We just toured a short sale property. It was an older wood-frame structure that looked out at the majestic mountains albeit over the noisy freeway. The acreage was neglected with dying trees and dirt where lawn had been. As we walked up the steep steps to the entry of the "A-Frame" home we wondered about the family that had lived there. The expensive front door with inset etched glass opened onto a small entryway with a tile medallion on the travertine floor. The kitchen had been remodeled, quite clearly by the hobbyist homeowner himself. It was designed for an ample family and guests as evidenced by counter seating adjacent to the freestanding fireplace that shared the window wall leading to the pool. As we continued through the home we saw electrical wiring and electronic cables dangling from every room that must have belonged to large TV and audio equipment.
This house had been owned by a family who used their home equity for amenities on the promise that real estate would always appreciate and there would be no risk. Traditionally they would not have qualified for the loans they obtained. Their family income was modest, earned from his landscape service and her job as a seamstress. They had 4 teenage children who enjoyed the new vanishing edge pool with friends and family. They had several TVs, including one in each bedroom. The family car was an SUV and they had a new truck for the landscape business. They also had a motor home for family vacations. But all that they purchased to make the family happy did not buy the money needed when their loan reset and their payment increased. It wasn't supposed to be this way.
The story above is a composite, based upon real people, that focuses on lower income families, which were disproportionately affected by the downturn. But the same things happened to middle income families that wanted more in their lives. We all forgot that "needs" are not the same as "wants." We forgot that our homes are shelters where we can feel secure and imprint our own personalities. Instead, our homes became ATM machines.
How did this happen? Until loan regulations were eased (if not totally eliminated), affordability meant that no more that 28% of gross income should be spent on housing expense, and that total debt including housing could not exceed 36%. Other than for government lending programs (VA and FHA), the borrower needed equity in the form of a downpayment. They needed "some skin in the game"--not to mention being credit worthy.
Over the last three decades, wealth disparity widened. In 2001 those in the top 20% of the population had 86% of national net worth. In fact, the bottom 40% had an average net worth of only $2,900. We all know that one of the cornerstones of net worth is real estate ownership. So efforts were made to find ways to increase affordability. Public policy developed, which dictated that lenders increase methods to get more people into homes (especially low-income families). First, loan approval rules were loosened and gifting and non-occupant qualifiers became acceptable. Creditworthiness and income verification gave way to "stated income" loans - often called "liar loans." Then, finally, new loan products were created. It was clear to everyone that some of these loans were risky, so a new secondary market was developed where risky loans were packaged with less-risky loans, theoretically reducing risk.
With so many borrowers eligible through the relaxed standards and new loan products such as the option ARM, hybrid, and negative amortization loans, prices of homes skyrocketed. Demand far exceeded supply. A frenzy set in--"buy now or you will be forever excluded from home-ownership."
By the Spring of 2005 when the first of the loans started to reset, housing prices outstripped income levels and borrowers began to default. At first it was the sub-prime borrowers whose income levels could not sustain even initial low interest-rate loans. The problem was exacerbated by negative amortization causing the principal balance to increase. Over the next 3 years, re-setting loans left a trail of foreclosures that affected whole neighborhoods. Lending institutions were left with non-performing assets, and even the short-sale process did not proceed soon enough or fast enough. A liquidity crisis developed and lenders froze credit. Some have said that this was the beginning of the fall of the "financial ponzi scheme."
The housing bubble was pricked on several sides. Individuals were hurt, including sub-prime borrowers and equity-line borrowers; and, the whole housing industry suffered lost employment--from contractors to lenders, title companies and other related businesses, including Home Depots. Even the homeowner who continued to make payments on a home that was dropping in value was injured by the surrounding market.
Public policy today is being evaluated to establish new regulatory guidelines. It is being coordinated with stimulus funds for troubled homeowners and to help lenders with liquidity problems in order to free-up credit.
How do we as individuals make the changes and sacrifices to overcome the economic crisis? U.S. Secretary of Defense Robert M. Gates, in presenting the 2009 Defense budget, said that we should "separate appetites from real requirements." Consumers too should rethink the difference between wants and needs. We will get past the current crisis but the behavior of consumers will surely change. At the recent G20 meeting, President Obama told the world that it could no longer depend on America to be a "voracious consumer market."
We have all learned a painful lesson--happiness can't buy money.
Carmen and Lloyd Multhauf are the founding developers of the Generational Housing Specialist™ Council, a national real estate designation that focuses on the unique impacts made by different generations in establishing housing trends, financial products, negotiating skills and reaching a successful closing.