There was once what could only be considered a heretic from the Univ of Chicago who said financing doesn’t create value. He won the Nobel Prize for this observation. An observation that seems forever lost on the Washington\Wall Str Nexus and American economy in general.
Nowhere was this principal made more clear than in the recent mortgage “situation” that wiped out $12 trillion in home values over 10’s of millions of homeowners. Derivatives, pass through securities a’la CMO’s and other Mortgage Backed Securities, Credit Default Swaps, etc. all illustrate Wall Street’s errant ways.
But Wall Street wasn’t the only industry fueling the belly-flop in values felt primarily by the 99% and the once upon time middle class. Don’t get me wrong, the second great depression wouldn’t have happened if it hadn’t of been for Wall Street, but let’s not forget that the Residential Real Estate Sales Industry played just as important part. And yea, sadly neither industry has changed it’s ways.
I recently had an affiliation with a real estate sales person that was very enlightening. She was utterly and constitutionally incapable of discerning the difference between the price based upon the maximum mortgage amount I could afford at the start of my ownership and the true value of the home. Basically, given the interest rate and other terms of the loan being offered I could qualify for a mortgage loan of a certain size and this loan, when added to my equity portion, was the total price I should be pay for the home.
We went around and around on the “safety” of this method of assigning a value to home. I asked her, “what happens during negotiations if interest rates go up and the same maximum monthly payment that I can afford relates to a lesser mortgage amount? According to you the value of the home will go down. Does that mean the seller is going to, say, remove the fireplace and some kitchen cabinets to keep the value of the residence that I am willing to pay before the interest rate jump on par with the cumulative lower price of the physical features I’ll be receiving after the rate hike pushes my mortgage amount down?” And “what about the fact that Wisconsin is arguably the worst labor and wage market in the nation right now? Does that explain why there is no-one bidding against me? Driving the prospective value of the home ever higher”.
She just sat there looking at me like I was speaking Klingon. The value of the home is the maximum you can afford to pay based upon your mortgage terms and that was that – it was not even a point of debate. And if I didn’t believe her, well, here were some comparable sales with prices reflecting similarly inflated values based upon the ease and availability of credit. All the comparable sales she showed me were rather recent – as they should have been – but thinking back the interest rate and credit terms that prevailed during the time of these comparables wasn’t really that much different than now. These other sale prices had been determined by the maximum-affordable-credit-terms method when credit terms, most notably interest rates, were pretty much the same. These prices were inflated to the extent that the price suggested based upon credit terms diverged from the value of the home dictated by Labor and Wage prospects, amongst other things, over and after the holding period of the home.
And here is the rub. Today’s interest rates are fantastically favorable to home ownership but Wisconsin’s labor and wage market is extremely unfavorable. Worse still, the problem of unfavorable wage, labor and other aspects of the 99%’s wealth isn’t that good anywhere in America right now, and there are still reports of declining home values to prove it. I would overpay for the true value of the home if I allowed my purchase price to be dictated by the maximum amount of the loan I could afford. If I did this, as apparently seems to be the “practice” enforced by the Residential Real Estate Sales market right now, I would then put on record a sales comparable that countless other realtors would then use to enforce the maximum-affordable-credit-terms method of valuation on other buyers. The problem would grow. It would snow-ball with each transaction so determined.
It is important to note that this SalesPerson had a signed buyer's agency with me. She was not just arguing with me in order to obtain the Seller the maximum sales price. The problem with her motivation was that the buyer's agency agreement did not change the way her commission was calculated as a percentage of sales price.
This is how “the rubber met the road” in the recent mortgage fiasco. Such practices by the Residential Real Estate Sales market amplified the loses suffered by homeowner’s that stemmed from wall street’s free and easy credit terms. Credit terms, that is, that technically do NOT create value.