Comprehending the Complexity of the Mortgage/Real Estate Crisis

Mortgage obligations in past times had experienced such low default rates against such high overall returns that it seemed sensible to bundled them and sell them as packaged securities. The amortization structure of the mortgage, while extremely expensive to the debtor, conversely, is extremely lucrative to the lender and remains an asset to him as long as the debtor has the means to repay and/or the resale value of property remains high and robust. It provides the note holder with a fruitful income stream for decades and as such represented a seemingly ideal institutional investment choice provided the underlying market conditions remain in place.

However, if a loan goes into default, the debt obligation no longer is an asset to banks or institutions, but instead becomes a liability. The focus abruptly shifts from payment collections to debt recovery, property seizures, property liquidations which are businesses that banks as pure lenders are not structured to perform. Yet as long as there remains a robust buying market, it seems to make sense to simply sell the note and focus on doing other loans to make up the lost. Moreover since the entity making the underwriting decision is not assuming the risk, rather selling it to other institutional entities, the necessary risk management discipline is disrupted. Worse still, if the underlying real estate and lending markets become severely disrupted, then that liability is magnified (since the ability to liquidate the property or to offset the defaulting mortgages with an adequate number of quality mortgages is compromised). This in summary describes the “perfect storm” environment creating the current financial and economic crisis we are currently experiencing.

It is extremely important to be attentive when mortgages go into default, the value-aspect of them shifts from the income generating component to the securitized property component. Yet the home, which was once held as a utilization asset by the debtor (since he used the property for his personal or business needs) does not offer the same values to the lender. He, the lender, becomes saddled with finding a new ready, willing and able homebuyer to highly value the property; which takes time and skill sets that few bankers have. Additionally, by law, lenders are required to place additional monies into reserves against loans in default which further restricts their ability to operate their core business practice (lending). This in many ways represent a ”double jeopardy” for lenders, making them extremely eager to dump these assets — property and all — in the market; even at huge discount provided the market conditions dictate that they can do so.

Opening Summary: While there are additional social economic issues and consequences about the crisis to consider, the one outlined thus far make it clear that the stability of the housing markets hinges primarily on a citizens ability to generate and sustain an income (labor). Therefore, the more “viable” and “sustainable” income opportunities created within the labor markets, the more stable the real estate markets will become and remain. This will ultimately provide relief and liquidity to the financial markets as well. All three of these vital markets play a critical role in the stability of our economy; so understanding the internal and intra- dynamics of each is paramount.

Policy makers must regulate in such a way to:

• Create new and preserve existing job opportunities in a way that will provide huge value-added returns to present citizens and future generations to come. Infrastructure and technology are viable options, but some pitfalls must also be observed here. (reserved for future discussion). Most stimuli must be directed toward human capital first as opposed to technology and machines since these cannot circulate capital.
• Relieve banks of as many distressed mortgages as possible and create localized agencies to manage and preserve the properties. Remember that the value of the mortgage is no longer in the debt obligation, but rather in the real estate property. As banks become unlevered, more normalized lending will resume and disciplines can be restored.
• Complement stimulus with tax legislation targeted towards working citizens creating a huge value-added incentive for them to pay for housing first. Such legislation would likely have broad base appeal making it easy to pass legislative scrutiny and expedite relief. This would address several components at the root of the current crisis:
  1. Such legislation, coupled with job increases, would spur home-buying which would stabilize home prices and stem defaults.
  2. A good portion of the stimulus would return to the government in the form of house/mortgage payments while constructively removing unwanted mortgage obligations off government and banks balance sheets.
  3. The huge net value added increases to workers could be used to negotiate wage concessions with unions which could make companies more competitive and thereby further attract job opportunities.

The important take-away here is that it’s not enough to put large sums of money into our system without directing that capital though the system so that it will quickly address multiple and highly pressing problems first.