Ten ways to Solve the Housing Crisis

J.K.,

Thanks for your note. I tend to agree with you on your first three points, especially the all-caps third one. People don’t seem to realize that of the dollars lost in this fiasco, 99% of them are from investors and banks who rated zero down piggy-back loans as having the same credit risk as 30-year fixed, 10% down loans. It’s truly mind-boggling.

Best,

Matt Woolsey

[mwoolsey@forbes.net]

Ten Ways To Solve The Housing Crisis

Today Forbes published "Ten Ways To Solve The Housing Crisis" and Matt Woolsey touches on some key points but the essence of today's housing finance crisis can be traced back to the concerted effort by the investment banking community to reform consumer bankruptcy laws starting in 1998 and culminating in 2004 withnew kaws enacted in Congress.

Greed, Greed, and more GREED are the three main causes of the market crisis. Investor greed, borrower greed and market participant greed have all contributed to the perfect storm for the housing collapse. The Federal Government has paved the way to turn housing from long-term societal commitment to a quick-buck Ponzi scheme.

I agree, the GSE’s have a role in the solution but not in their traditional business models of operation. Many of the folks at the GSEs simply don’t get it! The approach to the market must change, the approach to investors must change, the approach to regulation of market participants must change … if we are to see a significant re-engineering of the housing finance industry.”

Real Estate
Ten Ways To Solve The Housing Crisis
Forbes - Matt Woolsey, 11.07.07, 12:00 PM ET

As ongoing subprime fears send bank shares plummeting, ousted Merrill Lynch and Citigroup chiefs take responsibility for the firms' $8.4 billion and $14.9 to $17.9 billion write-downs, respectively, and Congress mulls overhauling the mortgage-lending industry, the question on many lips remains: Is there a way out of this mess?

Yes, say some industry experts.

No doubt the housing market's troubled. But how to fix it? Forbes.com asked a range of housing experts to examine the largest lingering problems, the most misplaced assumptions and the best solutions.

To be clear, there isn't a magic solution. Whether government intervention, Bank of America no-fee loans or re-calibrated lending risk models at ratings agencies, there isn't anything which will instantly recapture the dollars that have been hemorrhaged.

We talked with congressmen, CEOs of real estate brokerages, research directors at analytics firms, finance professors, real estate brokers, demographers and chief economists from lending institutions, trade organizations and rating agencies. Everyone had a different angle based on their corner of expertise. Brokers made sure to differentiate market segments and talked about inventory issues; politicians spoke to immediate mends; research directors pointed to what got us into this mess; and demographers looked to who got slammed.

There's a lot on the table right now.

One solution put forth by Congressman Lincoln Davis (D-Tenn.) involves expanding GSE (government-sponsored enterprises) securitization to rejuvenate lending, but to regulate it so that money doesn't flow to speculators and luxury developers.

"I feel that if we expand latitude through GSEs for the developers to sell luxury homes, it's the wrong thing," he says. "Our local banks and community banks have done a great job providing funding. GSEs should be there as a supplemental for people who have good credit."

Investors cheered late last month when Bernanke announced a 25-basis-point cut in the federal funds rate, to 4.5%. But some say cutting rates is the wrong answer.

"Artificially stimulating demand," says Glenn Kelman, CEO and president of Redfin, a Seattle-based Internet brokerage, "is what got us into trouble in the first place."

Instead, other factors such as job growth and restoring investor confidence may have a more significant affect on recovery, say others.

But Congress' step today is one in the right direction, says Jonathan Miller, director of research at Radar Logic, a New York-based real estate analytics and research firm.

"Federal regulatory oversight [is needed] to make sure the quality [underwriting] function of the lending industry is kept completely separate from the sales function," he says. "During the housing boom, the sales function had more political power and very little underwriting was performed."

In Pictures: Ten Ways To Solve The Housing Crisis

1. Federal Oversight Of Lending Industry

2. Restore Investor Faith

3. Expand The Scope Of Fannie, Freddie And The FHA

4. Jobs, Jobs, Jobs

5. Cut Prices And Construction

6. Non-Agency Loans Need To Return To The Market

7. Investors Need To Learn From Their Mistakes

8. Don't Cut Rates, Cut Inventory By Any Means Possible

9. Buyers Need To Look At The Market In A Long-Term Sense

10. Buyers Need To Realistically Assess What A Price Trough Means

The Emerging Markets Bubble

http://www.portfolio.com/views/blogs/market-movers/2007/09/20/the-emerging-markets-bubble

If the Fed's cutting rates, then it must be blowing another bubble, right? But it's not going to be tech stocks or housing again, so what's left? Green technology, obviously, is bubblicious right now, but it's also tiny: investment of $6 billion this year might be up 60% from last year, but it's still a long way from the point at which a crash could cause any real damage.

In today's WSJ, Justin Lahart and Joanna Slater put forward a different asset class: emerging markets, which are now officially trading on higher multiples than their developed-market counterparts. Everybody seems to think a bubble is forming, and everybody is very excited about this: after all, bubbles have the ability to make a lot of money for a lot of people before they burst, and most people in any case tend to overestimate their ability to get out before the crash....

DRC Blogger Response:

Yes, the term "emerging markets" is often overused and mis-used especially as a broad asset class. However many countries in stage two classification for economic development have been watching many of their couterparts in stage three economies and are rapidly learning from the mistakes made.

The investment strategies of captial market investors do not necessarily mirror the social and economic necessities inherent in emerging economies. One such area for investment oportunities rests in housing finance in many stage two countries. The fundamental economic needs of nations with strong population growth will underscore the potential strength of given investments. Moreover the will of the nation to succeed in addressing the needs of its businesses will create the win-win stategies critical for an emerging market investment.

This can be most evident in housing sector investments. For many nations housing is a commitment for the longterm. Unlike the U.S. where housing needs have been replaced by housing wants and investopr speculation. Many nations are committed to addressing the fundamental needs of its people in times of population growth and global economic expansion.

Lying With Statistics, Subprime Edition

http://www.nakedcapitalism.com/2007/05/lying-with-statistics-subprime-edition.html

"I am beginning to wonder whether there is a single statistic related to the state of the economy that can be trusted. The latest data point to bite the dust is the widely-quoted factoid that 13% of subprime mortgages are in default. Turns out not only is this number wrong, but the methodology used to arrive at it is ludicrous. The Mortgage Banking Association, the source of this information, classifies loans as prime or subprime based on who originated them. Thus, all loans by New Century were subprime and all loans by Wells Fargo (the biggest full service bank in the subprime market) are prime.
Details from the story "Subprime delinquencies higher than reported" by Matthew Padilla in the O.C. Register: ...

DRCBlogger Response:

I am not surprised to hear this story. This train has been running out of control for over 36 months. When market participants placed more trust in yesterday's strategies - gains became more important than the underlying processes of the business. The industry must get back to basics and recognize the importance of housing as a means to financial stability for all market participants. What we see now is long term funding commitments giving way to investor needs for safety and gains. Basic fears across the market cycle have been fueled by greed.

The only way out of this current tailspin is innovation - new products and new practices. Long-term success for housing finance requires more innovation throughout the market process. It requires market participants to develop strategies around disruptive innovations. It is through disruptive innovations that transcend the market processes that we will create new markets or reshape existing markets by delivering relatively simple, convenient, low-cost innovations to a set of customers who are ignored by industry leaders expected to serve the common good. Who should bear the responsibility for the cost of a house? Who should determine the value of home?

These questions are fundamental to our national housing policies and as such will be critical to secure positive trends in economic growth.

Some emerging market have it right!

It's the process ... not the rating agencies!

Today, the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises heard the testimony of Sean Mathis on the "The Role of Credit Rating Agencies in the Structured Finance Market." The hearing was meant to review the role of rating agencies (Nationally Recognized Statistical Rating Organizations - NRSROs) in developing debt products. The inherent conflict of interest among rating agencies, issuers and the investment banking industry should come as no surprise - especially when you consider the market processes and the flow of capital. As such the rapid introduction of new financial instruments and the intentions to maximize profits regardless has permeated every aspect of the credit cycle. Ultimately, you can't get something for nothing - eventual someone will pay.

The engineers behind the current mortgage market crisis are no different than any other time when the market saw such a swing. Overconfidence, rising asset values and growing leverage throughout the whole financing cycle is evident, but the music has stopped or at least changed.

When market participants placed more trust in yesterday's strategies -gains became more important than the underlying processes of the business. Congress must get back to basics and recognize the importance of housing as a means to financial stability for all market participants. What we see now is long term funding commitments giving way to investor needs for safety and gains. Basic fears across the market cycle have been fueled by greed.

The rush to exit the markets by investors once the music stopped was inevitable -- look at the past 20 years of financial crises. The rating agencies did not have a crystal ball, but they did have the responsibility to pose the questions needed to assess risk. But like all cycles and crises before this one, exuberance and greed clouded the ability to make prudent decisions and recommendations while regulators around the world have been asleep at the wheel.

To question how the credit quality of complex financial instruments is assessed serves what purpose? Yes the recent decisions by NRSROs to downgrade the ratings of many residential mortgage-backed securities and collateralized debt obligations in the wake of the recent global credit crunch is questionable but the real question that Congress needs to ask is, “What and where are our trusted institutions in the market cycle for housing finance?”

According to Mathis, "The pain that will be suffered from the collapses across the structured finance landscape will not merely be born by well-healed fund managers or greedy, intemperate citizens looking to make a fast trade in a frothy housing market. The pain will be felt as well by regular people whose pension funds have been impaired by investment in gold-plated highly rated securities whose performance will turn out to be far worse than the promise implied by their ratings,"

Mathis also stressed that Congress, it must act to address a number of critical and complex issues.

1. Regulatory oversight and supervision of the rating agencies (NRSROs). While this is in fact needed, it does not get to the systemic imbalances that exist in housing finance.

2. Applicability of NRSRO ratings. This is a moot point. Ask most investment bankers about the new BMW 760Lsi. It is rated to go top speed at 150mph, but is it appropriate to drive that fast?

The growth of subprime and subprime linked securities was inevitable when we lost sight of meaning of home and housing.

3. Compensation-driven conflicts of interest. With investment bankers realizing on average over $1,200 per mortgage underlying the mortgage finance instruments of recent years, it is pointless to assess the compensation-driven conflicts of interest at one point of the market cycle. Again the question that remains, “What and where are the trusted-institutions?”

Rating agencies have been expected to assess risk, and they have. But the real risk moves across the market process and pose different consequences to wide array of market participants. As such, it has become extremely difficult to link a prospective investor in mortgage securities with the mortgage instruments intended to finance housing transactions.

4. Accountability. Like liquidity, accountability is a fluid concept. Again the question that remains, “What and where are the trusted-institutions?” If Congress wishes to remedy the defects that contributed to the near meltdown of our financial markets, it must comprehend just how important housing finance is to our society and who bears the risks and costs associated with vehicles used to speed through our financial infrastructure which is not designed to handle them.

The role for public authorities in supporting the flow of credit to the housing sector has been critial throughout our recent hstory. The lesson learned during the S&L crisis was that it was catastrophic to finance home ownership through insured banking institutions that borrowed short term and then offered long-term fixed-rate home mortgages. Now a system reliant on securitisation, adjustable rate mortgages and non-insured financial institutions has broken down.

The only way out of this current tailspin is innovation. Long-term success for housing finance requires more innovation throughout the market process. It requires market participants to develop strategies around disruptive innovations. It is through disruptive innovations that transcend the market processes that we will create new markets or reshape existing markets by delivering relatively simple, convenient, low-cost innovations to a set of customers who are ignored by industry leaders expected to serve the common good. Who should bear the responsibility for the cost of a house? Who should determine the value of home?