"Getting Rich Through Homeownership - The End Of An American Dream," by Fred Carach

Much has been heard in the press lately about the end of the great American dream of homeownership but what the press has missed is that what has really died in the crash is a perversion of the American dream. The perversion of getting rich exclusively through homeownership. That perversion really started in the 1970s and died in the great real estate crash that began in 2007.

Prior to the 1970s homeownership was regarded as a key asset in the accumulation of wealth but it was never considered the only asset. Real estate values rose too slowly to accomplish that mission. In fact it is surprising how little real estate values have risen over the long term. According to the economist Robert J. Shiller, the recognized economic expert on this matter from 1890 when accurate records began to the crash year of 2007 residential real estate rose only 3.44% a year. Far less than most people would assume. Then the rise in inflation rates changed everything.

In the decade of the 1970s inflation turbocharged real estate and values rose a blistering 8.12% a year, the greatest rise in history and in the 1980s values rose an additional handsome 5.86% a year. These two decades convinced millions of American homeowners that they could now get rich solely through homeownership.

Their home they were now convinced was the truth, the light and the way to getting rich.

People adore owning real estate. They lust for the stability and permanence of the land. They can roll around in the stuff and as the saying goes they are not making any more of it. What’s more everyone knows or rather knew that you can’t lose money in real estate. People have always had an exaggerated notion of how profitable an investment real estate has historically been. This opinion is based to a great extent on the enormous leverage that is common in homeownership. If your down payment is 5% you are employing leverage of 20:1. Wall street speculators would kill for this kind of leverage.

But there was more to it than that. By the 1970s the American people had changed. They were for the most part no longer willing to make the sacrifices that their parents and grandparents had made.

Scrimping and saving and living below your means was too tough for them. Instant self-gratification was in. What was attractive to them was blowing every dime they had on a big-beautiful home and get rich while they were wallowing in their big-beautiful home like a pig wallows in slop. Saving and sacrificing was for dummies. As for the stock market it was way, way to risky. They were far too smart for that crazy gamble. Risk taking was for dummies. Their home was the perfect investment it required zero risk and zero sacrifice. Which was just what they were looking for.

An interesting component of this belief was an amazing lack of interest in any real estate other than their home. When there was enough equity in their home to support an investment in any real estate other than their home for the most part they turned it down flat. After all any investment outside their home would require a sacrifice on their part. We couldn’t have that happening now could we? Instant self-gratification always comes first. The smart career move from their point of view was to shoot for the Mcmansion. Boy could they pig wallow in that baby.

In 2007 their big-beautiful homes imploded on their heads. It is hard to overstate the financial devastation that the housing crash has had on the American middle class. The unemployment rate that everyone is whining about is almost a side show. For millions of middle class, home owning Americans their home was their only financial asset. In a matter of months millions of home owning Americans went “upside down.” They went from having $100,000 to $250,000 or more in equity in their homes and often much more. To being that much or more underwater.

For those who have twenty years or more before they retire recovery is possible but for the millions who are approaching retirement there is very little hope. The statistics are so grim that many of them are hard to believe. According to the famous Case-Shiller Housing Index home values hit rock bottom in the depression year of 1933 with a decline of -30.5% from the 1920s peak boom period. As hard as it is to believe according to the latest Case-Shiller findings we have just broken that record in the 2nd quarter of 2011 with a decline of -32.7% from the 2006 market peak.

About one-third of all the homes in America are paid off and have no mortgage. The remaining two-thirds of all homes have mortgages. An amazing 25% of homes with mortgages are underwater. The outstanding mortgages exceed the value of these homes.

Then there is the seldom reported vacant housing crisis. There are 126 million housing units in this country or about one housing unit for every 2.38 Americans. That is an awful lot of housing for each American. The classic 3/2 American home is overkill if there is only 2.38 people rattling around in it.

The census figures tell the tale. When I first read these numbers they were so bad that I could not believe that they were true. The 1990 census reported that there were a staggering 10.3 million vacant homes in this country. It gets worse, in the 2000 census that figure had risen to 15 million vacant homes and in the 2010 census that figure had risen to 19 million vacant homes. About 15% of all the housing stock in America is vacant. You could level 19 million homes and there would still be housing for every American. This is not good! What were we thinking? We were thinking that you can’t lose money in real estate. Every new home is money in the bank.

The chickens have come home to roost. There will be no quick recovery. We are not only broke but we have a mountain of inventory hanging over our heads. It will take us years to work our way out of this mess.

Forty Years a Speculator

Fred Carach

Oakland Park, FL 33309

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"Why A Real Estate Appraiser Prefers The Stock Market To Real Estate," by Fred Carach

The twin crashes of the stock market and real estate that began in 2007 have devastated the American people as nothing has since the Great Depression. The American people today are far,far poorer than they were prior to these twin crashes. But something very strange has occurred. The stock market bottomed out in March of 2009 and since then has blasted upward in a powerful bull market rally while real estate the favorite investment of the American people and where most of their wealth resides has twisted ever so slowly in the wind.

It is time to ask a most important question. What accounts for this strange divergence? Before we go any further I need to state that in this article I use the narrow, popular definition of real estate. I refer only to condos,townhouses and single family homes. This article ignores apartment buildings and commercial real estate. Those interested in my considerably different views on commercial real estate are invited to read my article on commercial real estate and REITs titled, "How The Small Investor Can Afford To Buy Commercial Real Estate," on my blog.

It is important to point out that until the recent crash real estate had enjoyed one of the greatest sustained booms of all time. You have to go back  to the S&L crisis of the late 80s to find the last time that real estate was not in boom conditions. That crisis ended in 1991 and from 1991 until 2007 real estate did nothing but go up. Everyone was riding a wave that they couldn't lose on. You had to be truly stupid or unlucky to lose money in real estate during this fantastic 16 year period.
For reasons that I have never been able to understand people have enormous difficulty in understanding that in residential real estate it is impossible for real estate to rise faster than people's income for any sustained period of time because people will not be able to qualify for the mortgage.

And this is exactly what happened as the boom progressed. All sorts of strange mortgages were being created to fudge the issue that people could not possibly qualify for the homes that they wanted to buy. Mortgages with weird names such as ARMs, Alt A, negative amortizing mortgages and of course the famous liar loans dotted the landscape.

In 2007 the yawning gap between what people could honestly afford to pay and ever rising real estate prices could no longer be papered over and the whole rotten edifice collapsed. In that year the median priced home sold for $230,000 and the median income household could afford to buy a home in the $150,000-$175,000 price range using honest standards. Incidentally, that is exactly what the median priced home is selling for today. For the first time in many years the median income American family can afford to buy the median priced home.

Why then do I an insider with 30 years in the appraisal industry and a licensed realtor prefer the stock  market to real estate? It is indeed fortunate that real estate is selling for the first time in many years at a price range that is affordable to the American people but the $64,000 question is what will make real estate values rise. The answer I am afraid is that in the next five years there is almost nothing that I can see that will cause a sustained increase in real estate values on the national level.

It is amazing to me that people can not figure out why real estate values are dead in the water and refuse to rise. Contrary to popular belief real estate doesn't increase in value because they are not making any more of it or some other idiotic popular delusion. Real estate increases in value for only one reason and that reason is because buyers engage in bidding contests to purchase properties. In the absence of bidding contests real estate prices cannot and will not rise.

By now it should be obvious to the reader what the problem is. The problem is that the American people have been financially devastated by the twin crashes of the stock market and the real estate market. They are no longer players. They are too broke to engage in bidding contests.

Until the crash there were millions of active real estate players throughout the country who had a net worth of say at least $1 or $2 million on paper if not in reality that they could borrow against. Huge numbers of these players no longer exist. They are done, through, finished, foreclosed upon and have
declared bankruptcy. These now vanished players were the heart of the real estate market and they will not be coming back anytime soon. Indeed many of them will never come back. Their credit ratings have been destroyed and no bank will lend them money. This is a fatal combination in the world of real estate.

The stock market sails serenely on for the best of reasons. You don't need a credit rating of 620 or better to buy stocks and you don't need a bank loan to buy stocks. Stocks are a cash market. In this sea of darkness there is one light. The remarkable rise in real estate of the "cash buyer." For the cash buyer with a 7-10 year time horizon real estate is a market that has real potential.           

Forty Years a Speculator

Fred Carach

Oakland Park, FL 33309

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"WHY THE REAL ESTATE CRISIS HAD TO HAPPEN" By FRED CARACH

We cannot understand the present unless we understand the past. The first question to be asked is when did the real estate crisis become inevitable? The correct answer is in the time period between 1980 and 1982. It has been forgotten today but the last real estate crisis in this country were the twin real estate crises of the 1980s. In the early 1980s the first crisis was brought on by double-digit mortgage interest rates. Then in the late 1980s there was the savings and loan crisis, which in those days provided most of the nation's mortgage capital. In response to these twin crises congress passed two laws that made today's real estate crisis inevitable.
After these acts were passed it was only a question of time until the stars aligned correctly for the volcano to erupt.
In 1980, congress passed the DIDMCA Act. Prior to this time, it was illegal to charge less credit worthy customers a higher rate of interest on their mortgage. Then in 1982, congress passed the AMPT Act, which allowed adjustable rate mortgages or ARMs for the first time. Prior to this act adjustable rate mortgages had been illegal.
If you go back to 1896 when reliable housing records first began to be kept you will find that from 1896 to 1996 housing prices tracked the rate of inflation. Then suddenly from 1996 to 2006 housing prices doubled. The problem of course in that the income of the American people did not come anywhere near to doubling in that time period.
When you stop to think about it, you will realize that it is impossible for the price of housing to exceed the rise in the income of the American people for any sustained period of time. Unless there is an enabler, a speculator's tool that allows this to happen. What was the speculator's tool or device that enabled this process to occur? What was the enabler?
In the whole of American history there has only been one prior real estate bubble that resembles the real estate boom and bust that we are now witnessing. It was the great Florida land boom of the 1920s. Real estate has always been expensive. What has always held real estate prices in check was that people just did not have enough money to bull prices up for very long. The money is just not there. The device that enabled the Florida land boom to occur was the "binder." This is a real estate term that has gone out of use today. In the manner in which it was then used it was essentially an option payment on the down payment if you can conceive of such a thing.
What it boiled down to is that people thought they were speculating on real estate but in reality they were speculating on real estate options.
The stock market has long been the ultimate proving ground for speculative tools. Those of us who are stock market speculators are very familiar with stock options. The only thing that the reader has to know about options is that they are speculating tools that possess tremendous leverage. In other words, you can make a killing on a chump change investment.
Both the binder of the 1920s and the ARM are in reality real estate options. All options expire worthless if they are not exercised prior to their expiration date. Most ARMs were written to expire in two or three years, the fixed interest rate period. At that moment the option had to be exercised or rolled over because the option would become worthless. People were deluded into believing that they were buying real estate. When in reality they were speculating in real estate options. As we have seen, the tools for the bubble were in place by 1982. the only thing lacking now was the mania. The boom years from 1991 to 2007 provided the mania. Real estate prices rose relentlessly. It was a boom that seemed like it would never end. You couldn't lose in real estate because no matter how much you over paid because rising prices bailed out everyone.
Today in the aftermath of the boom, we are already discounting the impact on the human psych that manias and bubbles produce. To put it bluntly by the end of the boom almost no one could believe that real estate prices could fall. This nearly universal belief gradually eroded prudent behavior. The more risks you took the more you were rewarded. There was no down side.
In the early 90s the use of sub prime mortgages and ARMs were limited-since almost all sub prime mortgages were also ARMs they will be considered as a unit- but as the boom progressed their importance grew and grew.
Mortgage brokers just could not stay away from sub prime mortgages. They were three to five times more profitable than standard mortgages. Once they had sold one they didn't want to sell anything else. The caution that lenders had originally shown toward the new mortgage products was relentlessly ground away as the endless boom continued. Caution wasn't being rewarded, it was being punished. There was a Gresham's Law in effect- Gresham was an economist-in which bad or reckless behavior which was constantly being rewarded by lush profits drove out good or cautious behavior because the profits were inferior. In the final years of the boom, conservative firms could not even keep their mortgage brokers from bolting to subprime lenders.
Then around the year 2000 Minsky's Law kicked in. Hyman Minsky was a Noble Prize winning economist.

Minsky's Law

Over periods of prolonged prosperity the economy evolves from financial

relationships that engender a stable financial system to financial relationships

that produce economic instability. The longer the trend persists the more

violent the correction when the trend reverses.

As the boom rolled on the most important factor was that almost everyone was a winner. This was true in spite of the fact that subprime mortgages were constantly defaulting at the higher rates that had been predicted. Not only was the higher default rate not a problem but everyone was making out like a bandit with subprime mortgages. This included the subprime borrower. As soon as he fell behind his friendly subprime mortgage broker would be there to write him a new subprime mortgage. In fact he often got to take out new money when he refinanced the mortgage. It was not unusual to have subprime borrowers take out new mortgages every two or three years during the boom.

If there wasn't enough equity to suit the lenders, real estate speculators would be pounding at his door offering to take the property off his hands as soon as the notice of default had been published. Often at a profit over his purchase price.

The banks were the greatest winners of all. They were making a killing. It is obscene how much money a bank can make during the foreclosure process as long as someone buys the foreclosed property. Not only do they receive all the back payments but the brutal penalty fees as well. Indeed the most profitable scenario that can be imagined for a mortgage lender is to make nothing but high profit subprime loans and then to have them all default. Their profits would be enormous. That is, so long as the lender never has to take back the property.

When the boom ended, things became incredibly ugly for the banks with amazing speed. One of the most important favors that real estate speculators did for the banks when they bought a foreclosed properly was that in addition to paying the obscene penalty fees they also paid the nearly as obscene attorney foreclosure fees. Not to mention repairing the often seriously vandalized property. An angry homeowner can easily do $20,000-$30,000 in damages.

When the boom ended all these expenses landed on the banks head like a falling safe. The banks never knew what hit them. I am sure that they still think that they were run over by a Mack truck.

Fred Carach is the author of the book, " Forty Years A Speculator." His blog is fortyyearsaspeculator.blogspot.com

"WHY THE BANK WILL NOT MODIFY YOUR MORTGAGE" BY FRED CARACH

We cannot understand the present unless we understand the past. To understand today's banking and real estate crisis you have to go back to the last banking crisis. The savings and loan crisis of the late 1980s resulted in a new banking paradigm. Under the old paradigm almost all banks were "full service banks." In other words all real estate lending functions were handled in-house. By the time the crisis was over with the typical bank had been transformed beyond recognition. Banks went from being full service institutions to limited service institutions that had farmed out to others many banking functions that had hitherto been regarded as being important core functions.

However,none of these dramatic changes were visible to the typical bank customer. It looked like the same old bank to them.

This transformation was part of a much broader transformation that was taking America by storm. This new business philosophy held that every business had a core competency and that the way to maximize your profits was to concentrate on your core, high profit skills and to farm out to other institutions your low profit, non-competency functions. It was taken for granted that the activities that were earning you the greatest profits were your core competencies and that anything that was low profit was a low competency skill that was bested farmed out to others. The flaw in this system was that in times of crisis you no longer had the in-house skills to cope with the crisis because the skills had been farmed out to others.

It has to be admitted that in normal times the new paradigm delivered on its promise of lowering costs and increasing profits. This is why today when you make a call to complain about a product or service you end up talking to a speaker who lives in Calcutta, India.

The Old Bank Model

In-house staff real estate appraisers

In-house mortgage originators

In-house servicing of mortgage payments

In-house warehousing of mortgages

The New Bank Model

No in-house staff appraisers

Very limited amount of in-house mortgage originating

No in-house mortgage servicing

Almost no warehousing of mortgages

(mortgages were sold off rather than kept)

Under the old banking model when a mortgage got into trouble the bank had all the expertise needed to solve the problem in-house. Under the new banking model not only was the bank clueless but it was enshrouded in total darkness as well.

Under the old system when a mortgage problem arose the bank knew exactly what to do. Under the new system it sits around and sucks its thumb. Under the old system the first thing the bank would do was send out one of its in-house staff appraisers to do a complete inspection of the home and a complete professional appraisal. Under the new system they call up a real estate broker and ask for a BPO, a broker's price opinion. No doubt you are wondering why they don't hire an appraiser? The answer the bank will give you is that they are way too smart to pay the $275-$350 a complete appraisal would cost. This standard appraisal also includes a complete interior and exterior inspection of the property.

A BPO they craftily inform you will only cost them about $75. That's because the broker never leaves the office. He spends fifteen minutes scanning comparable sale listings on the MLS system. Eyeballs what seems to him to be an appropriate number and another fifteen minutes writing up the one or two page BPO. As the bankers will proudly tell you they are way too smart to get the job done right. Guessing is so much cheaper.

I speak with an insiders knowledge on this point. You see I was one of the in-house appraisers that were thrown out on the streets like a dog.

Let's step back in time and continue our analysis. In the old days when a client asked for a mortgage The in-house appraiser and loan officer would carefully scrutinize the deal. Due diligence was taken seriously because the mortgage was going to be warehoused by the bank until maturity and not sold off. If the mortgage blew up the bank took the loss. In this case the appraiser and the loan officer give the deal a thumbs down. The appraised value is below the sale price and there are problems with the buyer's earnings and credit. The bank turns the deal down.

A month later, an independent mortgage broker shows up at the bank with the same deal. Only this time as if by magic the appraised value hits the purchase price and the earnings and credit problems have disappeared from the mortgage application. Now you know why the banks fired all their staff appraisers and most of their in-house loan officers. Prior to this time the banks originated about 90% of all mortgages. By the bull market peak independent mortgage brokers originated over 70% of all mortgages.

Of course, if the banker has a brain in his poor,stupid head he has suspicions. However his hot, little hands are now holding an appraisal done by a licensed appraiser and a mortgage application that has been done by a licensed mortgage broker. The bank accepts the deal but there is no way he is going to warehouse this mortgage or the ever growing number of dubious mortgages that the bank is accepting from outside mortgage brokers. These mortgages are going to be pooled and securitized into various types of mortgage-backed securities ( MBS and CDO) as quickly as possible.

Let's now return to the present. The bank now realizes that the outside appraisal was dubious and the mortgage application was even more dubious. It has probably sold off the mortgage servicing rights and kept the mortgage or it may have sold the mortgage and kept the mortgage servicing rights. Do not underestimate the importance of mortgage servicing rights. This is what gives you control of the mortgage. Others may own the mortgage but the mortgage servicers control the mortgage. There are about 8,500 banks in this country. The vast majority of which do not service their own loans. The 27 largest mortgage servicers dominate the service industry.

You now know why the banks are responding so poorly to urgent requests to modify mortgages even when it is in their overwhelming interest to do so. It is the common assumption that the reason why banks will not help out their clients is because they are just being mean or greedy. The reality is that in today's brutal real estate market it is almost never in the bank's interest to foreclose. Yet, the foreclosures continue because they are on automatic pilot. It is often the case today that the mortgage servicers start and often finish foreclosure proceedings without prior approval from the bank.

You see mortgage servicers are paid for foreclosing on the mortgages that they are servicing but until a recent change in federal regulations, they were never paid to modify a mortgage.

You now know why the banks and troubled mortgage payers are in such trouble. The reason why banks appear to be wandering around in a stupor, is because they are in a stupor. To a shocking extent they have lost control of the ability to manage this crisis. They are in trouble because they are as blind and dumb as a fence post. The expertize that they once had is gone with the wind.

Fred Carach is the author of "Forty Years A Speculator. His blog is fortyyearsaspeculator.blogspot.com