Issue 49 - Be careful when marketing your home… - March 2009

Recently, we have seen a surprising number of local real estate offices close their doors. Certainly, the sudden decrease in housing sales must be hurting some offices and their franchisees. I saw an estimate in the Herald a few weeks ago, that spoke in terms of 400 offices closing throughout New Zealand. If this is true, I think that this may be the worst housing downturn we have experienced in our 25 years of being in business.

Those thinking of selling their home through a real estate company, need to be aware that any marketing money that they pay ‘up-front’, will most probably NOT be placed in a Trust Account, (because there is no legal requirement to do so) but will almost certainly be paid into the office’s operating account.

The danger of this to sellers is that in the event of a real estate company becoming bankrupt, the sellers would be classed as unsecured creditors in respect of that pre-paid advertising and have to take their chances of recovering their money, along with all the other unsecured creditors.

The Official Cash Rate:

The sudden and dramatic fall in the Reserve Bank’s Official Cash Rate, may not affect home loan rates as much as some would think. While it is certainly an indicator of Governor Bollard’s intentions, it needs to be realised that the OCR is only one component of the mix that determines what the actual Trading Banks’ loan rates will be.

The other factors affecting trading bank lending rates are the rate at which they borrow on the domestic market, their costs of borrowing from international markets and the cost of the new government deposit guarantees.

We have a particularly interesting situation at the moment, world wide. Because of the activities of Central Banks, we have lower interest rates at the same time as there is a shortage of funds. Economic theory suggests that these are unlikely bedfellows. Usually, the laws of supply and demand would suggest that when there is a shortage of funds the price, (i.e. the interest rate) goes up, thus limiting the uptake of funds to match the supply.

Because that mechanism is no longer operative, funds are being allocated on the basis of equity owned by the borrowers. Thus, instead of offering 100% loans to all and sundry (or so it seemed), banks are now loaning only to those who have a sizable deposit for their purchase, typically 10-20%. Thus, the lower interest rates are being traded for greater security.

The Sub-prime mortgage fiasco.

I suspect that the sub-prime crises and the ensuing economic problems will continue to be studied in economics lessons for decades to come.

Opinion is divided on whether the (U.S.) Community Reinvestment Act (CRA)(passed in 1977, but with numerous legislative and regulatory revisions since), was at all responsible for providing the climate in which sub-prime mortgages could lent against.

Originally set up to ensure that low and moderate income neighbourhoods would be able to receive a fair proportion of available credit to finance home purchase and small businesses, the Act required banks and savings and loan associations to serve the credit needs of their local communities in a safe and sound manner.

Further, the (U.S.) Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required Fannie Mae and Freddie Mac (two government sponsored enterprises of whom I have written earlier), to devote a proportion of their lending to support affordable housing.

In October 2000, in order to expand the secondary market for affordable, community-based housing, and to increase liquidity for CRA-eligible loans, Fannie Mae committed to purchase and securitise $2 billion of ‘MyCommunityMortgage’ loans; and then in November of the same year, announced that the Department of Housing and Urban Development (HUD), would soon require it to dedicate 50% of its business to low and moderate income families. I suspect that the words ‘and securitise’ are where the genie was let out of the bottle.

‘Securitising’ refers to the practice that arose some years ago, of bundling together, say, $xmillion of mortgages and then selling what is known as a ‘derivative’ – i.e. a security that is effectively a little piece of each of the mortgages, together with the attendant income.

This was fine when the mortgages were properly secured over property and there was a very high likelihood that the loan and all the interest would be paid as installments came due. Unfortunately, some people became very greedy and saw this mechanism as a way to quit poor quality mortgages, mortgages securing loans that had very little chance of complete repayment, to get them ‘off the books’ of the lending agency. These ‘derivatives’ were sold on trust to a large extent and that trust has been misplaced. Banks around the world were mislead and the world’s population suffers.