Friday, October 31, 2008

How Did We Get Here? Where We Are Today.

Dear Friends,

I was recently forwarded this article/email by a friendly reader. I don't know the original author, but it is dead on. It contains some valuable information on how we got to our current market conditions.


To understand where we are today, we must look at the period from 2001, the beginning of the modern mortgage industry, to 2007, the peak of the housing bubble. Lending guidelines were significantly relaxed due to an ever increasing demand for mortgage-based investments. This led to a surge in borrowing power, home prices and mortgage origination.

Investor Demand Soars
Wall Street firms quickly realized the profitability of mortgage products and created a demand for more and more mortgage-based investments. Lenders relaxed their lending guidelines to generate higher mortgage loan volumes. With more borrowing power, buyers were encouraged to stretch for larger homes, second homes and investment properties. Homebuilders saw the potential as well and built new homes at a record pace.

Borrowing Power Surge
Prior to 2001, a typical borrower could qualify for a loan amount equal to three times their pre-tax income.
Beginning in 2001, borrowing power surged based on:
Rising income levels
Falling interest rates
Higher debt-to-income ratios
Interest Only mortgages
Low and no down payments options
Increased credit availability
With the loosening of mortgage guidelines, from 2001 to 2007, borrowers could qualify for a loan amount equivalent to nine times their pre-tax income.

Home Prices Skyrocket
As borrowing power increased exponentially, so did home prices. From 1975 to 2000, the Compound Annual Growth Rate (CAGR) for home prices trended at 1.4 percent. From 2000 to 2007, the rate trended at 7.6 percent. Home prices were driven up by unsustainable borrowing power increases.

Mortgage Lending Standards Ease
In addition to expanded guidelines, lenders also lowered credit standards. Subsequently, borrowers were introduced to 100 percent financing, Interest Only loans and limited-to-no documentation programs.

Investor Demand Drops
As home prices fell, and delinquencies and foreclosures rose, investors saw substantial losses in their mortgage-based investments. This led to a sharp decline in demand for mortgage-based investments throughout the world. As a result, total mortgage origination projections for 2008 are $1.9 trillion, down over 50% from a high point of $3.9 trillion in 2003.

Mortgage Lending Standards Tighten
In reaction to rising credit and investment losses, lending standards are returning to more prudent levels. The tightening of these standards coupled with reduced equity from falling home prices has greatly limited the number of qualified new home buyers and refinance opportunities for current homeowners.

Borrowing Power Decreases
The tightening of mortgage standards has also impacted borrowing power. Recently, the typical borrower’s buying power has dropped sharply; some say as much as 50 percent from its peak in early 2007.

Home Prices Fall
Prices of existing homes continue to soften. Foreclosures have risen, and home sales are falling leading to excess surplus in housing inventories.
To return to the trended growth rate of 1.4 percent, home prices must decrease an average of 34 percent from their peak reached in early 2007.
Additionally, it is projected that housing prices must return to or fall below 2.6 times the median income level.

When Will Equilibrium Return?
Given the fluid nature of the values and the external influencing factors of our industry – regulations, interest rates, economic conditions, availability of credit, etc., to pinpoint the exact timing for our industry to reach the bottom of this cycle is more art than science.
The best forecasting calls for the restoration of equilibrium to our industry in the first half of 2010. However, pending government intervention may impact the timeline for the return of stability to the market as well as investor confidence.

What Our Industry Must Do?
As an industry, it is important that we learn from our collective mistakes and take action to ensure these conditions are never repeated. We can all support the restoration of the integrity of our industry by:
Continuing the move towards realistic mortgage lending standards
Returning to a rational correlation between income and borrowing power
Accepting that home prices must return to a sustainable growth rate
Working to restore borrower, investor and regulator faith in our industry

Thanks for spending 3 minutes with me.....
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On Your Team
Jeffrey S. Stanton
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