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I am often asked why I, a commercial building sales broker, pay attention to the residential housing market. It is because we landed in this recession due to stresses in the housing market and the roads leading out of the recession will run through the housing market as well. During the summer, that road seemed to be heading toward recovery.Over the past few months, there have been some signs that the U.S. housing market had begun to stabilize. Some economists have even said that the market bottomed as early as the spring of this year. Let’s look at the reasons for the optimism.Industry experts were cheering October’s new-home sales figures, which easily beat estimates by climbing 6.2%. Prices, which had been in free fall, dropped by the smallest margin in nearly a year. (The S & P Case-Schiller Index, which only tracks 20 markets suggests prices have been increasing for 5 months running). The National Association of Realtors reported last monday that sales of previously occupied homes in October jumped 10.1% from September to a seasonally adjusted annual rate of 6.1 million, the highest level since February 2007. The number of home listed for sale nationally was 3.57 million at the end of October, down 3.7% from a month earlier. Much of the sales activity was driven by buyers who rushed to claim the first-time home buyer’s tax credit before it was to expire on November 30th of this year. The number of homes for sale in September was 3.63 million, down 15% from a year earlier.Mortgage rates have been at historically low levels. Mortgage backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae rose to their highest level of the year last week buoyed by strong investor demand. Risk premiums on the bonds, which measure their yield (moving inversely to the price), fell as low as 1.24 perceentage points above the yields of comparable Treasuries last Wednesday. The previous narrowest level was 1.29 in May. These dynamics have created an average rate on 30-year fixed rate mortgages at only 4.78%, which matches a record low from April. That rate was down from 4.83 the previous week and 5.97% a year ago.If we look at the housing market dynamics more closely, however, it appears there is a good chance that government intervention may be creating a bubble of its own, artificially and unsustainably propping the market up.Consider this: The average single family home price in the United States is $178,000. Most mortgages made today are guaranteed by the Federal Housing Administration which requires only a 3.5% downpayment (less in several circumstances) which is $6,230. With the $8,000 first-time home buyer’s tax credit, the government (the taxpayer) is paying people to buy houses (It has been estimated that 80% of the purchases that occurred using the credit would have occurred anyway so the “real cost” of the economic incentive to create a sale is $40,000, not $8,000). Buyers are utilizing artificially low interest rates as the Fed is buying a significant percentage of offered Treasuries to keep rates down. Without this quantitative easing, mortgage rates would be much higher. The Fed is also buying much of the residential mortgage-backed securities that are being sold. Between Fannie, Freddie and the FHA, the government( the taxpayer) presently guarantees 92% of all home mortgages in the country. To top it off, the government (the taxpayer) is also purchasing a substantial amount of these very mortgages that we, um – I mean the government, guarantees.  Does this sound vaguely familiar to you? Isn’t this type of shell game that got us into this mess in the first place?We must not forget that the catalyst for most of the stress in the housing market was government policy aimed at increasing the homeownership rate through lowering mortgage lending standards. These policies began in 1977 with the Community Reinvestment Act (CRA) which targeted banks and encouraged them to increase lending in low- and moderate-income communities. From 1977 to 1991, $9 billion in CRA lending committments had been announced.In 1992, congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, also known as the GSE Act (ironically, the name sounds so benign). The objective here was to force Fannie and Freddie to purchase loans that had been made by banks; loans that were made as part of the CRA. The GSEs had to do this to comply with the law’s “affordable housing” requirements. Since then, Fannie and Freddie have purchased over $6 trillion of these mortgages. The goal of community groups, of forcing Fannie and Freddie to loosen their underwriting standards in order to facilitate the purchase of loans made under the CRA, was achieved. Congress inserted language into the law encouraging the GSEs to accept downpayments as low as 5% or less, ignore impaired credit if the blotch was more than a year old, and otherwise loosen their lending guidelines.The result of these loosened credit standards, and a mandate to make “affordable-housing” loans, created a massive pool of high risk lending that ultimately drowned the GSEs, overwhelmed the housing finance system, and caused an expected $1 trillion in mortgage loan losses by the GSEs, banks, and other investors and guarantors. Most tragically, there is an expectation that, at the end of this cycle, the U.S. will have seen 10 million or more home  foreclosures.The refundable tax credit, available even if a family has no taxable income, will enable many more purchasers to buy a home, even if they are not qualified. But it could also bankrupt the FHA and, by doing so, would damage an already weak housing market.This credit was initially available only to first-time buyers with a combined income of $150,000 or less ($75,000 for individuals). In 2009, about 40% of all first time buyers used the credit, so extending it was strongly supported by residential real estate brokers, home builders and their congressional allies. The recently passed extension (until April of 2010) makes the credit available, not only to first time buyers but, also to those who have owned a home for at least five years. In addition, it raises the maximum income for a qualified buyer to $225,000.The first-time home buyers tax credit is expected to cost the Treasury about $15 billion in 2009, more than twice the projected cost when Congress approved the stimulus package (is it really hard to believe that the government could underestimate the cost of the programs it implements? – watch out healtcare reform!).The problem here is that, as we discussed above, the FHA insures mortgages with such low downpayments that it can be funded completely by the refundable tax credit. Owners who don’t invest their own money into a house are much more likely to default on the mortgage. The FHA is already looking at a number of serious problems. Two weeks ago, the agency reported that its cash reserves, which are federally mandated to be no lower than 2% (down from 3% last fall) of its portfolio, had dropped to 0.53%.The deteriorating quality of the FHA’s mortgage portfolio is a critical challenge to the housing market and the federal budget. A recent government audit concluded that the FHA would run out of money in 2011 and need a federal bailout if a recovery is not swift.Presently, the percentage of U.S. homeowners who owe more on their mortgages than their properties are worth swelled to about 25% according to a report in the Wall Street Journal. Moody’s.com pegs this percentage at nearly 33%. Either way, this dynamic threatens prospects for a sustained housing recovery. These so-called underwater mortgages present a roadblock to a housing recovery as these properties are more likely to fall into foreclosure and get placed on the market, adding to an already bloated supply.Over 40% of borrowers who took out a mortgage in 2006, when home prices peaked, are under water. In some parts of the country, home prices have dropped so much that borrowers who purchased homes five years ago now have negative equity. Even recent bargain hunters have been hit as 11% of borrowers who took out mortgages in 2009 already owe more than their homes are worth. Borrowers with negative equity are more likely to default and, today, about 7.5 million households are 30 days or more behind on their mortgage payments or are in foreclosure.This level of negative equity has some economists projecting that housing won’t really bottom out until 2011. There are additional factors that lead to their conclusions.The home sale statistics that are presented by the NAR and Commerce Department exaggerate activity as they double count some sales. If a foreclosure occurs and the bank sells the property to an investor at an auction who subsequently resells the house to someone who intends to live there, that counts as two sales. Additionally, “seasonally adjusted” numbers also will exaggerate the real level of activity.Moreover, most of the sales activity is taking place in the areas which have been hit the hardest such as California, Southern Florida, Arizona and Las Vegas where we see the highest level of distress and very cheap condos, co-ops and single family residences.Home prices are measured in three different ways: 1) median income to median sales price, 2) the cost of owning versus the cost of renting, and 3) the total housing stock value as a percentage of GDP. If we consider these three different methods of measuring home prices and affordability, it is possible to conclude that home prices have another 10% – 15% to adjust before the market actually hits its natural bottom.All of the government intervention has prevented the market from hitting its natural bottom. No one wants to see people displaced but artificially propping the market up only makes things take longer to correct and simply delays the inevitable. The American consumer has had a long-held taboo against walking away from their home, but this crisis seems to be eroding that.The Fannie and Freddie bailouts have already cost us $112 billion (and counting). How much will the FHA bailout cost? If housing values don’t recover, or the FHA cannot outrun its problems, the government audit suggests that FHA could ask for $1.6 billion by 2012. judging from history, that is probably a low-ball estimate.Congress probably doesnt mind, however, because these liabilities are technically off budget, until they aren’t. i certainly hope the housing market recovers quickly but there appear to be many hurdles to overcome before this can happen.Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

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