Wednesday, November 14, 2007

The Financing of Sprawl...

This column offers an ominous, yet entirely practical, prediction:
Even if ordinary mortgages do continue to be offered – and they are bound to be restricted – sub-prime mortgages will no longer be available for first-time buyers. Yet the housing market depends on people being able to sell their first houses when they trade up to their second. If all banks are anxious to protect their cash reserves, and to reduce their level-three assets, that will make ordinary borrowing difficult and level-three borrowing impossible. Probably the downturn will spread into stock markets, even though it did not originate in stock market speculation.
Okay, so here's what happened. In the U.S., those who could not afford a 10% or more down payment historically were very unlikely to get a mortgage loan.

But, this large, large segment of the population still needed a place to live. So, they rented--all the while, often saving up the money needed for a down payment.

Unfortunately, sprawl development twisted this very reasonable and practical system into knots.

It did so by allowing houses to be built--primarily on the suburban and exurban fringes--at unrealistically low prices. One of the main reasons for the low house prices were the low land prices--after all, farmland located 20+ miles from a city center typically does not have alot of inherent development value. Especially, when the farmers are looking to retire and the next generation is not interested in continuing to farm.

Unfortunately, like the buyers, the banks became seduced by this brand (and really large) new pool of potential loan clients (and, among other things, the closing costs and fees they paid on the front end).

So seduced that they wrote home loans for this large segment that historically had to rent. But, to do so, the banks came up with gimmicky loans that even an amateur could see made little sense in the long run: interest-only, balloon loans, gimmick interest rates, and the like. These were necessary because this pool would not qualify for a conventional loan.

Now, this ponzi-like scheme is beginning to crumble. Primarily because, these folks who could barely afford to buy a house with the gimmick loan in the first place certainly can't afford to keep it as whatever slim budgetary wiggle room they had is rapidly being gobbled up by increasing gas, food, and utility expenses.

Meaning that, unless the banks decide to start renting these houses, there's really no one left to buy--or continue to make mortgage payments--on them.

Which shouldn't be a surprise because, again, historically these loans would have rarely been written in the first place because they make very little fiscal sense.

In the end, the U.S. bought sprawl but didn't make plans on how to pay for it when the true costs were revealed.

Daily Sprawl senses a new generation of "Ghost Subdivisions" are in the offing sooner rather than later...