through a $168 billion economic stimulus package that, aside from putting a few hundred more dollars in everyone's pockets, raised the FHA jumbo-mortgage limit in high-cost areas to $729,750. The move was aimed at bringing more buyers to the housing market and, thus, stop falling property values by reducing the inventory of unsold homes.

So how much of a positive effect will all this official activity have on the foundering mortgage market and the shaky economy as a whole? According to two industry experts, not much at all.

The trouble with all those interest-rate cuts by the Federal Reserve, says Robert Pavlik, the investment chief at the investment firm Oaktree Asset Management in New York, is they only help when an individual or institution has actually obtained a loan. And loans, he says, have become increasingly difficult to obtain.

"The real-estate market faces high mortgage rates despite the fact that the Fed continues to cut short-term interest rates because lenders have raised credit standards -- they want a certain level of income and verification," Pavlik says. "So it's harder to go out and obtain those loans for investment and personal buying. (The cuts) are a step in the right direction, but the lenders have to be willing to make those loans."

Pavlik also expressed concern that tottering financial institutions might not use the liquidity freed up by the Reserve for its intended purpose.

"I think that the Fed's actions, while designed to increase lending, might be used by banks and federal borrowers as a way to shore up their weakening balance sheets."

Ken Mayland, president of the economic analysis firm ClearView Economics LLC in Pepper Pike, Ohio, says interest-rate cuts and increasing market liquidity might provide some initial relief, but he worries that it could come at a high cost. Further, he says, nothing the federal government has done thus far addresses the problems at the core of the mortgage crisis.

"The rate cuts are a good thing for real-estate markets and mortgage lending, et cetera, and the Fed has injected a substantial amount of liquidity into the system," he says. "Things tend to work better when there's money growth versus no money growth. But it carries a risk; it's a two-edged sword. Putting too much liquidity into the system can cause inflation.

"Is this going to resolve the problem?" he continues. "I think it will only have a modest, limited effect, because the real problem is that there was a lot of bad underwriting, and people were allowed to be put into mortgages and homes that they really couldn't afford under any circumstances. On top of that, there was a substantial amount of fraud on the part of the homebuyers. Buyers bought homes without any intention of living in them -- they just planned to flip them."

Mayland and Pavlik say that, despite the frenzy of activity in Washington, the real-estate market is going to get worse before it gets better. Both men, however, see bright spots in their otherwise gloomy forecasts. Pavlik believes that the coming recession "will probably last six to nine months, at the longest," while Mayland suggests that the good thing about hitting bottom is you have nowhere to go but up.

"Step back and look at the big picture," he says. "We started to slide in 2006, when new housing starts were at about 2.2 million. We're at 1 million right now. We know that housing declines are cyclical, and that, historically, the deepest 'bottoms' tend to be around 900,000 new housing starts. That means that most of the decline is behind us."