Previously, I have posted articles regarding housing and foreclosure issues. The purpose was to begin a dialogue on the steps to be taken to alleviate the foreclosure crisis, and to promote housing recovery.   Now, we need to explore how to restart lending in the private sector.  This will be a three part article, with parts I and II herein, and III in the next post.

To begin, we must understand how we got to the point of where we are today, and whereby housing became so critical a factor in the economy. (This is only an overview. I leave it to the historians to fill in all the details.)

Part One – Agreeing On The Problems

Historical Backdrop

At the beginning of the 20th century, the U.S. population stood about 76,000,000 people. By the end of 2000, the population was over 310 million. The unprecedented growth in population resulted in the housing industry and related services becoming one of several major engines of wealth creation during the 20^th century.

During the Depression, large numbers of farm and home foreclosures were occurring. The government began to get involved in housing to stop foreclosures and stimulate housing growth. This resulted in the creation of an FHA/Fannie Mae- like program, to support housing.

WWII led to major structural changes in the U.S., both economically and culturally. Manufacturing and technological changes spurred economic growth. Women entered the work force in huge numbers. Returning veterans came back from the war desiring to leave the rural areas, begin families, and enter the civilian workforce. The result was the baby boom generation and its coming influence.

From the 1950s through the 1970s, the US dominated the world economically. Real income growth was occurring for all households. Homeownership was obtainable for ever increasing numbers of people. Consumerism was rampant.

To support homeownership, the government created Fannie Mae and Freddie Mac so that more people could partake in the American Dream. These entities would eventually become the primary source of mortgages in the U.S. F&F changed the way mortgages were funded, and changed the terms of mortgages, so that 30 year mortgages became the common type of loan, instead of 5 to 15 year mortgages.

Storm clouds were beginning to appear on the horizon at the same time. Japan, Korea, Germany, and other countries had now come out of their post war depressions. Manufacturing and industrial bases had been rebuilt. These countries now posed an economic threat to the U.S. by offering improved products, cheaper labor costs, and innovation. By the end of the 1970s, for many reasons, US manufacturing was decreasing, and service related industries were gaining importance.

In the 1980s and 1990s, manufacturing began to decline in the U.S. Service Industries were now becoming a major force in the economy. With the end of the Cold War in 1989, defense spending began to decline dramatically, further depressing the economy.

In the early 1990s, F&F engaged in efforts to increase their share of the mortgage market. They freely admitted wanting to control the housing market, and took steps to do so, undermining lenders and competition, and any attempts to regulate them.

In 1994, homeownership rates were at 64% in the US. President Clinton, along with Congress and in conjunction with Fannie and Freddie, came out with a new program with the intent to promote a 70% homeownership rate. This program was promoted even though economists generally considered 64% to be the maximum amount of homeownership that an economy could readily support. Above 64%, people would be “buying” homes, but without having the financial capabilities to repay a loan. The program focused upon low income persons and minorities. The result was greater demand for housing and homeownership, and housing values began to increase.

Lenders and Wall Street were being pushed out of the housing market by F&F, and had to find new markets to serve. F&F did not want to service the new markets being created by the government homeownership programs. The result was that Wall Street would naturally gravitate to that market, which was generally subprime, and also to the jumbo market, which F&F could not serve due to loan amount restrictions. This was the true beginning of securitized loan products.

The events of 9/11 would ultimately stoke the fires of home ownership even further. 9/11 occurred as the US was coming out of a significant recession, and to keep the country from sliding back into recession, the Fed lowered interest rates and kept them artificially low until 2003. Wall Street, recognizing the promise of good financial returns from securitized loans, freed up more and more capital for banks and mortgage bankers to lend. This led to even greater demand for homes and mortgages.

To meet the increased demand, home construction exploded. Ancillary services did well also, from infrastructure, schools, hospitals, roads, building materials, and home decor. The economy was booming, even though this was “mal-investment” of resources. (Currently, as a result of this activity, there are estimated to be from 2m to 3.5m in excess housing units, with approximately 400k being added yearly to housing stock.)

It did not stop there. Buyers, in their increasing zeal, were bidding for homes, increasing the price of homes in many states by 50 to 100,000 dollars more than what was reasonable. The perception was that if they did not buy now, then they could never buy. Additionally, investors began to purchase multiple properties, hoping to create a home rental empire. This led to unsustainable home values.

Concurrently, the Fed was still engaged in a loose money policy. This pumped hundreds of billions of dollars into the housing economy, with predictable results. With increasing home values, homeowners could refinance their homes, often multiple times over, pulling cash out and keeping the economy pumped up artificially. A homeowner could pull out 50,000 to 100,000 dollars or more, often every year or two, and use that money to indulge themselves, pretending they had a higher standard of living than what existed. The government knew that this was not a reasonable practice, but indulged in it anyway, so as to keep up an appearance of a healthy economy. Of course, this only compounded the problem.

The end result of the past 40 years of government intervention (and popular support for that intervention) has been a housing market that is currently overbuilt and still overvalued. In the meantime, real wages have not increased since the mid 1990s and for large numbers of the population, negative income growth has been experienced. Today, all segments of the population, homeowners especially so, are saddled with significant mortgage debt, consumer debt, and revolving credit debt. This has led to an inability on the part of the population to buy homes or other products. Until wage and debt issues are resolved, employment increases, and housing prices have returned to more reasonable values, there can be no housing recovery.

Current Status

As all know, the current status of housing in the US is like a ship dead in the water, with no ability to steer except to roll with the waves. A recap:

Private securitization once accounted for over 25% of all mortgage loans. These efforts are currently nonexistent except for one entity, Redwood Trust, which has issued one securitized offerings in 2010 and one in 2011. Other than this, Wall Street is afraid to invest in Mortgage Products (to say nothing of downstream investors).

Banks are unable to lend their own money, which represented up to 15% of all lending. Most banks are capital impaired and have liquidity issues, as well as unknown liabilities from bad loans dating to the bubble.

Additionally, banks are suffering from a lack of qualified borrowers. Either there is no equity in the home to lend on, or the borrowers don’t have the financial ability to afford the loan. Therefore, the only lending that a bank can engage in is to execute loans and sell them to Fannie Mae, Freddie Mac, or VA and FHA. There are simply no other options available.

F&F are buying loans from the banks, but their lending standards have increased, so the loan purchases are down. F&F still distort the market because of government guarantees on their loans (now explicit instead of implicit), and they are still able to purchase loans above $700k, which was implemented in response to the housing crisis.

F&F are still having financial issues, with the government having bailed them out to the tune of $140b, with much more to come.

VA is buying loans and doing reasonably well, but they serve a tiny portion of the market.

FHA has turned into the new subprime, accepting credit challenged borrowers, and with loan to values of 95% or greater. Default rates on FHA loans are rising significantly, and will pose issues for the government when losses absorb all FHA loss reserves, which may have already happened (depending on how you look at the accounting).

The Mortgage Insurance companies are financially depressed, with PMI being forced to stop writing new policies due to loan loss reserves being depleted. Likely, they will cease business or be absorbed by another company. Other companies are believed to be similarly in trouble, though none have failed yet.

The US population is still overburdened with debt. It is believed that the household consumer debt burden is over 11%, for disposable income. This is far too high for effective purchasing of any products, especially high end. (There has been a lessening of this debt from its high of 14% in 2008, but this has primarily been the result of defaults, so most of those persons are not in a position to buy.)

Credit has been destroyed for a large part of the population. Until such credit restoration can occur, there can be no assistance from this sector for housing recovery.

Employment conditions have worsened. With 16% of the labor force either unemployed, underemployed, or having given up on work, a significant number of potential home buyers have been lost to homeownership. They cannot return to the housing market without employment, a two year current work history, and restoration of credit.

The Baby Boomer generation is retiring. With 78m births during the period, these people are beginning to pass into retirement and will do so in record numbers. They will not be driving homebuying.

Home values are still overpriced on a general basis, especially in regard to homeowner affordability. Values are predicted to fall further, 17% more if Case-Shiller is to be believed. However, Case-Shiller appears to only look at the short term, and is ignoring many relevant factors that I presented in a previous article. To achieve true affordability, home values must drop another 30-50% in some areas.

What can be done to resolve these issues? It is time to take a look at possible solutions in many areas, and to develop effective plans to deal with the problems facing us. Much of what I propose will be controversial, but does need to be considered. Some proposals will be long term, and some will need government support, but all must be considered. Hopefully, readers will have other ideas to present for evaluation. Maybe, with more input, we can come to a reasonable consensus on what to do.

Part Two – Proposed Solutions For The Economy

As discussed, above many of the problems holding the housing market back have to do with the broader economic backdrop, before housing. We look at those first, and what is needed to solve each of them.

Consumer Debt Burden

The first issue to address is the consumer being overloaded with debt. Burdensome debt not only prevents homeownership, but also an ability to buy consumer goods for economic growth. Fortunately, this part of the equation offers solutions, though it may take years to properly accomplish.

To resolve the issues of the debt challenged consumer, a full and comprehensive review of their financial situation is undertaken and issues identified. A plan of action is developed to resolve the debt issues. It may include a Chapter 7 or Chapter 11 bankruptcy in some cases, or for others it may involve simply debt resolution services. The purpose is to reduce the amount of revolving credit card debt to a manageable level which can be paid off in a reasonable time. Otherwise Chapter 7 bankruptcy is considered with the purpose of eliminating all that debt.

Second mortgages should be looked at for consideration of either liens stripping, or paying off if certain assets are available to utilize such as 401 K’s. Seconds can be negotiated down, especially if foreclosure is likely, and which would ensure complete loss on the second mortgage.

Finally, any loan modification on a first mortgage should be reviewed and terms determined they would benefit both borrower and lender, and in accordance with what can be accomplished on the second mortgage or revolving debt and, incorporated into part of the trial mod offer. This would go a significant way towards reducing the homeowner’s debt and decreasing any likelihood of default.

For the non homeowner, the credit card debt will be easier resolve steps can be taken to eliminate it as above and a sense of financial responsibility restored to the consumer.

Now, being blunt, fiscal responsibility is not the forte of many Americans. It would be highly recommended that any person pursuing this type of program also be subjected to classes promoting financial responsibility, and learning how to live within their means.

This steps that I have outlined could be utilized for homeowners, non-homeowners, the unemployed who have recently returned to work and others who fit certain scenarios.

Credit Restoration

After a person has gone through the debt resolution process, the next step is to engage in a credit restoration program. Strategies should be developed and executed that will lead to the establishment of credit once again and a good credit rating. Yes, it will take 3 to 4 years to restore credit, but the importance is that the person has been placed into a secure financial position. Anyway, since purchasing a home should not be considered for 3 to 4 years minimum due to current market conditions, the timeline to restore credit would not pose an issue.

Increasing the Pool of Buyers and Off-Setting Baby Boomer Exits

Increasing the pool of home buyers is an issue that must be considered, but will be very controversial for emotional reasons.

As mentioned previously, the baby boom generation accounted for 78,000,000 births. As the generation passes, there will be a profound impact because new births will not keep up with the upcoming retirements (along with the concomitant “down-sizing”) and even deaths. As a result, the housing surplus will once again begin to grow. (It is estimated that housing stock is from 2m to 3.5m overbuilt.)

There is only going to be one way to increase the pool of buyers in both the short and long term. That, as has been proposed by others, is through immigration policy. The policy must allow for people to immigrate to the U.S., so that this pool can increase.

The reality is that the U.S. population is a mature market. The American consumers have their toys, and outside of nondurable goods such as food and clothing, and the random electronic purchase, they do not purchase large numbers of other goods. Furthermore, due to debt constraints and the issues of unemployment, they haven’t the funds to purchase on a discretionary basis.

Establishment of an immigration policy that would allow both professionals and nonprofessionals to enter the country legally, and to contribute to society in a productive and effective manner would greatly change the economic conditions of the U.S.. Remember, new immigrants by cars, rent or buy homes, need food and clothing, other essential goods and consumer services. This would stimulate the economy and allow for more growth. Furthermore, it adds a talented pool of workers to a diminished workforce.

Many people will complain about this proposition, but, let’s be realistic. These are the principals that the U.S. was founded upon. An immigrant would come to this country with hopes of freedom, making their mark in the new world, establishing a new and secure life, raising a family, and other motivations and ambitions. We see this occurring today with the Asian and West African immigrants. They come to the country and they make good. Other groups do so as well. Isn’t it time that we took advantage of this opportunity like we did for the Italians, the Irish, and other ethnic groups in the 1800s and 1900s?

Doing this would certainly increase population and begin to offset the shrinking of demand that will be occurring from the aging of the baby boomer generation and help offset the coming surplus of homes. Furthermore it would increase gross domestic product and lead to a strengthening of the economy. But, to accomplish this goal, jobs must once again be available.

Returning People to Work

The next action that must be considered is the unemployment situation in the U.S. Using unemployment calculations procedures that were done 30 years ago, the unemployment rate in the U.S. would be close to 20%. (The government has changed how it determines unemployment so as to produce a better picture than what actually exists. That is why we see unemployment at 9.2% according to the government, yet the situation feels much worse.)

It has to be realized that the government has no ability to stimulate hiring. Programs such as “shovel-ready projects” that don’t exist do not stimulate the economy, as has been shown by this latest round of stimulus. All the programs do is to secure votes for parties to remain in power.

After WWII, the Marshall plan was instituted to assist European recovery from the war. The first round was a dismal failure because, like with the stimulus here in the U.S., the money was provided to governments to try and stimulate the economy, where it went down a “rate hole.” When it was recognized that the plan was a failure, the second round of money went directly to businesses and business owners, the people who had to make the real-world decisions regarding what was needed for their own businesses. This led to a rapid recovery of the European continent.

Today, if we want to restore the economy and promote hiring, it is time to return to the principles of the Marshall plan. Money to promote such hiring and capital improvements need to go directly to businesses and the people who make the decisions. Tax breaks should be offered, the corporate tax rate reduced to 20% or 15% from the 35% that it currently is. It’s time to stimulate the economy by doing things that work, instead of doing things that just buy votes.

New startup companies add to job creation. Today, from the very start-up of a new business, the first year has the owner worrying about putting food on the table and paying employees. The second year, the worry is about putting food on the table, paying employees, and how to pay taxes from the previous year. The third year, if he stays in business, his worries remain the same, but an additional worry is how to reduce tax payments.

It’s time that we consider giving new businesses tax breaks so that they can develop and grow and mature. Let’s give them a chance to survive, to grow, to hire people, and to be successful. Let’s not burden them with unnecessary regulations and taxes that strangle the company before it can succeed.

Finally, it is time to get a handle on government growth in all areas, state, Federal and county. Quit playing games with “budget cuts”. What people don’t realize is that even with the “discretionary spending cuts” imposed by the latest round of debt reduction talks, the budget has not been reduced, but has actually increased.

Every year, discretionary and non discretionary budgets have built in increases from 5% to 8% or more. The government proclaims that budget cuts have occurred, but any “cut” is only to the rate that the budget would otherwise increase. They have simply decreased the amount that they were going to increase. If you or I did that, we would be bankrupt. It is time to put an end to the sham.

What I propose is that we allow discretionary and nondiscretionary budgets to grow at 2% per year and no more. New additional spending programs would require at least a 75% vote in order to establish the program. Programs to fund other spending such as wars would require the same 75%.

Next, we do what is necessary to stimulate the economy by reducing the burdens on business and individual taxpayers. Allow businesses to be successful so that they can grow, make profit, and pay taxes. Improve Gross Domestic Product to a 5% increase annually, and in 7 – 10 years, the budget would be in balance. This is realistic, if we have the will to do what is necessary.

Entitlement programs like Social Security and Medicare must be means tested, and in the case of Social Security, a program developed that would allow for workers to opt out and develop their own retirement strategies. Otherwise, Social Security will strangle the country. (Many will proclaim that Social Security will go broke and there will be no means to pay retirees, but each year’s Social Security payments are factored into the budget, so the above restructuring of the budget would not pose an issue. And, eventually, Social Security in its current form would wither and die, due to this privatization – a happy outcome for a program that was never actuarially sound.)

Too large of a number of employees working for state, Federal, and county governments are nothing but “paper-pushers” and/or are in “make work” jobs. The government has engaged in a giant “make work” program to offer non-productive employment that does nothing but impose additional burdens of regulation on the population and on business. It is time to end this practice. Government is not in the business to “create employment” for people out of work. Nor is it in the business of controlling people and business by regulation.

To be continued in Part III, “Proposed Solutions For The Housing Market“.