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Easy money is almost always followed by hard lessons

September 09, 2007|By TIM ROWLAND

In Washington County, the first indication that something was fishy in the real estate market didn't come from the plethora of outsized McMansions bristling along ridgelines like armored plates on a stegosaurus.

It was less obtrusive, coming as it did on average streets in average communities.

In the hot real estate market, for-sale signs were coming down as fast as they went up - and in many cases, they were quickly replaced with for-rent signs.

Realtors' voice mail was jammed not so much with local, first-time homebuyers, families looking to move up or empty-nesters looking to downsize.

The calls came from Rockville, Silver Spring and Frederick. A fair number had no intention of ever living here. God forbid. Instead, they were speculating.

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Skyrocketing housing prices made a fast buck look like no more trouble than signing a slip of paper. Speculators sought to buy a house, rent it out for a year or so and then sell at a handsome profit - smart business, under the prevailing circumstances.

Those with limited capital looked to the lower housing costs of outlying areas because it allowed them to get in on the real estate action without the big outlays that would be needed in the cities.

Although in truth, capital was never much of an issue. Banks and mortgage companies were beating the bushes looking for people to hand money to.

It must have looked so easy - no money down, a minuscule teaser interest rate for the first couple of years (the house would be resold long before the higher rate kicked in) and a commodity that could, so they thought, be expected to increase by tens of thousands of dollars in a year or two.

During that year or two, the rent would pay the artificially deflated mortgage payment. In theory, it was essentially nothing out of the speculator's own pocket with the probability of a $50,000 profit, per house, in 12 months' time.

For some savvy investors who got while the getting was good, it probably worked just that way. But I suspect many others have been left holding the bag. Now, instead of several months, it is likely to be several long, grueling years before any money can be made on these properties.

The lesson is that money is never this easy, without consequences down the road. (Remember the tech bubble?)

While speculators were getting unbelievable terms and unbelievable increases in value, regular homebuyers were as well - until this self-generated bottle rocket burned out.

As documented in The Herald-Mail today, foreclosures have shot up locally as rosy lending terms have suddenly gone dark.

It is doubtful, as has been suggested, that too many homebuyers bought into these teaser loan rates with their eyes closed. Instead, they probably never saw an end to higher home values. If the adjustable interest rate adjusted upward to the point that their loan payment burst their budgets, they could always sell for a tidy profit and move on.

Lenders apparently thought the same thing, which is why they approved loans for people walking on the financial edge.

But the artificial rates brought in artificial buyers - the speculators - who dumped their properties on the market at the first hint of trouble. All of a sudden, instead of a housing shortage there was a housing glut, which further served to depress values.

In a sense, this mess began with a noble premise, perpetuated by the nation's central bankers: All Americans deserve wealth and the best path to wealth is home ownership. So the Federal Reserve congratulated these "creative" lenders and their creative loans when, in fact, it should have been raising warning flags.

Meanwhile, in its role of inflation watchdog, the Fed went on a three-year binge of increasing interest rates. That may have kept inflation in check, but it also put a dagger through the wallets of homeowners with adjustable-rate mortgages that were tied to the fed rate.

Points add up. On a $300,000 loan, the difference between a 5 percent teaser rate and an 8 percent adjusted-to-prime rate is about $600 a month. As the nation is now finding out, a lot of sub-prime borrowers, by definition, just don't have an extra $600-a-month cushion in their budgets.

Pollyannas like to say that lending flames will die down in a few months and it will be back to business as usual. That's possible, but personally I believe that there were too many greedy fingers in too many disparate pies that still have to be accounted for in the cold, unbiased eye of the market.

Whenever New York financiers cook up some cockamamie scheme to become fabulously wealthy, Main Street America gets the shaft.

These sub-prime loans you have heard so much about have been bundled, renamed and prettied up like makeup on a hog and sold as overpriced bonds to pension funds and institutional investors - the big money purveyors who help fuel the economic engine.

Now these sub-prime products are worthless, meaning that a lot of capital has suddenly dried up. Good things don't happen when you take the capital out of capitalism.

The bright side? Well, those concerned with runaway growth in Washington County ought to be able to breathe easier. Early on, we were told that the turnaround would boost the real estate market by 2007. Then 2008. Now they're saying that 2009 may be more realistic.

Generally speaking, for each year of unjustified, artificial economic happiness, a year of economic pain must be endured to make things right. If that's the case here, those wishing to sell their homes for a decent profit may want to mark the year 2011 on their calendars.

Tim Rowland is a Herald-Mail columnist.

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