July 2009
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Real Estate: Symptom or Cause?
Whether or not you believe the axiom, “As real estate goes, so goes the country,” most would agree that real estate is a vital contributor to our nation's economic activity. For most middle-class Americans, their home represents their largest personal investment. Over the past couple of decades, many homeowners came to depend on the ever-increasing equity in their homes to satisfy their appetite for spending. They used their primary residence as a piggy bank: When they needed or wanted a big-ticket item and didn't want to wait until they could save enough to pay for it, they simply borrowed against the equity in their home. Consequently, when the housing bubble burst, many homeowners found themselves with little or no equity left to tap into. Those who severely abused this practice, or bought at the height of the housing market, found that they were “upside down” on their mortgage—they owed more than their house was worth.
Slow housing sales have left an abundance of properties on the market, and when supply increases, basic economics dictates that prices must fall. Even those who are not planning to sell their home have felt the effects of falling real estate prices because as home values decline, the amount of equity an owner can access is reduced. The reduction of these discretionary funds—combined with growing unemployment—has put a significant damper on consumer spending, which forms the basis of much of the U.S. economy.
Government Intervention
Many people have expressed frustration that mortgage rates aren't lower after the hundreds of billions of dollars that the federal government has spent on the bailout of financial institutions. This deficit spending by the federal government has prompted fears of inflation. In fact, mortgage interest rates have risen a full percentage point over the past month, in part because of these concerns. The difference of one percentage point on a 30-year fixed rate loan could add up to tens of thousands of dollars over the life of the mortgage.
The Treasury Department's Troubled Asset Relief Program (TARP), which was intended to keep credit flowing and readily available for the American public, has not been the solution. TARP has cost American taxpayers lots of money—money we didn't have. So the federal government borrowed the funds by selling Treasuries as fast as it could print them. The resulting glut pushed prices down and yields up. And because mortgage rates are typically tied to the yield on 10-year Treasury notes, the end result was an increase in mortgage rates. If borrowers aren't frightened away by the higher interest rates, lenders are charging prohibitive fees for even the most credit-worthy customers. Not surprisingly, financial institutions that have taken TARP funds are more focused on fattening up their bottom lines and wresting control of their operations back from the government than they are on the effect bank policies and fees are having on consumers, the housing market, or the economy.
Any Solutions?
Although this meltdown may have started with subprime mortgages, it has spread throughout the credit markets. In today's lending environment, even borrowers with excellent credit scores and substantial down payments are having problems securing loans at affordable prices, which is vital to investments in real estate. On a national level, the affordability of residential housing is affected by unemployment and mortgage interest rates and fees. These factors make real estate a good barometer of the health of our overall economy.
Many people are concerned that if historically low mortgage rates weren't able to halt the decline in home prices, rising interest rates and unemployment may cause home prices to fall even further. The Federal Reserve chairman and the Treasury secretary have been trying to control our economic troubles with monetary policy and bailouts of those companies deemed “too big to fail.” But that hasn't worked to provide the impetus for the changes we need to turn around our economy. Perhaps a freefall in real estate prices would prompt an overhaul of our financial institutions. Admittedly, this would hurt many property owners and investors, but a Band-Aid solution can't solve a problem that calls for major surgery. And it's usually less painful to simply rip the bandage off quickly, rather than pulling it slowly and prolonging the misery.
As always, I welcome your comments.
Mary-Jo Kranacher, MBA, CPA, CFE. Editor-in-Chief.