Thoughts on the Real Estate Market Crisis

It’s in the news every day. The U.S. housing market is in trouble, but how did we get here? There are many theories being bantered about. The group most commonly blamed for the crisis is the financial institutions who made these so-called “sub-prime” loans. Are they responsible for this mess? Forgive me for quoting Sarah Palin, “You betcha!” While it’s easy and convenient to point the finger at the financial institutions there are other parties at least equally culpable, if not more to blame.

The beginning of our housing crisis started many years ago. It started during the Clinton Administration. Yes, the same Clinton Administration which many believe guided us to economic stability. Let’s get real for a moment. “Slick Willy” Clinton benefited by the economic policies created by the previous administrations. Frankly, the smartest economic move Clinton ever made was the one he didn’t make. He retained Alan Greenspan as Chairman of the Federal Reserve. Greenspan subsequently repays Clinton in his memoirs titled The Age of Turbulence. In his memoirs, Greenspan sites Clinton as one of the smartest President’s he’s ever worked with (Nixon being the other). Thank goodness Greenspan’s economic aptitude was far better than his abilities to judge the intellect of others.

It’s easy to point the finger at our outgoing President for our economic mess, but he only deserves only part of the blame. President Bush also inherited many problems left behind by his predecessor.

Back in September 1999, The New York Times reported that the Fannie Mae Corporation was easing the credit requirements on loans that it would purchase from banks and other lenders. Fannie Mae was under enormous pressure from the Clinton Administration to do this. This action which began as a pilot program, encouraged lenders to give mortgages to people whose credit was generally not good enough for a conventional loan (aka “sub-prime” borrowers).

Fannie Mae took on significantly more risk by taking this action. In order to provide loans to less than qualified buyers, financial institutions created a whole slew of new mortgage products. These products became known as “sub-prime” loans. To summarize, new loan products were developed to give less than qualified buyers an opportunity to achieve the American dream. Gone was paying your bills on time to have a good credit score. Gone was saving enough money for a down payment, not to mention an emergency reserve. Heck, who needed income?

Many experts predicted that Fannie Mae would run into trouble during an economic downturn and would need a government rescue package similar to the one given to the savings and loan industry during the 1980’s. Now that day has come. Are people quick to point the figure at Fannie Mae? You betcha!

One more legislative failure of the Clinton Administration, a tax break proposed by Clinton during his 1996 Presidential campaign and eventually passed by Congress (known as the Taxpayer Relief Act of 1997). This tax break gave special treatment for capital gains on the sale of primary residences. It basically exempted most home sales from capital gains tax.

Quoting an article from The New York Times on December 19, 2008…

…many economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade that it would be without the law.

Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for “fueling the mother of all housing bubbles.”

By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than a place to live. It helped change the national conversation about housing. Not only did real estate look like a can’t-miss investment for much of the last decade, it was also a tax-free one.

Don’t let my Clinton bashing lead you to believe I am anti-Democrat. I just have distain for “Slick Willy”. In good conscious I can’t heap all of the legislative blame on the Clinton Administration. Fairly recent legislation under the Bush Administration also exasperated the housing crisis.

On December 20, 2007, The White House sent a press release announcing President Bush had signed legislation called, The Mortgage Forgiveness Debt Relief Act of 2007. In his press release, President Bush remarks…I'm pleased to sign a bill that will help homeowners who are struggling with rising mortgage payments. The Mortgage Forgiveness Debt Relief Act of 2007 will protect families from higher taxes when they refinance their homes. It will help hardworking Americans take steps to avoid foreclosure during a period of uncertainty in the housing market.

On the surface, this piece of legislation sounds great. I could easily argue it was redundant and pointless. How so? The Internal Revenue Code already had a similar provision. Under Internal Revenue Code Section 108, a taxpayer who is insolvent can exclude from income any debts which have been forgiven or cancelled. The key is the taxpayer being insolvent. What is insolvency? It’s when your total debts exceed your total assets. It would stand to reason that anyone in danger of losing their home in foreclosure is likely to be insolvent.

The effect of the new legislation has actually benefitted people who aren’t insolvent. It has helped numerous people get out of mortgages completely unscathed (tax-wise). It helped people who aren’t in any financial difficulty. These people can make their payments, but choose not to because the amount they owe is greater than the market value of their home. I will address the market value issue later on. Isn’t the real problem the people who made a bad decision by substantially overpaying for their homes? Now they can walk away with only a ding on their credit report. If you think this isn’t happening, I have received dozens of e-mails from people all over the country doing this very thing.

What about these mortgage workouts we’ve been hearing about in the news? Here’s what’s really happening. Lenders are not adjusting interest rates (thereby lowering the payments) or reducing principal balances. They are simply back loading mortgages with a balloon payment for the missed payments. What is the result of these so-called workouts? A redefault rate in excess of 50%. When are we going to learn that sub-prime borrowers who couldn’t afford the payments before the workout would fare any better with these new arrangements? They are sub-prime borrowers for a reason.

Now that we have covered the major legislative aspects of our housing crisis, it’s time to move on to other contributing factors. The one I consider most important and truly the inspiration of this piece. Face it, a lot of the blame has been directed to mortgage brokers, appraisers and real estate developers. Did they play a significant role in this crisis? You betcha!

However, one group has flown under the radar of culpability. They are the realtors! Believe it or not, they played and continue to play a significant role in this mess. I’m not suggesting every realtor is to blame. There are a number of highly skilled, professional realtors out there. I am well acquainted with several of them.

Here’s the problem. Buying and selling a piece of property without a realtor is difficult. It’s almost as much of good old boy network as our judicial system. Try going to court without an attorney and representing yourself pro se. You know what happens? The judge sends you away telling you to show up with a lawyer next time. Judges were lawyers once upon a time and they take care of their own. The same thing happens with real estate transactions. How many realtors are going to show you a property on the market as “for sale by owner”? The answer is…none! Realtors are only going to show you properties in which they can receive a commission.

How did realtors contribute to our housing crisis? It goes back to the commission thing. The only person represented by a realtor is the realtor. The best explanation I’ve come across was contained in a book titled, Freakonomics written by Steven D. Levitt and Stephen J, Dubner. Here are some excerpts from that text…

…a transaction that wouldn’t seem, on the surface, to create much fear: selling your house. What’s so scary about that? Aside from the fact that selling a house is typically the largest financial transaction in your life, and that you probably have scant experience in real estate, and that you may have an enormous emotional attachment to your house, there are at least two pressing fears: that you will sell the house for far less than it is worth and that you will not be able to sell it at all.

In the first case, you fear setting the price too low; in the second you fear setting it too high. It is the job of your real-estate agent, of course, to find the golden mean. She is the one with all the information: the inventory of similar houses, the recent sales trends, the tremors of the mortgage market, perhaps even a lead on an interested buyer. You feel fortunate to have such a knowledgeable expert as an ally in the most confounding enterprise.

Too bad she sees things differently. A real-estate agent may see you not so much as an ally but as a mark. The book continues with a study cited in an earlier chapter which measured the difference between the sales price of homes owned by realtors and homes sold for their clients. The study found that an agent keeps her own house on the market an average of ten extra days, waiting for a better offer, and sells it for over 3 percent more than your house-or $10,000 on the sale of a $300,000 house. That’s $10,000 going into her pocket that does not go into yours, a nifty profit produced by the abuse of information and a keen understanding of incentives. The problem is that the agent only stands to gain an additional $150 by selling your house for $10,000 more, which isn’t much reward for a lot of extra work. So her job is to convince you that a $300,000 offer is in fact a very good offer, even a generous one, and that only a fool would refuse it. These are very powerful words given today’s marketplace when the realtors are going around asking sellers to lower their asking prices because it’s a “buyer’s market” and there is “a lot of inventory”.

The agent does not want to come right out and call you a fool. So she merely implies it-perhaps by telling you about the much bigger, nicer, newer house down the block that has sat unsold for six months. Here is the agent’s main weapon: the conversion of information into fear. Consider this true story, related by John Donohue, a law professor who in 2001 was teaching at Stanford University: “I was just about to buy a house on the Stanford campus,” he recalls, “and the seller’s agent kept telling me what a good deal I was getting because the market was about to zoom. As soon as I signed the purchase contract, he asked me if I would need an agent to sell my previous Stanford house. I told him I would probably try to sell without an agent, and he replied, ‘John, that might work under normal conditions, but with the market tanking now, you really need the help of a broker.’”

Within five minutes, a zooming market had tanked. Such are the marvels that can be conjured by an agent in search of the next deal. The fact is realtors have significant influence on the market as they are mostly responsible for setting the price for which a property is sold. When the real estate market was “hot”, who raised the bar on asking prices? The realtors. What was their rational? If a buyer can only afford a certain monthly payment for a piece of property, the amount of house they can afford increases as interest rates declines. Who cares if the property was overpriced? Not the realtors. They are well versed in telling buyers to focus on the monthly carrying costs and ignoring the actual price of the property. No doubt you can tell who the winners and losers are.

Consider now another true story of a real-estate agent’s information abuse. The tale involves K., a close friend of one of the book’s authors. K. wanted to buy a house that was listed at $469,000. He was prepared to offer $450,000 but he first called the seller’s agent and asked her to name the lowest price she thought the homeowner might accept. The agent promptly scolded K. “You ought to be ashamed of yourself, “she said. “That is clearly a violation of real-estate ethics.”

K. apologized. The conversation turned to other, more mundane issues. After ten minutes, as the conversation was ending, the agent told K., “Let me say one last thing. My client is willing to sell this house for a lot less than you might think.”

Based on this conversation, K. then offered $425,000 for the house instead of the $450,000 he had planned to offer. In the end, the seller accepted $430,000. Thanks to his own agent’s intervention, the seller lost at least $20,000. The agent, meanwhile only lost $300-a small price to pay to ensure that she would quickly and easily lock up the sale, which netted her a commission of $6,450.

So a big part of a real-estate agent’s job, it would seem, is to persuade the homeowner to sell for less than he would like while at the same time letting potential buyers know that a house can be bought for less than its listing price. These are very poignant words when we are seeing realtors who sold properties during the “seller’s market” and had the audacity to tell buyers they are getting such a great deal. Today, these same realtors are now telling these people they overpaid for their properties and are worth significantly less in today’s “buyer’s market”. You could say realtors want it both ways, but in reality they want it one way. A quick sale! If you have your property on the market and your realtor insists you lower your asking price, here’s a bit of advice. Tell your realtor to kiss your a**, stop whining and do their job. Suggest they cut their commission. They got you into this and they need to get you out of it. If they can’t do their job, list your property with a realtor who can!

Not only can we question a realtor’s ethics, but we should also question what qualifies an individual to become a realtor. To be blunt, it doesn’t take much at all. Prospective realtors must be high school graduates, be at least 18 years old, and pass a written test. Most states require candidates for a sales license to complete between 30 and 90 hours of classroom instruction. Geez, anyone can become a realtor!

Now that I’ve cast my wrath on the realtors, I want to conclude with some final thoughts. It’s time to stop treating our home as some kind of short term investment. A home is place to live. The real estate market is going through a much needed correction. We won’t be seeing people making a killing by flipping real estate. Real estate will return back to the good old days of small but steady returns. Back to the days when you couldn’t sell your home for a profit within 2-3 years after its purchase because the closing costs and commissions ate any small profit you might have.

The real estate market will rebound. When? Who knows? I suspect when our elected officials stop tinkering with the tax code, when lenders completely revert back to how we qualified for mortgages prior to 1999 and when realtors start letting buyers and sellers dictate the market.