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The mortgage system is broken and needs to be
fixed by people that are not part of the problem. Congress can't effectively
fix the problem, because they are the reason for the current economic
situation.
In September of 2003, Treasury Secretary John Snow went before
Congress to propose a regulatory agency to oversee Fannie Mae and Freddie
Mac, because the Bush White House was concerned about their lending
policies. Fannie Mae donated large sums of money to key congress people and
no oversight was established. Congressman Barney Frank replied "Fannie Mae
and Freddie Mac are not in a crisis". He actually pushed back that Fannie
and Freddie needed to do even more to increase home ownership in America.
Hearings occurred in 2004 and 2005. A second attempt to regulate
Fannie Mae and Freddie Mac was also blocked. In hearings, Congresswoman
Maxine Waters stated that she was unhappy they were trying to "fix something
that frankly wasn't broke. Mr. Chairman, we do not have a crisis at Freddie
Mac and particular at Fannie Mae".
How America Get into the Current Financial Crisis
Why are so many Americans in such financial trouble? How many homes will end
up in foreclosure by the time the economic crisis has ended? How can we, as
a country, pull out of this nosedive? Experts around the country have been
debating this situation since early 2008. What's clear is that the crisis is
a complex issue and resolving it won't be easy or done quickly.
The real estate market, and the broader economy, is cyclical. We all know
it, and we've all heard it. Life is a rollercoaster ride and at times it
goes up and at times it goes down.
Mortgage brokers pointed out that we weren't accounting for the huge
number of subprime loans that might be foreclosed and lead to a sharp
decline in home values. Many also explained that the mortgage industry had
become too lenient. Lenders were giving loans to virtually anyone.
Part of the reason that lenders were giving loans so freely was a
change in policy in Washington that eased restrictions on lending in order
to assist more families in owning their own homes instead of renting. While
this was a noble cause, it was not the best use of our financial system and
is one of the primary reasons that we're in this historic decline.
As an example - you can't sell your house because it's worth less
than you paid for it a few years ago. It's worth less because the mortgage
market has collapsed, making it more difficult to get mortgages and driving
real estate prices down. The mortgage market has collapsed because the
government and many other governments made decisions based on "feel good"
politics rather than making sensible decisions.
History repeats itself. At this point in time, we are passing
stimulus packages and housing packages to try to correct the symptoms, but
ignoring the real fundamental problems.
In 1990, approximately 64% of Americans owned their own homes. Lenders
carefully selected who would receive mortgages based on a few key indicators
of their ability to repay the loans. In the real estate industry, they are
the four "C's". They include:
Credit Worthiness. If the borrower doesn't have a decent credit
score, it shows they have not paid their bills on time. If the borrower
isn't paying their bills now, what would make a lender believe they will get
better at paying them once they own a home?
Capital. In business, it's called having skin-in-the-game. Lenders
don't want to loan the entire amount of a purchase, because the buyer or
borrower doesn't have anything invested in the purchase. If their situation
changes, it is easier for the buyer or borrower to walk away because they
don't have anything to really lose, other than their credit rating.
Collateral. The home simply has to be worth what the buyer is paying
for it. A lender doesn't want to risk having to take back a property and
re-sell it if there isn't enough equity to sell the home in the case of
default.
Capacity. The borrower has to have an income that allows them to make
the payments. Lenders carefully determined whether or not the borrower could
make the payments by assessing how long the borrower had been employed and
what percentage of their income could be used to make the mortgage payment.
This system of carefully screening candidates for mortgages worked
effectively in keeping the number of foreclosures very low for most of the
last century. During the 1990's, the Community Reinvestment Act (CRA) was
used to pressure lenders to reduce restrictions on the qualifications
of buyers in order to increase the number of home owners, and particularly
to assist minorities and low-income home buyers in purchasing homes. In
fact, in 1999, the New York Times reported "that Fannie Mae and Freddie Mac
were under pressure from the Clinton administration to increase
lending to minorities and low-income home buyers"
During the beginning of his administration, the 1992 Housing Bill set a goal
for Fannie Mae and Freddie Mac to have 30% of their home loans be made to
low and moderate income households. In 1996, that number was raised to 40%
and then raised again to 42% in 1997. The GSEs then gave preferential
treatment to mortgage companies and lenders who reduced their underwriting
criteria. Countrywide Financial Corp. was the first to sign HUD's
"Declaration of Fair Lending Principals and Practices."
All this boils down to the fact that these quasi-government institutions
were the largest buyer of loans, and they actively reduced the
restrictions required for obtaining a mortgage. Most lenders followed along
in order to take advantage of writing more loans and selling them to these
institutions.
Programs became available, through Fannie Mae and Freddie Mac lenders and
through Subprime lenders, offering 100% financing, 103% financing and in
some cases, up to 125% financing. The supposed logic behind this idea
was that buyers had decent credit and stable jobs but weren't able to save
any money, so why not loan them the entire amount? Unfortunately, it also
means that these home buyers had little or no money put into the property,
and therefore, little to lose by walking away. It also left no equity for a
lender if the buyer defaulted on the mortgage.
Even that wasn't enough. Programs were created that allowed borrowers
to state their income on applications rather than actually provide proof of
their earnings. In this case, the logic was that self employed people didn't
show all their income, or couldn't prove it readily, so these individuals
could not be turned away from being approved for a mortgage. The lender
would simply charge them a slightly higher interest rate than the norm for
the privilege of "stating" their income.
Lower and lower credit requirements continued to push the pool of
potential home buyers into the depths of unqualified individuals. The checks
and balances of the mortgage industry were totally out of whack with
reality. Low interest rates, combined with low or no down payments and easy
credit with very few verifications is a recipe for mortgage disaster.
In many cases across the country, there were lenders who were conservative
and unwilling to follow these new reduced guidelines. Some of these banks
and mortgage companies were sued by community action groups
claiming they were discriminating against segments of the population based
on archaic rules. Most lenders gave in, rather than go through the negative
publicity and legal costs associated with continuing along a more
conservative path.
Part of the dramatic rise in prices was directly attributable to the rise in
home ownership. From 1993 to 2005, the percentage of Americans who owned
homes jumped from approximately 63% to approximately 69%. Although that is
only a 6% increase, those new homeowners were first time buyers.
In any given year, approximately 9-10% of the population purchases a home,
and a little better than a third of those buyers are first time home buyers.
When the number of first time home buyers was increased, it created a huge
demand for first time homes, which drove the prices up. Those home sellers
then relocated into "move-up" homes, creating a significant demand for
those. Home owners who planned to never move again reconsidered. A home
owner living in a moderate home and never expecting to afford a "dream home"
now found that "dream home" within range. The increasing prices of moderate
housing, combined with historically low interest rates created an
opportunity to move to a luxury property that many people never expected to
achieve.
If these programs had not allowed unqualified home buyers to purchase homes,
the housing recession would not have been nearly as severe. Foreclosures
would not be reaching their current levels, and it is unlikely that housing
prices would have dipped as low as they have.
Ultimately, the combination of easy credit, low interest rates, high
affordability, low unemployment and high immigration all coalesced to create
one of the highest periods of home appreciation in history. Like all good
things, this too must end.
The mortgage system is broken and needs to be fixed by people that are
not part of the problem. Congress can't effectively fix the problem, because
they are much of the blame for our current economic situation.
Giving buyers the chance at home ownership is an admirable thing, but it has
to be done with sensible rules that won't destroy our country and our way of
life. Forcing the banking system to give away money to anyone and then
propping it up with government backing by raising taxes is not the answer.
There is plenty of guilt to go around, but it starts with government
intervention.
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