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  Is the Housing Market Going to Crash?


Is the Housing Market Going to Crash?

by Fred Cederholm

Cheap money and refinancing have fueled an unparalleled boom/inflation of real estate prices across the nation. Most gains have been cashed out via the equity loans that have provided a supplemental "income" for households to keep this economy spending. It’s the costly S&L tragedy all over again.
I’ve been thinking about real estate, equity, liquidity, CMO’s, GSE’s, and bubbles.

Home ownership was a central component of the American dream. It was the foundation of community, security, accomplishment, and family. However... all that has been eclipsed because "renting" from lenders is NOT ownership.

You see, real estate has evolved from being more than home and hearth and a family’s largest single asset. It is now viewed as THE hot investment vehicle (an "equity cow," if you will) to be tapped as an evergreen source of collateral/cash. When that Italian monk invented double-entry bookkeeping (with debits equaling credits), assets equaled liabilities plus/ minus equity. If assets exceed liabilities, equity is positive and can be used to secure more credit.

In simpler times, loans were financed by deposits. Lending more required liquidity--an ongoing flow of new/additional money. In the post-WWII era, the Federal Reserve functioned as a broker, matching institutions having excess deposits with institutions having excess demand for loans. There were also the Savings and Loans, which specialized in real estate lending. To improve things, the 1970’s/1980’s saw a deregulation/blurring of financial service. However...when the cost of funds suddenly rose to exceed the "locked in" longer-term rates on loans, we saw the death of the Savings and Loan industry and a slew of major bank failures to boot. Read on.

To accelerate the lending cycle, and to spread the interest rate differential risk, we saw the birth of the real estate investment derivatives called CMO’s--collateralized mortgage obligations. To get a fresh supply of cash to fund more credit, the lenders pooled the mortgage loans and sold them to investment bankers who in-turn packaged and resold them to investors. The dollars were huge, and so were the fees. Uncle $ugar entered the game by authorizing the creation of the GSE’s (Government Sponsored Enterprises) called Fannie Mae and Freddie Mac.

Back in the 1970s and 1980s, the cost of funds suddenly rose to exceed the "locked in" longer-term rates on loans. That's when we saw the death of the Savings and Loan industry and a slew of major bank failures to boot. See a parallel here?

The process accelerated, with more loans being packaged and sold (and repackaged and resold) in a manner not unlike publicly traded stocks and bonds. These CMO’s were seen as safe investments since their value was "derived" from underlying mortgages that were collateralized by the real property itself. These were snapped up and traded by pension funds, insurance companies and banks as well as by corporations and wealthy individuals--domestic and foreign. Refinancing became common. (It’s 10 PM; do you know where your mortgage is tonight?)

Fannie and Freddie had the extra advantage of a multi-TRILLION dollar line of credit from the US Treasury. There is the "perception" that their CMO’s are as good as US Treasury securities themselves, even though they do NOT have the "full faith and credit of the US Government" behind them. (SOURCE: US Code, Title 12 - Banks and Banking, Chapter 46 - GSE’s, Section 4503 - Protection of Taxpayers against Liability).

As interest rates rose in the 1990’s to challenge the "irrational exuberance" of a dot-com stock bubble run amok, all markets dropped. (You can’t blame this only on the 9/11 attacks, as the market indexes were headed south well before the terrorists hit.) We then saw the PPT (Plunge Protection Team, AKA the Fed) cut rates to practically zero to swing the pendulum back again. However...the cheaper interest rates "compounded" by an investing public mourning the "loss" of their paper stock fortunes focused attention on homes and real estate. The Fed now lost control of the money creation process and this next bubble was on its way.

These past two Februarys saw Chairman Greenspan beseeching Congress to rein in both Fannie and Freddie. Cheap money and refinancing fueled an unparalleled boom/inflation of real estate prices across the nation. It would be one thing if the so-called paper equity gains stayed in the property for the occupants. However...most gains were cashed out via the equity loans that provided a supplemental "income" for households to keep this economy spending! It’s the costly S&L tragedy all over again--only bigger; the characters may be different, but I fear the plot and outcome are the same.

I’m Fred Cederholm and I’ve been thinking. You should be thinking, too.

Copyright 2005 Fred Cederholm. All rights reserved. Fred Cederholm is a CPA/CFE, a forensic accountant, and writer who contributes the column "TH*NK*NG" to The Weekly Observer in Creston, (Ogle County) Illinois. He is a graduate of the University of Illinois (B.A., M.A. and M.A.S.). He can be reached at

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This story was published on March 31, 2005.

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