Bleak Housing Data Has a Silver Lining
The recently released high foreclosure data provided by RealtyTrac combined with record low housing starts is a step in the right direction for bank balance sheets that have been clogged with illiquid mortgage-backed securities.
Many banks, as well as Fannie Mae and Freddie Mac, have had a temporary moratorium on foreclosures while waiting for more detail on the administration’s mortgage modification plans. These institutions have lifted the moratorium as more details on government-sponsored loan modifications have become available, and foreclosures in March were up 17 percent over February and up 46 percent year over year.
Housing starts fell 10.8 percent in March from the previous month to an annual rate of 510,000 units, the second-lowest reading on record.
This lack of new housing inventory combined with the banks’ willingness to cut prices on foreclosed properties has made the price of homes more affordable than they have been in years. Record low mortgage rates also will entice new buyers into the housing market, and there finally will be some pricing clarity on all the toxic assets that have paralyzed the financial system since last fall.
The journey from AAA to toxic for mortgage-backed securities is the culmination of several decades of poor regulatory oversight, government policies encouraging lax underwriting standards, low interest rates, extreme leverage and greed.
Mortgage-backed securities traditionally have been considered extremely safe investments. Lenders such as banks and savings and loan associations would make home loans in their communities based on strict underwriting guidelines, and then package them for sale to Fannie Mae or Freddie Mac, the government-sponsored agencies charged with providing liquidity and stability to the U.S. housing market.
The lending institution could use the proceeds of the sale to make new loans, and Fannie and Freddie could hold the new mortgage-backed security or sell it to an investor looking for a safe instrument that yielded more than U.S. Treasuries.
The thought process was that homeowners would do everything they could to avoid foreclosure and that Fannie and Freddie were enforcing strict underwriting guidelines on their approved lenders. If a home did go into foreclosure, it was assumed that the eventual sale of the property would make the loan whole.
This relationship began to break down in the mid-1990s as Fannie and Freddie executives sought higher and higher levels of compensation based on the firms’ ability to borrow at or near Treasury rates and then invest the funds in increasingly risky assets.
These poorly underwritten loans made to less creditworthy borrowers quickly turned toxic when the housing bubble popped and investors couldn’t count on price appreciation to bail out the bad loans.
While it is tragic for anyone to lose their home, it is essential to the overall health of the financial system and our economy to finally begin to reach a clearing price on homes in order to begin to recover from years of bad decisions.