Ride The Storm: Credit Crunch Overview
“Subprime” was the word of 2007 as voted by the American Dialect Society. As we kick off the 2008, “Ride The Storm” is our proposed phrase of 2008. The phrase isn’t to trivialize or oversimplify market issues. It’s to be realistic about the current economic cycle in America.
Market Inevitabilities
We’ve been discussing a real estate correction and tighter lending conditions since May 2004, noting back then that: “Whether we see higher rates by August or they hold until 2005, the low rate cocoon we’ve all been living in has to break. It’s a market inevitability.”
Two months after that in July 2004, the Fed started hiking rates off of all-time lows, and up until Spring 2007 we often used the word “orderly” to describe rising rates and tightening loan standards. Then mortgage lenders started going bust because they lacked experience or had flimsy loan approval processes. At first, global investors panicked about subprime mortgages and stopped buying. Soon the panic spread and investment in all types of consumer and corporate debt froze. Also, warehouse banks that enable mortgage lenders to fund loans and enable companies to invest in new ventures stopped providing funds.
This tighter credit pattern proliferated way beyond the U.S. subprime mortgage market, and the lack of liquidity has been anything but orderly. It’s been an outright storm. It has caused household names like Citigroup and Bear Stearns to announce billions in losses and massive job cuts, and caused once top players like Countrywide to be taken over by competitors. For consumers, it has contributed to a steepening correction in home prices.
How To Break The Storm Clouds
The FOMC will continue cut the Fed Funds Rate and the Discount Rate in order to coax consumer and corporate rates lower, easing by as much as 1.75% during 2008 according to Goldman Sachs estimates. Also, Treasury Secretary Henry Paulson is leading the charge toward temporarily increasing conforming and FHA loan limits up to as much as $729,750, offering rate freezes for certain subprime ARM holders, and this relief may be expanded beyond subprime. Positive steps that could be counteracted by politics.
A presidential election year could bring about even tighter loan guidelines. There’s an urgency right now to pass lending laws, anything so political candidates can sound tough while campaigning.
Make no mistake: a rush to legislate tougher loan guidelines will prohibit countless existing homeowners from refinancing as rates drop. Instead of legislating loan approval decisions, the market will force lenders to recalibrate approval guidelines accordingly, and the market should weed the rest out. Then politicians can save legislation for bigger issues.
As for the weeding out process, so far hundreds of mortgage companies have closed, 100,000+ mortgage-related jobs have evaporated, and billions in losses have been reported as global and local financial firms re-group, merge, acquire and find a way to bring market-relevant product to consumers. Legislation of broader financial products like credit derivatives is perhaps necessary, but legislating loan guidelines isn’t required because no warehouse banks will fund loans and no investors will buy blocks of loans until they see that each and every borrower behind that loan is a good credit risk. The system is currently correcting itself for new loans being made for home purchases, but it’s a question of when.
Fortunes From Wreckage
It could be 6 months or 36 months. Nobody knows. That’s why we all have to Ride The Storm together. Real estate is no different than any investment, you must have a long term perspective to succeed.
Consider this perspective from a January 2008 Economist article on the state of the mortgage and housing market: “After America’s savings-and-loan crisis in the 1980s, in which hundreds of mortgage banks went bust when interest rates moved against them, fortunes were made by those who sifted through the wreckage for bargains. The same will be true of the current credit crunch. But when is the time to pounce?”
Add to this some consumer perspective from our May 2004 article when we talked about rising rate expectations: “For many homebuyers, a rate increase will help you by taking overly-leveraged competitors out of the market.”
There’s a theme here: the housing market will eventually find a bottom, and when it does, there are opportunities.