Imagine Housing Without a Secondary Market

In 1974, the United States was reeling from Watergate and the Vietnam War and stuck in a vexing recession. Inflation was out of control and President Gerald Ford was struggling to get control of the country and its economy. A collectible from those days is a "WIN" button, which stood for "Whip Inflation Now" -- a promotional device that the desperate Ford administration ginned up.

At the time, I was fresh out of college, living in Peoria, Ill., and working as an urban planner. One distinct memory I have was passing the downtown office of Peoria Savings with a sign on the window that read "No Home Loans."
A moratorium on home loans -- can you imagine?
Get ready.
In the early 1970s, the housing market had no meaningful secondary mortgage market. When passbooks savings -- which capitalized most mortgages -- shrank, money for home loans dried up.
In 1968, Fannie Mae and Freddie Mac were re-chartered by Congress as shareholder-owned companies funded solely with private capital raised from investors on Wall Street and around the world. But it was not until the 1980s that they found their footing and their growth mushroomed. Mortgage-backed securities got traction in the early part of this decade with the national push for home ownership. New mortgage instruments were invented to capture global interest in U.S. home loans.
In this period, a secondary market came onto the scene with brute force. By 2005, the size of the market had ballooned to $3 trillion.
And today? It has collapsed. Even Fannie Mae and Freddie Mac are poised for a government bailout. Today, Fannie Mae's stock has tumbled 45 percent and Freddie's has fallen 20 percent. This is after steep declines all week.
So, imagine a return to a housing market without a robust and functional secondary housing market. In other words: a severe credit crunch.
Here are 10 things that I predict will flow from its collapse (many of which have already hit the beleaguered housing market):

1. The capital that exists from direct lenders such as community banks, savings institutions and large commercial banks will fall short of potential demand and focus on bread-and-butter loans, leaving most borrowers out in the cold.

2. Exotic loans of any kind will be completely out of favor, leaving many borrowers and many properties unfundable.

3. Home sellers will become active lenders, but only those who have equity. Seller financing will help some transactions.

4. Second homes, expensive houses and certain types of investment property will be penalized and difficult to fund.

5. Small boutique lenders will enter the business, capitalizing on market voids, funding specialized but secure niches.

6. Investment banks will take care of unleveraged high-net-worth customers, but terms will be unfavorable so this market will further shrink.

7. Sovereign wealth funds are not the solution, because many were burnt on mortgage-backed securities.

8. Those that do lend will revert to back-to-basics underwriting: perfect credit, large down payments, proof of income, personal character and good family upbringing.

9. Housing industry lobbyists will make the mortgage liquidity problem their number one policy issue in the next two years. They will argue that the sky is falling and it is.

10. The trend will keep the housing market starved for capital, prolonging the slump.

Like so many parts of our American culture, the accessibility to unlimited and poorly scrutinized debt helped turn Americans into a sloppy group of consumers, which spawned greedy Wall Streeters, out of control lenders and starry-eyed investors.



By: Brad Inman is founder and publisher of Inman News