Buyers' Security Blanket

Despite my teeney bit of experience in the banking industry, I certainly would not consider myself an economist by any means and therefore don't want to delve into my opinions on the pros and cons of the so-called government bailout we're hearing about every day recently.

One thing I'd like to point out, however, is the real estate market tends to be largely driven by consumer confidence. Take, for example, the "home flippers" of a couple years ago who were buying & flipping homes left and right on the confident whim that the market would keep going up. Or look at now, when job security is shaky, we're all uncertain about the future, and essentially people have lost confidence in the economy - the high end real estate market has become a desolate landscape of multi-million dollar mansions left vacant and on the market for months and the other ends of the market aren't doing much better either.

U of M Consumer Confidence Oct 2006 - Present

What am I saying? I think that no matter what the government intervention does to the economy, this intervention in itself will be enough to boost consumer confidence and see a pick up in home sales. Prices can't drop forever and it is uncertain how long mortgage rates will remain so low, so these facts, along with the government acting as a "security blanket" for buyers, should have an encouraging affect on real estate sales.

I'm Back! ... with some info you might find interesting

After a little blogging hiatus, I am back in full-force. Since the last update, I have switched to Coldwell Banker to join a team of two women who have been successful in the real estate business for 30+ years. Also, since the last update, there have been a number of monumental occurences in the real estate market. Most notably, last Sunday, the government took control of Fannie Mae and Freddie Mac. Effectively this has decreased mortgage rates for conventional loans by a significant amount in just a matter of days. Why is this, you ask? Let me break it down.

Fannie Mae was a child of the Great Depression, followed by the creation of Freddie Mac in 1970. For a very simple dissection of how Fannie Mae & Freddie Mac work to support the mortgage banking system, see below.

Banks make money off the interest they charge on the loans they make. The reason they even have money to lend is that they hold cash in the form of deposits & savings from people like you and me. So basically when a bank loans money to someone as a mortgage, they are lending out a portion of the money you've deposited into your savings (or some other form of) account.

The problem is that mortgages are generally long-term - so if a bank loans out all of its money in the form of mortgages, it would have to wait many many years before it can make another profitable loan since it won't have any more cash to lend. Also, if it lends out all of it's money, you and I wouldn't be able to cash out our savings accounts. Not a very sound business plan, right? Also, with this structure, very few people would actually be able to get a home loan since money would be so tight.

That's where Fannie Mae & Freddie Mac come into play. Our government believes that home ownership is very important to our economy and quality of life. Without being able to get a home loan, it's very difficult for many people to own a home. So they created Fannie & Freddie. Fannie & Freddie purchase mortgages from banks - essentially, they purchase the right to receive the monthly payments from the borrowers. When the bank sells these mortgages to Fannie & Freddie, it gets cash which allows them to make more loans and remain liquid. Fannie & Freddie then "securitize" the loans - they package the loans into bundles based on credit risk, and sell these packages called Mortgage Backed Securities (MBSs) to investors. So Fannie & Freddie get their cash, and the investors have a variety of credit profiles to choose from in order to meet their investment strategy. Fannie & Freddie then guarantees the MBSs so that if any of the homeowners default on their mortgage payment, the investor still gets paid by Fannie or Freddie due to the guarantee. Therefore, as long as Fannie & Freddie are financially solvent, the investor gets paid.

The problem comes into play when it looks like Fannie & Freddie might not be able to back all the loans that are defaulting. With an increasing number of mortgage defaults over the past year, investors began to wonder...

Interest rates are based on credit risk. If you were going to loan $1000 for a year to someone who had a good job, a history of timely loan payments, and a good credit score, you might ask for $1030 (AKA 3% interest) at the end of the year. But if you were going to lend that $1000 to someone you know has a history of losing his job, failing to pay bills, missing credit card payments, etc., you might ask him to pay you $1100 at the end of the year (10% interest) since the only thing that would be worth the risk of not being paid back would be the potential for the extra cash at year end.

With credit risk increasing on Fannie & Freddie backed loans, interest rates increased. But when the government took over the two entities, all of the loans backed by Fannie & Freddie became risk-free. That's because the government has taxing authority and will always be able to fund its obligations. So, when the government took over Fannie & Freddie, interest rates went down.

So overall, banks need money to make loans. People need loans to buy homes. Fannie and Freddie buy mortgages from the bank which frees up money to be lent. Without Fannie & Freddie, we'd be in trouble. So good thing the government has stepped in to avert a more serious crisis.

Make sense?