homes. Investors could tune in to “Flip This House,” then

switch channels and watch “Flip That House.”

In post-World War II U.S. history, there have been three barriers

to buying a first home: a down payment, a job and good

credit.

But early in this decade, the desperate search for yield

prompted investors to buy riskier mortgages. Lenders had a

new way of doing business. No job? No credit? No cash? No

problem! They began making 100 percent loans without documenting

borrower financials. Traditional risk management

and mortgage underwriting standards that had served well for

decades were swept aside.

This new type of mortgage lender went by the name of Wall

Street. Mr. Street did not need Fannie Mae and Freddie Mac

By Mark G. Dotzour

A year has gone by since the real estate mortgage markets

experienced the first day of “nuclear winter.”

For three or four years prior to July 2007, the credit markets

for real estate lending were on fire. The thinking among the

“smart money” on Wall Street was that under modern central

bank policies, risk was a thing of the past. The economy would

still move up and down, but in much gentler waves, and when

things got rough, the Fed could fix it.

Remember the Y2K crisis? The Fed fixed it. Remember

the stock market difficulties after 9/11? The Fed fixed them.

Remember the 1998 Russian ruble crisis and the ensuing credit

market turmoil it caused? The Fed fixed it. Even when the

stock market crashed in October 1987, the Fed fixed it.

These examples prove the Fed will not tolerate more than

minimal corrections in the U.S. economy. Investors have

now succumbed to the notion of “The Greenspan Put.”

This catchy little phrase essentially means there is

no longer any risk in the markets that the Fed cannot

fix by lowering interest rates.

When global investors perceive no risk,

investment capital flows everywhere. Investment

prices go up and yields go down. Cap

rates on real estate hit record lows. In this

kind of environment, how do investors

find higher yield? The answer

is that they take on more risk. They

make home loans to people who cannot

afford to pay them back. Then they

sell those loans to investors who do not

know what they are buying. The profits

roll in.

This new “no risk” era has had a remarkable

impact on the housing market. Prices

started rising and suddenly homes were

no longer just places to live — they became

investments as well. As prices continued to

escalate, investors figured if one house

was a good investment,

why not buy more?

underwriting guidelines because he did not sell his loans to

Fannie and Freddie. He sold them to all kinds of investors all

over the world. These loans were supposed to be virtually riskfree,

rated AAA by the most reputable ratings agencies.

In 2006, prices stopped going up. Then they started to decline.

Some people stopped paying their mortgages. Suddenly,

investors decided not to buy more U.S. residential mortgages

from Mr. Street. At this writing, those investors still are not

interested in buying new mortgages.

So guess who is left to make the loans? The traditional lenders

who made them back in the good old days. Even an old

friend — FHA — is looking dapper again and is quickly evolving

into the subprime lender of the 21st century.

will begin to bottom out. First, home prices have

to stop falling, and second, investor confidence in the

traditional U.S. residential mortgage must be restored.

What must happen for home prices to stop falling? The

answer is a painful process. Prices fall when there are more

houses for sale than there are buyers who want to buy (or can

afford to buy).

The abrupt “nuclear

event” that occurred

in July 2007 shut off a

substantial amount of

demand for new homes

almost overnight. The

large group of lowincome

homebuyers

that was active in the

market in June 2007 was

gone completely the

next month. Meanwhile,

new homes were still

piling into the market.

The excess supply has

continued to grow as foreclosed homes are put on the market.

This overwhelming imbalance of supply and demand caused

prices to fall. Prices will stop falling when the excess supply

is eliminated from each local market. This can happen in only

one way.

First, new construction must be reduced to virtually nothing.

The relentless population growth in most of America will

ultimately absorb the excess inventory. The inventory of unsold

homes will decline until selections get too limited to meet

the needs of picky homebuyers. At this point the market will

begin to shift from a buyer’s market to a seller’s market. Prices

will stabilize, and the market will begin to heal itself.

The pace of this turnaround will vary from city to city. If

home builders cut back dramatically on new supply, the recovery

will occur faster. Communities with fewer foreclosures

will work through the excess supply more quickly. Communities

with strong job and population growth will create demand

that will absorb the excess units faster. Conversely, communities

with slow job growth could take years to bounce back from

the excess supply.

The “no-risk” environment of the past few years spurred

lenders to make risky loans and investors to buy those

loans. Before the U.S. housing market can begin to bottom

out, prices have to stop falling and investor confidence in

traditional mortgages must be restored.

Political action could change the timeline as well. If the

Federal government were to offer tax credits for people to buy

homes, the excess inventory could be soaked up even faster.

This would cause the housing market to bottom and turn

around much faster.

Another stimulus that would speed the recovery is gently

rising mortgage rates. Typically, when mortgage rates are

falling, homebuyers postpone buying. But when they see that

mortgage rates have stopped declining and may rise, they hop

off the fence and buy.

As the economy begins to rebound in 2009, look for mortgage

rates to take an upward turn. As long as rates do not increase

dramatically enough to impact affordability, this should

stimulate housing demand.

The long-term outlook for the Texas housing market is

clearly strong. In the 1970s and 1990s, house prices in Texas

rose in nine out of ten years. And even in the 1980s — the

most challenging decade for Texas in the past 38 years — house

prices increased eight out of ten years.

Job growth in Texas has doubled the national average for

most of the past ten years. Demographic experts estimate another

13 million people will live in Texas by 2030. Many Texas

cities still have tight

inventories of homes for

sale with prices continuing

to appreciate.

The state’s metropolitan

areas have strengths

and weaknesses in their

local markets. Attractive

properties located

in older neighborhoods

close to downtown are

still performing well and

will continue to do so.

The challenges in big

city housing markets

will be in select sections

of the suburban perimeter. In the short term, these markets

will struggle because too many new homes have been built.

But even in these areas, supply is being quickly withdrawn as

new home starts plummet. It may take a few years for these

areas to return to a balanced supply.

For now, builders are accepting substantial concessions to

make a sale. If you plan to buy a house to live in for a number

of years, this would be a great time to buy. If you think you

may not live in a house for two years before you move again,

you might be better off to rent.

Real Estate Center.

D. Marc McDougal, Lubbock, chairman; Ronald C. Wakefield, San Antonio, vice chairman; James Michael Boyd, Houston; Catarina Gonzales Cron, Houston;

David E. Dalzell, Abilene; Tom H. Gann, Lufkin; Jacquelyn K. Hawkins, Austin; Barbara A. Russell, Denton; Douglas A. Schwartz, El Paso;

and John D. Eckstrum, Conroe, ex-officio representing the Texas Real Estate Commission.

are free to Texas real estate licensees. Other subscribers, $20 per year. Views expressed are those of the authors and do not imply endorsement by the

Real Estate Center, Mays Business School or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of