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Sunday, October 5, 2008

If Housing MUST Stabilize...Then We're All In Trouble

Fox News has a troubling and interesting perspective on the bailout.

Washington's financial bailout plan is now law. So the credit spigot will start flowing again, banks will resume lending, and an economic recovery can begin, right?

Wrong. Experts say the most important thing that needs to happen before the $700 billion bailout even has a chance of working: Home prices must stop falling. That would send a signal to banks that the worst has passed and it's safe to start doling out money again.

The problem is the lending freeze has made getting a mortgage loan tough for everyone except those with sterling credit. That means it will take several months or longer to pare down the glut of houses built when times were good — and those that have come on the market because of soaring foreclosures — before home prices start appreciating.

Housing is a critical component to the U.S. economy and by extension the availability of credit. Roughly one in eight U.S. jobs depends on housing directly or indirectly — from construction workers to bank loan officers to big brokers on Wall Street. A turnaround in housing prices would boost confidence in the wider economy and, experts hope, goad banks into lending again.

Now, if this bailout will only succeed if housing stabilizes, then we are all in for a huge problem. In my opinion, the housing market is going through structural reallignment that will force this market much further down and there is nothing the bailout will do to stop it. Here are the problems if need the housing market to stabilize in order for the bailout to succeed.

1) This market was built on no money down loans and now the market is moving toward a minimum of 20%.

While the real estat market was booming, it was booming on the back of loans with little or no money down. This brought millions of new buyers into the market and many of them were totally unqualified. Once the real estate market stabilized, those loans were removed from the mortgage market. During the boom, it was the so called sub prime and Alt A niches that were booming most of all. Now, those two niches simply don't exist. No amount of bailout will make up for the fact that real estate boomed because two niches boomed and now those two niches don't exist. As such, we simply have significantly fewere potential buyers as we did over the last several years.

2) Real estate boomed for four years, and that boom won't correct overnight.

Just take a look at what happened to real estate values. You could see real estate value increase thirty and forty percent per year and this continued for the better part of four years. The market won't correct itself overnight. Especially since there is simply a structural correction that is moving the market from no money down to 20% down for a loan.

3) Banks won't expand residential mortgage lending no matter how big the bailout.

Expanding residential mortgage lending is what got banks into this mess. Why in the world would they go back to the problems that caused this once they receive this bailout. Banks have tightened their lending not merely because their own liquidity has tightened. Their lending has tightened because they are attempting to correct prior mistakes. We could have an $80 trillion bailout and it is unlikely that banks would loosen their lending standards much. That's because banks are afraid of the mistakes of the past.

It's as though politicians and analysts don't understand what happened and want banks to do the exact same thing again. We got into this mess because banks approved loans for unqualified borrowers. They aren't going to go back to that posture no matter how much money they have.

This brings us to the crux of the problem.

4) The real estate market is full of folks that shouldn't be in it in the first place.

Since banks approved loans for unqualified borrowers what actually happened was that the market is now full of homeowners that should never have been homeowners. They got loans with no money down in which their income/assets were stated but not unverified and now they are stuck in loans they should never have gotten. That is yet another dynamic that no amount of bailout will resolve.

As such, if we need the housing market to stabilize in order for this bailout to work, then that is something that should have been verbalized better prior to the bailout. In my opinion, this bailout will do little if nothing to stabilize the housing market. It has a long way to go down, and no sized bailout will stop what will continue to happen to housing.

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