Real Estate
Mission Accomplished
By Dan Smith

Mission Accomplished

“In my many years, I have come to the conclusion that one useless man is a shame, two is a law firm, and three or more is a congress.” –John Adams (2^nd U.S. president)

Well, I think that adequately sums up yet another month of financial news, don’t you? Let’s review a couple of the more mind-boggling and egregious acts for fun.

We’ll start this month with the Administration’s circumvention of Article 1, Section 10, Clause 1 of the U.S. Constitution which is intended to prevent government from “… impairing the Obligation of Contracts …” otherwise known as the “Contract Clause.”

Our forefathers placed this clause in the U.S. Constitution for very good reason. As professor Zywicki, a professor of law at George Mason University, recently summed up in an article for the Wall Street Journal, “While the rest of the world in 1787 was governed by the whims of kings and dukes, the U.S. Constitution was established to circumscribe arbitrary government power. It would do so by establishing clear rules, equally applied to the powerful and the weak.”

Now, fast forward to 2009 and the Chrysler bankruptcy. We watched our own president browbeat senior debt (bond) holders into accepting 30 cents on the dollar, and then turn around and give the UAW 50 cents on their junior debt positions. So … let me get this straight. The Constitution is a sacred document when discussing the torture of Khalid Sheikh Mohammed, but it’s a worthless piece of paper when referring to contract law?  And what about more of those pesky unintended consequences, you might ask? Well, let’s just see how hard (expensive) it is to get private debtor-in-possession (DIP) financing lined up when GM goes through its bankruptcy—or eventually AIG, for that matter. Then, there is that toxic asset auction coming up one of these months. I bet the hedge fund and private equity guys (some of the same guys that were short-changed above) can’t wait to jump into bed with the government, knowing that any contracts may be subject to change shortly after the ink is dry. At least they will have the satisfaction of knowing it was their patriotic duty. I am sure that will be incentive enough, right?

This last month we were also treated to the stress test results for the nation’s 19 largest financial institutions. Pursuant to the Federal Reserve’s findings, 10 of the 19 were ordered to raise a total of almost $75 billion in additional capital. We were told that this was just a precaution against further economic downturn. The other nine were reportedly all quite healthy. That number was much better than most experts feared and sparked a nice little rally in financial stocks over the last few weeks.

So, what’s the hitch? Well, the only fact that concerns me is that the test purposely used a “cash flow” methodology for determining the value of these bank’s assets, rather than the standard account practice know as “market value.” This is a much more complicated (read as statistically manipulative) way to conduct the test. My guess is that it was determined early on that using standard accounting practices would have produced failing grades across the board, and that all 19 banks may actually be insolvent. So, this leaves one big question: If it was not for that reason, then why was this suspect method used? (Gee, wouldn’t it be nice if we still had any real journalists left in this country? Maybe then one of them might ask just that question.) If my suspicion is correct, then it appears the plan is to live with a bunch of zombie banks like they have in Japan. They have been in a recession for over a decade, waiting for their banks to earn their way out of the mess they made. And their banks were rank amateurs when it came to making a mess, as it turns out …

What does all of this collectively mean for mortgages and why should you care? Well, even if the Constitution doesn’t grab you, then maybe this fact will: Nationwide funding capacity for mortgages is down 85 to 90 percent from just one year ago. Yes, you read that correctly. That should tell you what shape these 19 banks are really in. That means getting a mortgage is taking much longer than usual. I see many clients who have waited with other lenders for 60 to 90 days without any results or answers, only to pull their loan applications and have to start all over. Then there is the other fact that the government’s $1.2 trillion program to suppress mortgage rates will be past its half-way point as early as the end of July. After that, rates will likely start drifting back up at an accelerated rate through the end of the year.

The bottom line is that if you are going to get in on these current rates, you need to start NOW! Once the government turns off the tap and this program is gone, I fear the mortgage market will go back to the same log jam we had before—but at substantially higher rates than before this program started. Unless you know something I don’t, you can’t simultaneously print $12 trillion dollars and avoid a severe case of inflation. Barring further market manipulations by Washington, think of mortgage rates approaching double digits again as early as late next year. I guess we’d better hope the housing market is all better by then, huh?