The perfect storm is generally acknowledged to be a brief moment in time when the victim is caught in a simultaneous cascade of events that would be survivably bad as single events, but fatal as multiple events.

Housing’s perfect storm began as a hint of impending bad weather when segments of the financial community began to offer multiple loan financing for home purchases. This generally was done with 80% first mortgages coupled with 15% second mortgages, or some other combination equally 95% loan to value (LTV). This was occurring back in the mid 1990’s. By itself, not a problem, because the home buyer (borrower) had at least 5% of their own “skin in the game”. People fight a lot harder to avoid foreclosure if there is a direct loss to their pocketbook, so that 5% was very important to the safe operation of the home ownership system. It certainly did not hurt that residential property values were increasing steadily.

The downside of steady increases in home values is that most home buyers that purchased their first home from 1992 to mid 2007 had never seen a down market, so a large number of homeowners were lulled into the idea that property values always went up. The wind was starting to blow, but ever so gently.

By the late 1990’s, house values were increasing at a level that allowed the re-finance boom to flourish. With relaxed underwriting standards, it became possible to re-finance the old mortgage and take out a bunch of cash to buy speedboats and European vacations. The home became a big piggy bank or ATM machine. And make no mistake, segments of the financial community encouraged this behavior with almost criminal intent. Everyone was making money and the politicians and regulators were busy with other things. Now the stage is set for 2001.

After the horrible events of September 11, the Federal Reserve Bank lowered interest rates to unheard of lows. Money became cheap and available to all. Mortgage credit underwriting became a “fog the mirror” test. The multiple or packaged loans of the 1990’s became 100% financing, and refinances and piggy-backed seconds were often made in excess of the appraised value of the house. Almost anyone could buy a home that wanted to, with little or no commitment. No “skin in the game” necessary. The sky was dark in the West, but it was sunny overhead. Housing prices went nuts, builders built as fast as material, labor, and regulations would allow, and everyone was as happy as pigs in slop. Places like Las Vegas and Phoenix were having speculative appreciation as high as 45% in a single year. Smart people smelled rain, and got out of housing, banking and building.

By early 2007, the idea of foul weather was beginning to become very apparent to many people close to the business of housing. Some smart lenders began tightening the underwriting guidelines, and home builder stock had peaked. By August it was too late to run. The capital market collapsed, sub prime financing was curtailed, and there was no one left to buy, and no money to buy with. But the storm had not yet peaked.

Tomorrow: Salvage and Recovery

Written by Larry D. McGee, Denver Realtor - Visit Website Sphere: Related Content