Home foreclosures are being filed at a record pace here in Chicago and around the Country. A wave of commercial foreclosures will be arriving soon. An underlying problem is that the overall real estate values have fallen to the point that properties are worth less, in many cases, than the loans against them -- in everyday terms, the loans are "under water".
The last time this happened was in the late 1980's. You may remember the "S&L Debacle". Then, Savings and Loans (specialized banks set up to make home mortgages), failed at an alarming rate. Congress and the press attributed the catastrophy to greedy, inept S&L owners. There were some greedy, inept S&L operators, to be sure, but actually, two miscalculations by the federal government were the real cause of the disaster. First, in 1986, the IRS ended the practice of allowing tax payers to deduct real estate depreciation from their personal income tax returns. For years, the real estate business grew like wildfire as promoters designed "tax shelters" -- real estate projects structured to maximize investor's tax benefits. There were other tax shelters, too, like investing in movies, but the economic impact of those was microscopic compared to real estate.
When congress ended real estate depreciation deductions, they didn't do so only for new projects, they applied the change retroactively, so that taxpayers who invested in shelter deals in prior years lost the benefits immediately.
At the same time, Congress decided to "Whip Inflation Now" (the "WIN" incentive). To do that, they pushed interest rates up so that people would not be tempted to invest in new business ventures, including real estate projects, with borrowed money. The unintended effect was to place banks and S&L's in a situation where they had to pay 16 - 20% and more to attract deposits -- which they needed to support loans already outstanding, while carrying loans they made when interest rates were much lower. Banks and S&L's hemoraged money until they had none left.
With no money to lend to those who might want to buy real estate and with the value of the real estate falling each day, so many banks and S&L's failed that the government set up the Resolution Trust Company, a government agency to take over failed financial institutions. It took years for the real estate market to recover.
Then, in the late 1990's Congress struck again, along with a weird social movement. First, Congress decided that it was every American's inalienable right to own a home. Then, Congress de-regulated the Banks.
People began buying homes, not just to have a place to live, but so they could "flip" them and make a profit. In fairly short order, individuals who a few years earlier couldn't qualify to finance a used car were signing "no documentation" loans and buying homes they couldn't possibly afford. Loans with low initial interest rates flooded the market, encouraging individuals to buy bigger and bigger homes and sell them before interest rates adjusted upward.
Stories began to circulate about the fabulous money otherwise marginal individuals could make, and "flipping" became a social movement. Churches assured parishioners that Jesus wanted everyone to be wealthy. Real estate investing became a mania. It was like musical chairs with money.
When the music stopped, lots of people couldn't find seats. When the value of real estate stopped climbing, the whole house of cards collapsed. Now, as the economy continues to contract, real estate values shrink further and further and those who can't service their loans through income, face the loss of everything they once had.
Next: What to do now?
Thursday, January 14, 2010
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