Investors did it. According to the Federal Reserve Bank of New York, real estate investors had an outsized role in the collapse of the mortgage marketplace and the national economy.
Mortgage investors, says a new report from the New York Fed, “played a previously unrecognized, but very important, role. These investors likely helped push prices up during 2004-06; but when prices turned down in early 2006, they defaulted in large numbers and thereby contributed importantly to the intensity of the housing cycle’s downward leg.”
Oh my. The horror of it.
The conclusion you can reach is plainly summed up by The Washington Post.
“Researchers with the Federal Reserve Bank of New York found that investors who used low-down-payment, subprime credit to purchase multiple residential properties helped inflate home prices and are largely to blame for the recession.”
The reality is different. Without real estate investors a lot of people would be living in parks, home prices would be substantially lower and the national economy would be a whole lot smaller. Rather than fewer real estate investors we need more. Here's why.
The New York Fed's staff report is curious for several reasons.
First, the New York Fed says the report's views “do not necessarily reflect the position of the Federal Reserve Bank of New York, or the Federal Reserve System.” Nope, no responsibility there, just four individual authors with email addresses at “ny.frb.org” who perhaps in their spare time managed to write a 50-page study that was published on the New York Fed's very own website.
Second, the report sorely misses several important points.
When last we looked it was not possible to get a mortgage from an automatic teller machine. Instead, you have to go through a rigorous process — or what should be a rigorous process — called underwriting.
As the Fed report itself explains, “during the early phase of a housing boom, lenders may reduce the required downpayment percentage on new mortgages and begin to relax other underwriting standards due to the strong performance of house prices and low delinquency rates. These actions enable the optimistic buyers to purchase additional housing. The increasing leverage allowed in the market, then, begins to shift the composition of new purchase transactions in the market toward more optimistic buyers who are willing to bid higher prices for houses.”
So — logically — if lenders did not relax underwriting standards they could reduce marketplace “optimism” and thereby crush any trend toward price appreciation.
Lenders are supposed to do their due diligence through the underwriting process to protect mortgage investors and their own shareholders. In addition, they have another tool to reduce risk: they absolutely control the nature of the loans they originate. You can only get a mortgage in the lender's usual form.
The lender makes the rules. If a lender requires you to complete a fully-documented loan application then either you provide the evidence and verifications demanded or you don't get financing.
However, as the Fed report tells us, “there was a sizeable shift from full-doc to low-doc loans for subprime and especially for Alt-A mortgage loans. By 2006 some 38 percent of newly originated subprime and 81 percent of new Alt-A loans were low- or no-doc loans.”
Alt-A loans include such infamous “non-traditional” mortgage products as option ARMs and interest-only mortgages. The important point is that not only did the use of no-doc loans increase, the world of Alt-A loans grew enormously and fueled much of the foreclosure crisis
“To put this increase in perspective,” says William A. Frey in his new book, Way Too Big To Fail, “in 2000, Wall Street securitized less than $25 billion of Alt-A assets; by 2005, that number had grown to more than $300 billion.”
Frey is the founder of Greenwich Financial Services, a broker-dealer firm which has structured and sold mortgage backed securities worth billions of dollars — and none with subprime collateral.
“What came to be labeled ‘prime’ in 2005 would not generally have been considered ‘prime’ in 2000,” Frey explains. “What was labeled as ‘subprime’ in 2005 would never have been made at all in 2000. The underwriting standards that dictated these characterizations were being loosened, creating more credit risk per loan concurrently with the increased production of subprime loans.”
In other words, if you dump traditional lending standards you can make more loans and bigger profits. And by selling mortgages in the secondary market you can shift risk from loan originators to investors.
You might think that a regulator — the folks we pay to oversee the lending community — would notice such a trend and as overseers of the lending system would put an end to it. That didn't happen.
The Federal Reserve could have stopped the mortgage meltdown before it began. Under the Home Ownership Equity Protection Act of 1994 (HOEPA), the Fed can ban UDAP -- “unfair and deceptive acts or practices.” Unfortunately, the Fed failed to prevent the origination of millions of “affordability” loan products which are at the heart of the housing crisis.
Why We Need More Investors
“The problem we have with the housing sector is not that we have too many investors it's that we have too few,” says RealtyTrac spokesman Jim Saccacio. “Home prices are down precisely because supply grossly exceeds demand. The solution to the problem is to generate additional home sales, sales which are much more likely if we encourage more investors to enter the marketplace.”
The National Association of Realtors reports for October that 17 percent of all existing home sales were foreclosures and 11 percent were short sales. Investors accounted for 18 percent of all sales.
October home values were 4.7 percent lower than a year ago according to NAR. Now imagine a housing market with 18 percent fewer buyers. Consider where home prices would be with 18 percent less demand.
It's simply not possible for home prices nationwide to stabilize — much less increase — as long as a vast inventory of foreclosed properties and short sales remain readily available. The idea ought to be to encourage investors to purchase every distressed home they can find. That would raise local home values, increase the inventory of rental properties, clean up lender books, reduce vacant property issues and perhaps cause local tax revenues to rise along with home prices.
Implying that real estate investors are “largely to blame” for the mortgage meltdown is like demanding that ambulances should be outlawed because they're loud. It's an argument that misses the point.
Peter G. Miller is syndicated in newspapers nationwide and operates the real estate news and information site, OurBroker.com.