David H. Stevens

The assistant secretary for housing and commissioner of the FHA said housing financing brought the country’s economy to its knees. “No parents were watching the kids,” he said.

Stevens said too many people looked at buying homes as a way to make millions. “That’s what was wrong. Owning a home was no longer about shelter; it became an investment. Mortgage programs started that weren’t sustainable,” he explained. 

He said the administration has saved what could have been a larger crisis and the FHA has played a role in helping the recovery.

“FHA was boring with 30-year, fixed-rate loans,” he said. FHA has more than doubled the number of mortgages given in the last three years and is now 30 percent of the housing market’s mortgages. In 2007, FHA issued 400,000 loans and last year, two million were issued.

Stevens said changes have been made to achieve mortgage sustainability. Changes include:

• A required 3.5-percent down payment
• Minimum FICO scores of 580, with larger down payments. Studies show that default rates are too high when applicants have a credit score less than 580
• Upfront mortgage insurance requirements.

“There’s a lot of work to do but the amount of investment in the housing recovery by this administration is unheralded,” he added. He said the FHA will work to create an environment of responsibility, integrity, trust and ultimately bring back private investments.

You know you are in a different time and place when:

1. House prices are lower this year than last year and last year’s prices were lower than the previous year’s prices.

2. There’s a continuing danger that the equity in many homeowners’ properties is at risk, especially the down payment for recent purchasers. In today’s real estate market, down payments evaporate if prices fall.

3. Despite recoveries over the past seven months in terms of prices, sales and reduced numbers of foreclosures, markets are still weak. The Wall Street Journal reported that new home sales dropped another 11 percent in January 2010 (after a December 2009 decline of 7.6 percent) to a seasonally adjusted rate of 309,000. This is the lowest level of new home sales since record-keeping began in 1963!

4. Interest rates are at historic lows yet consumers are not buying most things, including houses.

5. Tax shelter is increasingly being viewed as a bad thing in the housing market (since it results in higher asking prices today). Brokers may promote it as an advantage to homeownership but buyers, especially first-time buyers, would rather not have to pay the premium built into the settlement price.

6. Sub-prime loans, Alt-A mortgages and Option ARMs were heralded as favorable innovations by industry and consumers alike; soon afterward, they became dreadful memories.

7. Defaults and foreclosures have become everyday terms around America’s water coolers. Once a fraction of one percent, now these are everyday problems.

8. It’s good news when the number of borrowers in arrears increases but at a decreasing rate.

9. Mortgage modifications currently total over 116,000 but four million borrowers seek help.

10. The federal government has announced a new program to bail out borrowers in states with large price declines and high rates of unemployment — but even before it’s implemented, government officials are lowering expectations. As important as $1.5 billion will be to those five states (California, Arizona, Nevada, Florida, and Michigan), it’s not going to solve what is a catastrophically large problem.

11. “Strategic defaults” are beginning to be questioned as immoral financial decisions.

12. Even the market for jumbo loans is very tight. A recent report indicated that a borrower with $8 million in assets could not refinance his home mortgage.

13. “More affordable” is about the best thing you can say about the current housing market.

14. Rents are falling and are expected to continue to decline.

15. In terms of legal issues, the authority of eminent domain is a significant government threat rather than the major constitutional protection of private property in the U.S.

16. Commercial real estate defaults are likely to be the next shoe to drop. One report indicates as much as $1.4 trillion in commercial mortgages will require refinancing over the next four years. Expect $200-$300 billion of defaults threatening as many as 3,000 banks.

17. While the housing market is on a “path to recovery,” no one believes there will be significant appreciation, revived sales activities or shortages of inventories for a very long time.

They found that 213 of the 299 cities selected for the study were over-valued. Number one on the over-valued list was Naples, FL, with a whopping 84 percent of its housing stock selling for more than what was thought to be the “correct” price or fair value. The 2010 follow-up study found that housing in Naples now sells at a 29-percent discount to fair value. Median prices fell from more than $390,000 to about $165,500.

By 2010, only 87 of 330 cities studied were over-valued. The most under-valued market in the 2010 study was Las Vegas at 41 percent below fair value, followed by Vero Beach, FL, down almost 40 percent; Merced, CA, down nearly 38 percent; and Cape Coral, FL, down almost 37 percent.

How do Pennsylvania cities compare? Here are the numbers:

All Pennsylvania cities show evidence of relative price declines from their fair value estimates from 2006 to 2010, except Harrisburg, which extended its over-valuation, and Scranton, which is about the same.

The primary implication of these numbers is that the median prices in the overvalued cities may decline further while the undervalued set (except Pittsburgh) overshot their fair values during the recent years’ declines. The Steel City was slightly undervalued in 2006 and is even more so now.

It is important to note that it is quite possible for over- or under-valuations to persist for some time. Economics and other forces exert pressure on prices to “revert to the mean” but this process may take several months — or even years.

The conclusion of the report observed that for a few years, the average buyer “should forget about home purchases as investments.” But homebuyers, especially in under-valued markets, can expect long-term appreciation as prices approach fair values.

In the real world of real estate, with unique assets, various local market conditions, changing demographics and uncertainty about the future, property values are unknown. Values remain unobservable, so as before, we rely upon prices. This time, prices are not the same as values: price is merely an estimate of value.

This distinction is important but is often overlooked. Prices are used by market participants as indications of value because true values cannot be observed. Often supply and demand conditions in real estate markets change, sometimes quickly. In these cases, prices can diverge from values upwardly or downwardly, depending on the direction of the change.

For example, suppose housing prices are found to be rising faster than household income for an extended period. We know from experience that there is a relatively constant relation between house prices and household incomes. Yet, we sometimes see prices changing compared to incomes (e.g., consider most housing markets from the mid-1990s until about 2006). We cannot explain the rise in prices relative to incomes, yet it has occurred. Values are determined by the underlying long-term and complicated relationships set out in the past. In this case, prices diverge from values.

The debate over “prices” and “values” is a very old and famous one in economics, perhaps 250 years in the making. In the short run, it is quite possible to find prices higher or lower than values due to unusual events or rapid changes in market conditions. In the long run, price equals value due to market forces.

We make decisions in the short run. Therefore, it is possible that prices will exceed values (this is typically called “over-valuation”) or prices may be less than values (this is called “under-valuation”). If there were no differences between value and price, under- and over-valuation would have no meaning.

Researchers and analysts study markets in attempting to identify situations where there is over- or under-valuations. We can observe prices (as reported by MLS offices from actual transactions) but we cannot observe values. The latter must be estimated in careful studies by statistical analysis.

Are PA housing markets over-valued or under-valued?  A major study of this precise question has just been completed and will be the subject of my next blog.

Dr. Elliot Eisenberg

Pennsylvania needs to rethink its “anti-growth” mentality in order to become more fiscally sound, according to Dr. Elliot Eisenberg, senior economist of the National Association of Home Builders (NAHB).

“In order to attract business into Pennsylvania, it needs to be home-builder friendly or it will continue to lose out to other states. Other states look more attractive to businesses and residents,” Eisenberg noted. “The state needs to rethink what it’s going to do moving forward. ‘No-growth’ is a recipe for a bad situation,” he said.

He suggested that local planning and zoning boards, as well as local municipalities, look at density incentives and still preserve farmlands. “Denying growth reduces affordability and results in higher taxes,” he added. “Essentially we need to work together to allow housing growth, yet preserving agriculture and the small villages for which Pennsylvania is known.”

Eisenberg conducted a survey of home building in the Dauphin County area and found its new homes to be priced “well-over the national average” and property taxes to be “nearly double” that of the national average.

His economic impact study was presented Wednesday evening to the Home Builders Association of Metropolitan Harrisburg, along with area legislators. The study concludes that a representative group of 100 single-family and 67 multi-family homes built in Lower Paxton Township in 2008 will generate a cumulative $29.2 million in revenue over a 15-year period, more than offsetting $13.8 million in costs.

Eisenberg’s study showed that builders in the Harrisburg area employed approximately 2,160 in 2008, making the industry the eighth-largest employer in the area.

“The results show that home building is more than paying its own way and should put to rest any notion that existing homeowners are subsidizing new home construction in this area,” Eisenberg said. “This result tells me that local residents should be thanking the building industry for footing the bill for a lot of municipal services.”

Austin Jaffe, Ph.D.

PAR’s consulting economist Dr. Austin Jaffe says the economy and the unemployment rate need to rebound in order for the real estate market to get stronger.  Jaffe says when prices stop declining it will be a bright spot for the industry. “That will be a signal to the rest of the market that buying homes and investing in housing as a consumer good will be less risky,” he added.

Duration: 2:23

Most economists agree that about 25 percent of all homeowners in the U.S. have negative equity in their homes. In fact, some reports claim the percentage is as high as 33 percent; others show it at 21 percent.  The loss in residential property values nationwide is estimated at about $500 billion for 2009 and at about $5 trillion since the 2006 peak. No wonder one of every four borrowers owe more than their properties are worth, especially given the low down payments used in many markets prior to the collapse.

Negative equity is proving to be a key indicator of trouble for housing markets, if not the most critical element of the housing crisis. Here’s why:

• Research shows that having negative equity is a very strong predictor of a forthcoming default
• Often, the default and subsequent foreclosure are “strategic” (i.e., the homeowner chooses to walk away)
• Foreclosures continue, providing additional downward pressure on prices and increasing the number of  households with negative equity
• Even if mortgage rates remain low (although most observers expect them to begin to rise in the months ahead), negative equity will prevent owners from treating the house as a valuable asset. Refinancing is generally out of the question.

Pennsylvania residents may be somewhat reassured that our state’s experiences with negative equity are much less than in the five hardest hit states: in Nevada, 65 percent of mortgages are underwater; in Arizona, 48 percent; in Florida, 45 percent; in Michigan, 37 percent; and in California, 35 percent. Many of the borrowers in these states made their situations worse by using option ARMs with negative amortization provisions, thereby increasing their mortgage balances over time.

We are not out of the woods yet. Until prices reach a solid bottom and cases of negative equity subside, the housing crisis will continue. It turns out that falling property prices over an extended period is perhaps the most devastating element in the residential housing market.

The general rule at least is, that while property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.

Then, for about 65 years, there was virtual silence about property rights until the late 1980s and early 1990s. Cases such as Nollan v. California Coastal Commission (1987), Lucas v. South Carolina Coastal Council (1992), Dolan v. City of Tigard (1994) defined what became known as “regulatory takings.” More importantly, they limited the scope of authority of the state as to what constituted a taking.

Citizens are traditionally compensated for takings by the “just compensation” clause in the Fifth Amendment of the U.S. Constitution. Regulations are not takings; their authority stems from police power originally stated in enabling legislation in the 1920s. Sometimes, however, as in the Michigan Poletown (1981) case, the debate shifted as to what constitutes “public use.”

Skip ahead to 2005.  The case of Kelo v. New London changed the debate once again. In a stunning 5-4 decision, the U.S. Supreme Court upheld the state court’s decision to permit the New London Development Corp., a private organization, to condemn Susette Kelo’s and six other families’ homes for the express purpose of “economic development.” You see, Pfizer, the pharmaceutical firm, wanted to expand its presence in Connecticut and build a $270 million global research facility. The controversy was that prior to this case, the power to take property was the exclusive right of the public and forbidden from usage by private firms.

Forget about the fact that Pfizer also negotiated an 80-percent reduction in property taxes for ten years on its existing facility. It also does not matter that in late 2009, Pfizer decided not to build the new facility after all and announced the company was moving out of New London. The important issue is: What does private property mean when one private party can use the state’s eminent domain authority to take another private citizen’s property?

The outcry by most state legislatures was loud, immediate and extensive. Forty-three states have since passed laws limiting or outlawing the use of eminent domain by private parties for economic development.  Seven states, including New York, New Jersey and Florida, however, continue to permit this practice. 

In September 2005, PAR’s Board of Directors issued the following Policy Statement in support of private property:

The Pennsylvania Association of REALTORS® recognizes that there are times when government may need to take private property for public use. Building hospitals, municipal buildings or public utilities exemplify these needs. PAR believes that government’s use of the eminent domain power should be limited and closely monitored. As the vanguard for the real estate industry in Pennsylvania, PAR will work diligently to protect an individual’s right to own and maintain property, and to appropriately limit the government’s reach and ability to take that property.

Laws were passed in Harrisburg in May 2006: Senate Bill 881 (“Property Rights Protection Act”) prohibited the use of eminent domain for “private enterprise” and narrowed the definition of “blight.” (House Bill 2054 amended the PA Eminent Domain Code with limitations.) The record shows that while the Senate bill was approved unanimously, it is limited by some exceptions for large cities. One review by a property rights citizens group in 2007 graded Pennsylvania only a B- in terms of its reaction to Kelo.

There is a new property rights case in the U.S. Supreme Court this session. Stop the Beach Renourishment v. Florida Department of Environmental Protection is a dispute between homeowners with beach-front property and the government. It seems after the renourishment program (i.e., replenishing sand on the beach due to erosion), the State of Florida now claims it owns the area between the waterfront property and the ocean. In a 5-2 decision, the Florida Supreme Court ruled for the state in its quest to protect natural resources and promote recreation areas.

The Wall Street Journal reported that in oral arguments, newly appointed Justice Sonia Sotomayer said, referring to the property owners, “None of your actual use rights, pleasure rights, or anything else has been changed.” But the more conservative justices are likely to see the issue differently.  Justice Samuel Alito is quoted as saying “Suppose that a city … wanted to attract more students who were going to the beach in Florida for spring break, and so therefore it decided to create a huge beach in front of privately owned homes.  You could have televised spring-break beach parties in front of somebody’s house.”

Watch for Justice Anthony Kennedy to be the key vote (although Justice Stevens has recused himself as a Florida property owner). If Kennedy joins the liberal wing, the lower-court ruling will stand. If he joins the conservatives, it will be a small but important victory in the post-Kelo environment.

PAR’s consulting economist Dr. Austin Jaffe says price stability and reduced foreclosures are contributing factors needed to stabilize the economy. Jaffe says it’s time to get back to basics. Although home prices won’t increase, they will stabilize in time. Jaffe believes we will be heading toward a time of low rates of appreciation and moderate borrowing, “View housing as a place to live instead of a place to trade up to,” Jaffe said. “That may be the concept of the housing market in the next decade.”

Duration: 2:58

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Perhaps the last major “consumer innovation” of this era was the Option ARM. Option ARMs were used from 2004 until 2007 with five-year resets (or less) to higher interest rates with standard amortization schedules. Thus, many have come into play during 2009 and we will see many more in the months ahead.

In November 2009, Standard and Poor’s completed a study of Option ARMs. Let’s look at the details, as reported by cnnmoney:

1. Option ARMs were intended for borrowers who expected to flip their transactions or refinance their purchases as property appreciated but long before the mortgage rate reset kicked in, often five years after origination.

2. Like other ARMs, these instruments began with so-called “teaser rates,” although some were not as low as might have been expected. They were all lower than what the resets would be in the future.

3. The Option: the rules required borrowers to pay something each month: either the normal principal and interest, interest-only or something less than the interest owed for the period. S&P found, perhaps not surprisingly, that 93 percent of the borrowers chose the last option!

S&P reports that nearly all of the 350,000 Option ARM borrowers now owe more than the original balance on their loans due to negative amortization (the adding of unpaid interest to the original loan balance). Not surprisingly, default rates are sky-high at 25 percent and evidence exists that the newer the loan, the more likely the default. (Those issued in 2007 tend to default after only 20 months.)

Where are these loans? Yes, in California, Nevada, Florida and Arizona, where prices have fallen the most. Borrowers are overwhelmingly underwater in these markets to begin with and are now facing severe resets (frequently over a 100-percent increase in monthly payments), no opportunities to refinance and no chance to qualify for loan modifications. Can you say default?

As if this weren’t bad enough, 80 percent of the mortgages were liar loans (where applicants reported unsubstantiated incomes at often grossly exaggerated levels in order to borrow more money than they could manage). Now, after the party, it is hopeless to expect these borrowers to be able to service their loans.

Epilogue: There are many possible villains in this regrettable story and fingers have been pointed at everyone and at each other. To be sure, borrowers were caught up in the fury, if by no other evidence: they surely knew they could not repay 100 percent or more of their monthly pay after a reset.

This sad tale will continue to unwind into 2012.