Sunday Musings: Would You Be Better Off Today Without The Subprime Saga?

I received the following e-mail from reader Rich:

“Thanks for your rational take on the market & its current woes. I happened to mention the need for a look at what US Government lending regulation might have prevented & nearly got fired on the spot this week. I recall mentioning this in my College Economics curriculum years ago & the response was calmer, if stoic.

However, if there were limits to the types of lending these institutions have been offering, such as there is concerning the use of fireworks on a local basis, perhaps not only personal safety would prevent loss, but financial as well as high hopes for the American Dream, might be limited.

The most clear example is lending without restrictions on income as well as debt to income. Many more follow but at this time even the Fed wants to shore up lending confidence. Too bad is has to happen this way. It is entirely a reaction rather than an action which could have been helped by just a small bit of regulation.

A bulwark if you will against massive individual losses in addition to institutional bankruptcy proceedings.

I’m just fine, but I wonder how my children, were they of an age to sign onto one of these shady loans, might have ended up.”

Rich’s arguments made me reflect back some years ago when interest rates dropped sharply and real estate prices started to head into orbit. For any asset to increase in value there has to be demand, which is reflected in the stock market via volume. Generally speaking, high volume translates into higher prices, while low volume reflects stagnation or lower prices.

In real estate, demand starts at the entry level. Many first time buyers (volume) shopping for homes give existing home owners the opportunity to sell at a profit and move up in the housing food chain. Subsequent lax lending standards allowed mortgage companies to increase the volume of first time buyers by making “fog up the mirror” home loans and thereby adding a huge number of buyers to the market place, who previously did not exist. The result was an ever increasing price spiral until the point was reached where volume dried up—a classic Ponzi scheme.

My thought is this. If we had had strict lending standards back then, I have to wonder if real estate prices would have ever reached the lofty levels that we ended up with. While no one has the answer, there is a chance, however, that prices might have hit a glass ceiling a long time ago. So, in some perverse way those of us that owned real estate were the unintended beneficiaries of the artificially created volume due to subprime loans. Otherwise, you might have never seen your home triple or quadruple in value.

This is not meant to be a justification for subprime loans, just a reflection of what might have been.

Why look at it now?

Because once the total severity of the subprime debacle has been recognized, publicized and “fall guys” identified, you can be sure that, for the time being, marginal home loans will be a thing of the past. The pendulum always swings from one extreme to the other.

The obvious conclusion is that real estate volume will be greatly reduced, which in turn will affect the ability of (average) people to sell their homes quickly to move on to greener pastures. Some will ‘have to’ sell due to job transfers and lack of demand will pull prices lower. How low, no one knows.

My point is that we all have benefited from the subprime debacle and as long as we own real estate, we will be forced to participate in the unraveling.

That’s my view, what’s yours?