In this presentation, Dr. Pozdena recounted the factors that led us to where we are presently regarding our mortgage/credit crisis situation. He had some great insights, and I left with some positive feelings about where we are and where we are heading.

He began by detailing two critical events that he believes truly set the stage for what we are presently experiencing as a national economy.

Back Story Part One: the 1977 community re-investment act.

The 1977 Community Reinvestment Act was an attempt to regulate Banks by incentivizing them to extend more credit to minority Groups. There was data that showed minority groups being turned down for credit at a much higher rate than the rest of the community at large. However there has never been any evidence showing that banks were declining credit for any reason other than credit worthiness. Yet, this bill passed through Congress and it has greatly affected the way credit is distributed. Since its passing, we now see minority groups getting credit at a significantly increased rate compared to non-minority groups. The government historically has attempted to get the banking industry to extend more credit despite the consistent warnings of the economic scholars of the day.

Back Story Part Two: “the Greenspan ‘Put’”

Prior to Alan Greenspan, the Dept of the Treasury had never intervened quite to the extent that took place during his tenure. After the 1998 collapse of the Long Term Capital Management Hedge fund, Greenspan stoked up our national economy by flooding our financial system with cheap short term debt. This made making mortgages at historically low rates very profitable. A refinance boom put this cheap/secured money into many individual bank accounts. Ours being a consumer based economy, this was the stimulus needed to pull through some unprecedented national and international market turbulence.

This cheap money also had the consequence of bringing rise to the Subprime Mortgage industry which, combined with the 1977 CRA was bringing entirely new borrowers into the marketplace.

Long story short: This is my bottom line take away from this presentation.

Lots of money started to be made by extending credit to borrowers who had never before been considered creditworthy. This creation of huge numbers of new qualified homebuyers greatly added to the overall demand for residential real estate, and pushed prices higher (creating some regional bubbles along the way).

This VERY SAME segment of the marketplace is the segment that is being foreclosed upon as I blog. These borrowers are now exiting the marketplace, and the new rules of the mortgage industry are not replacing them with new buyers. This is now where we are, these exiting borrowers are flooding the market with housing inventory which is putting downward pressure on home prices.

This subprime market segment isn’t just “low credit score” although that is a big component. Many subprime borrowers had great credit scores. The subprime Mortgage industry allowed borrowers not to document income in many cases, as well as have no cash in reserve in many cases, as well as purchase multiple investment properties with little reserves… you get the idea. Just generally high risk type borrowing scenarios that used to get laughed at by Mortgage lenders.

The Good News:

According to Dr. Pozdena, this problem seems to be manageable. It is approximately 1/3^rd of the magnitude of the Savings and Loan crisis of the late 1980’s (relative to GDP). His analysis of the numbers are leading him to believe that the national real estate market will absorb the foreclosures and normalize sometime in the second half of 2009.

My feeling is that there is that there is some consensus finally beginning to develop in the credit marketplace. Citi Bank was able to unload over twelve billion dollars in mortgage bonds not too long ago. Even though they took a loss, the fact that they found a purchaser indicates that there is a value in these bonds that all banks have TONS of and can’t find buyers.

National City Bank was also able to find Seven Billion dollars of capital not too long ago.

So now we (the mortgage industry) are recapitalizing as well as repenting by restricting our risk tolerance.

My hope is that the government doesn’t bring the club down on our industry in the coming sessions as we seem to be making some very serious adjustments on our own.

It is ironic that the very same politicians asking for reform (ie- any politician running for office in America right now) and pointing fingers at the mortgage industry, have in the past supported and lauded policies that put us all in this situation to begin with.

Personally, I think that industry over-regulation will likely have the opposite effect than that which is intended. Over regulation will only prolong the downturn.

Regulations that I CAN support are things like: increased initial and continuing education requirements for Mortgage Loan officers, and making the barrier for entry higher with a more rigorous certification process.

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What is also happening is that Loan to Value ratios or “LTV’s” are becoming more restricted as well. Where there used to be a fairly wide variety of 100% LTV programs available (100% Loan to value = the loan is equal to 100% of the purchase price) they have been steadily shrinking in 2008. Most of the remaining zero down loan programs were made available by virtue of the Mortgage Insurance industry. A mortgage Bank would be happy to lend 100% of the value of the property if the borrower funded an insurance policy that protected the bank in the event of a default.

For instance, someone borrows $200,000.00 to purchase a $200,000.00 property and then loses his job and has to go into default/foreclosure. The mortgage insurance company would pay out 20-30% of the loss, and the Mortgage Bank would only have to recover the difference. So from their perspective zero down with mortgage insurance is not that different than a purchase with a 20% down payment. The Portland real estate market has seen this to a point, but not nearly as much as other parts of the country.

As we are seeing most markets in the nation decline in value, the Mortgage Insurance companies will no longer insure a zero down purchase. Their attitude is: “why would we allow someone to borrow $200,000.00 to buy a $200,000.00 house, when there is a possibility that the house will be worth $195,000.00 in the near future?”

The result of this is that the Mortgage banks will only lend to the maximum amount that an insurance company will insure. And folks… that new magic number is 97.

So the maximum insurable LTV is now 97…. The new Minimum down payment is 3%. Heck, even the Oregon Bond loan which used to dispense a 3% cash grant to cover your down payment has been temporarily suspended. (the other OR Bond program “rate advantage” is still available however… but it will require a 3% down payment).

So this is simply our new reality. 3% is the new 0%. I believe, that until we see national appreciation trends move up again for a sustained period of time, this 3% minimum is here to stay.

I have been researching a new loan program that is a 97% loan with mortgage insurance that will allow for a Grant loan from a National non profit to pay for the down payment, and closing costs. It seems to be the last remaining zero down loan available, we’ll see how long it lasts.

Note: These are the views of the author and does not necessarily reflect the views of the Portland Real Estate Cafe and Keller Williams Realty Professionals.

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