Only the Last Trade Counts

I realized when reading the last post that some might disagree with the idea that commercial real estate runs on a 10-year cycle while residential real estate reprices more quickly.

To see why, we can’t  look at the 30-year maturity of residential loans and conclude they are longer than their 10-year commercial mortgage cousins.  We have to look at how long people stay in their mortgages.  The reality is that most mortgages are paid off (by one means or another, including default) in five to seven years.  Only a tiny fraction of 30-year mortgages actually last 30 years.

Like with stocks, where everyone’s stock is worth the last trade and not what they paid for it, the value of residential mortgages moves up and down with the market, and so does the value of their houses.

We’re a mobile society, and some of us, probably 5% or more, are in the market trying to sell our houses every year, no matter where the economy is going, and no matter what interest rates are doing.

It’s that 5% that set the price for properties.  When Fannie and Freddie (the “Agencies”) became insolvent, it wasn’t because they made subprime loans, or no-doc “liar” loans.  It was because the available financing for houses suddenly shrank by half, and the value of houses nationwide got marked down 25% or more.

Once the “owners” of those houses were underwater on their loans, the last trade effect kicked in, and caught that 5% of Fannie and Freddie’s borrowers who had to sell.  They were changing jobs, going through divorces, or dealing with death of a breadwinner.

Those families weren’t the lying deadbeats so many lazy or political analysts want to believe they were, nor were Fannie and Freddie following some Congressional mandate to make bad loans to flaky people.  These were people who made 20%  down payments, honestly disclosed their income and assets, and took out loans they could afford.

Facing a market that wouldn’t pay them as much for their houses as the 80% they had borrowed a few years earlier, those people (several million of them every year) could either show up at the closing of their home sale with a big check, or default.  That’s what so many of them can’t afford – to make large payments of additional principal when they sell their houses.

Feel free to argue that Fannie and Freddie should have tightened their standards and only guaranteed loans with 30% or even 50% down payments in areas of the country that had huge runups in the price of housing.  Or argue that the Wall Street controlled subprime business or the bank-controlled alt-A business should have been shut down to prevent the housing bubble.

You can even argue that the “implied” Federal guarantee made Fannie and Freddie mortgage borrowing available at too low a yield, leading some investors to support a mortgage market just as big as Fannie and Freddie’s, but without the sensible standards written into the Agencies’ charters.

We all know what happens to the market value of our own homes if a house down the street sells at a foreclosure  price.  If your house suddenly gets marked down in value to $100,000 less than you owe, does that prove you are a liar that couldn’t handle your mortgage?  Of course not.  Does the fact that you may not have $100,000 (plus legal costs and commission) to plunk down when you sell your house make you a bad credit?  I would say not.

What that decline in home values does do, if your loans is in a Fannie or Freddie MBS, is put Fannie or Freddie on the hook to come up with that $100,000+ if you can’t.

That’s why Fannie and Freddie are now wards of the State, because 5% of us have to sell each year, and too many of us can’t possibly write that  enormous check.

The first step to solving any problem is understanding what caused it.  The house price decline caused Fannie and Freddie to become bailout candidates, not political agendae, or poor credit standards at the Agencies.

If you absolutely need to blame some individuals for bad behavior, how about those who can afford to pay their mortgages, but are choosing not to, following the advice Jim Cramer was willing to give on TV?



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