In the space of a year, the mortgage market went from a sprint to nearly a stop.
Although the Federal Reserve has tried to stimulate the market by lowering rates and making it easier for banks to borrow money, brokers and economists have noted that developers, building buyers and consumers continue to struggle to get loans, particularly from large banks.
In addition to the troubles in the primary market, as banks have struggled to stabilize their balance sheets and investors have stayed away, the secondary mortgage market has essentially disappeared. Taken as a whole, the credit crunch has led to a precipitous drop in the overall dollar value of building sales.
While housing prices were rising, banks had no problem making a market for real estate deals, even when the borrowers were questionable credit risks. For one thing, the banks held billions of dollars worth of real estate debt on their own balance sheets, expecting that bet to pay off handsomely as prices kept rising. But the national market for housing peaked in the second quarter of 2006, according to the Case-Shiller index; it had fallen more than 10 percent by the end of 2007.
Banks have since had to write down the mortgages on their balance sheets, taking billions of dollars in losses. That’s made them wary of lending.
“Lenders are being a little pickier because they know they’ll have to close the loans,” said David Wyss, chief economist at Standard & Poor’s. “We’re just not seeing the CMBS (commercial mortgage-backed securities) deals coming through; there are some in the pipeline, but nothing getting done. That means banks are being a little bit tighter. They’re demanding developers have more equity in it.”
The slowdown in the secondary market has also hit homebuyers, who struggle to get good rates on large loans in markets like New York. The spread between 30-year fixed rates for conforming loans and those for jumbo loans widened from less than 20 basis points at the height of the housing boom to 134 points in April, according to Freddie Mac. The stimulus package that President Bush signed in February included a temporary increase in the limit for jumbo loans that could be guaranteed by Fannie Mae and Freddie Mac from $417,000 to $729,750, but there are loopholes; the guaranteed loans do not apply to co-ops, for instance. Even as the spread has narrowed again, investors continue to be wary of jumbo-loan securities, so much so that Congressman Barney Frank, the chairman of the House Financial Services Committee, held a hearing to determine why the market was still illiquid. (As of late June, rates hovered around 7.35 percent for 30-year fixed jumbo mortgages, according to bankrate.com.)
So what can be done to fix the liquidity crisis?
Before borrowers will get better rates from banks on home loans, investors need
to be convinced that those loans are a good risk, experts said. Right now, banks are
simply unwilling to hold some mortgages on their balance sheets, so they need to
feel comfortable that there is a market for those loans.
Tomasz Piskorski, an assistant professor at Columbia Business School, said investors need to see that the originators of the loans aren’t simply pushing the risk onto the investors. If, for instance, loan originators had to hold onto the riskiest portions of the loans — the ungraded portions — investors would know the securities they were buying were good bets, he said.
Piskorski said he did not think the government should impose that kind of rule, but government agencies and industry groups could issue guidelines to that effect. The investors themselves would have to demand the changes, he said.
“I would simply say it should be just imposed by the market participants,” he said. “A smart investor would essentially require this kind of thing.”
The best way to convince investors that loans are safe is to require more stringent documentation and sizeable down payments, said Wyss of Standard & Poor’s.
“If you’ve only got 2 percent down on a house, which was the average with subprime mortgages, and the house price goes down 20 percent, mailing the keys back to the bank is the rational thing to do,” he said.
Standard & Poor’s has already begun to demand more documentation on securitized loans, Wyss said. As long as buyers have to verify their income and put enough money down, investors will trust the mortgage market again, he said.
The government can also help by taking on some of the risk, Wyss added, but it needs to consider the cost to taxpayers of taking on that kind of risk.
Real estate industry insiders said
they are wary of new government regulations that could limit the kinds of products they offer. Furthermore, not everyone thinks that the decrease in liquidity is such a bad thing.
Howard Michaels, chairman of the Carlton Group, a real estate investment banking firm, noted that financing is still available for good deals.
“What’s not available is 90 to 95 percent capital from calling certain investment banks,” Michaels said. “It’s actually healthier; people will put more equity into deals. Prices are getting more economic, and they make sense. Overall, it’s probably healthier.”
He continued, “Business is getting done, and there is definitely capital available for projects that make sense.”
During the boom, too many borderline companies were in the market for financing, skewing costs, Michaels said.
“You had people who weren’t as well capitalized bidding up prices,” he said.
Professor Joseph Gyourko, chair of the Real Estate Department at the Wharton School of the University of Pennsylvania, said he thinks current credit conditions are less of a crisis and more of a correction.
“The great liquidity was right before the credit crunch,” he said. “Times were abnormal. You and I as taxpayers don’t want us going back to those conditions.”
Gyourko said that investors have demanded more information about the securities they are buying, which will help bring more sanity to the credit market. If the government does decide to get more involved in the real estate securities market, officials should concentrate on transparency, he said.
“If there’s a role for the government, it’s in mandating that lenders are providing really accurate information on what the costs of loans are,” he said. “If there was a failure, it was in not being upfront with everyone buying loans about what the risks are.”