The Housing Market Rebuilds Brick by Brick

In mid-December, just as some analysts saw a glimmer of life in housing, the National Association of Realtors announced that it had been overestimating home sales for five years now. The market was actually about 20 percent smaller than the group's statistics suggested. Those new figures made the climb back to what's considered a healthy market appear even steeper than previously estimated.

There are certainly enough conventional reasons, from unemployment to the number of homes whose mortgages are underwater, to explain why the housing market hasn't begun a significant rebound four years after the slide began. But if you talk to people in the industry you know that there is more to it than conventional explanations. The housing market's systems and infrastructure as we knew them largely crumbled starting in late 2007, and they are slowly being remade from the ground up. From underwriting departments to appraisals to workouts, the business today is filled with new people, new criteria and plenty of uncertainty. That's why even when you can put together a willing seller and qualified buyer, you can't be guaranteed of completing a deal. Until that changes, it's difficult to imagine a sustained housing rebound.

Underwriting departments have undergone turmoil. During the go-go years many banks loosened their lending standards and reshaped their loan departments to reflect the new competitive reality. The people who rose to the top in these departments were often the biggest risk takers, those most willing to stretch the limits of what was acceptable. At Washington Mutual, America's sixth largest bank before the housing bust, supervisors in the underwriting department told loan officers that a ‘thin [mortgage application] file is a good file," meaning that the less information, the better. Loan officers who investigated what seemed to be obviously fraudulent applications were chastised by their superiors and told not to dwell too long on any submission in the go-go atmosphere of 2005 and 2006.

Many of those people are now gone. New faces are running these departments, and their standards for obtaining a mortgage are much tougher. But in some cases these new criteria are unpredictable and perhaps even not very rational, at least the way the new folks interpret them. Deals regularly die as a result.

Let me give you one example I heard about recently. A well-qualified buyer had a contract on a modest, middle-class home using a conventional mortgage. Everything seemed ready to close until the lender discovered that the house had been purchased recently by the seller, who was the owner of a small construction company. He'd bought the home in foreclosure, did some work to clean up the mess left by previous owners, then put it back on the market at a small profit. But the lender now has a blanket prohibition against such transactions involving a 90-day or less turnaround. That's because back a few years ago plenty of people were flipping homes in this manner to make a quick buck in what seemed like an ever-rising market. Today, of course, the circumstances are vastly different. This particular home was selling now for much less than it had sold for back at the market's peak, during the housing boom, and the seller had made the house into move-in shape. That may be precisely the kind of deal you need to help get this market back on its feet, but the bank was having none of it.

Banks are also overwhelmed by all of the mortgages on their books that have gone bad. At the institutional level that's led to plenty of headaches, like government investigations into so-called ‘robo-signings" of mass foreclosure documents. At the local level, it simply means that whole parts of the market are frozen.

Here's an example of what I mean from a tale I was told in the New York area. In late October a fellow working with a local real estate agent put in a bid on a home in what would be a short sale, that is, a sale by the bank for less than the outstanding sum of the mortgage. Only recently, after two months, did the bidder get the go-ahead to get an inspection done on the home.

Yet the bank hasn't even accepted his price yet or come back with a counter offer. The process is likely to take so long that the home - whose utilities are all shut off - is in danger of sustaining damages this winter. As a result, the would-be buyer recently paid out of his own pocket to get some insulation work done on the home's heating system so it isn't destroyed by the cold. He isn't anticipating closing a deal under the best of circumstances until the spring, when he'll have to roll up his sleeves and go to work getting the house into move-in shape. He's a hardy and persistent buyer, and even he has less than a 50 percent chance of finishing this transaction. There aren't many other buyers like that.

New government regulations aren't helping. Consider how state and federal regulators have tried to fix the process of appraising the value of a home. As the market inflated during the bubble, appraisers found themselves under pressure to value homes at prices that would allow the bank to approve a mortgage. Appraisers who didn't play along lost business; those who did served up inflated valuations that contributed to the frothiness of the market.

The real problem was that during the housing bubble banks, which once had an interest in obtaining accurate appraisals so that they could minimize their own risk from bad mortgages, only came to care about doing as many transactions as possible, because they intended to sell off mortgages quickly to private investors or to quasi-government ones like Fannie Mae and Freddie Mac, who would then bear the risks.

There are any number of ways to fix this problem, but the government choose to institute new rules that have essentially driven many of the best appraisers out of the business, pushed down fees for those who remain at work, and turned over valuations in many neighborhoods to appraisers who are unfamiliar with the areas that they are now working in. As a result, real estate agents estimate that as many as 15 percent of all their contracts fall apart because of bad valuations.

It seems like anyone's guess how long it will take for all of these new players, new benchmarks and new systems to gel into something like a coherent market. Until then, we can talk all we want about the kind of economic fundamentals necessary for a housing rebound. The market has even bigger problems right now.