There is alot of talk in the news about the housing market. Most of it is not very positive. In the Olympia area we are fortunate to be in much better shape.

In parts of the country speculation in real estate has had the effect of creating a vast over supply of houses. In some places that is over three years worth of inventory. Because of the time on the market before a house sells it is a buyers market now.

Our rate of sales in the Thurston County area has slowed from last year. However, homes are selling at a reasonable pace (the average home is selling in 78 days). Some sellers are finding that the gain they anticipated based on the gains of the last few years are not there. Still, the overall value of homes in this market place are up about 5 percent.  During the boom prices were rising an average of about 25 percent per year.

Though our area did not over build like other areas in the country we still have more homes on the market than the last couple of years. Sellers placing their homes on the market are often not aware that the market has not appreciated as much recently and their expectations often result in price reductions. A house priced in accord with the market will sell in about a month and a half on average.

Because of the excess inventory of houses increases in value will likely be flat for a time.

We are hearing about the sub prime mortgages being a problem for the housing industry and for the economy as a whole. Yet, most of us do not understand exactly what that means and how it happened. Keep reading if you would like to know more.

There was a logic for individuals who got sub prime loans. The idea was that the loan with its low initial interest rate would easily be refinanced in a few years when the value of the house had risen substantially. The buyer would refinance and never face the bump up in rates that would amount to having to pay hundreds of dollars more per month. The great thing was that no verification of income or assets was required and the payment might be less (for two years) than the rent they were now paying.

But that didn't happen. When they went to refinance there was no loan available. The payments on the loan stopped and the loan goes to foreclosure.

(Remember now, we are not talking about your local homegrown savings and loan. The local savings and loan that only lends the money it has from depositors and they require you prove you can repay the mortgage. We are talking about a business that has money to loan because investors are willing to buy bundles of mortgages because of the high interest they can earn. This is like you buying a cd from your bank. You don’t know how the cd is able to pay you eight percent. You don’t know where your money is invested. You trust the bank to invest the money to earn you interest.)

The problem comes from a desire to profit. If I give you my money to gamble with (you can’t keep my money only the profits) you will won’t you. What do you have to lose? Nothing. We will come back to this since this is the core, the crux of the problem.  You might be wondering where the money to lend came from.  It comes from monetary policy of the private banking industry best known as the "federal reserve".  The fed had decided to print more money and make it available at low interest rates.  That money flooded the financial system and borrowing became rampant from big banks to small home buying investors.  The lenders now had so much money to lend they had an increased willingness to take greater risks hence the ultimate lending to people who are now in trouble.

In the recent rising real estate market there was much money to be made by many different groups. The groups included appraisers, real estate agents, mortgage brokers, loan officers, investment banks and investors in mortgages.

In the subprime business it was in everyone’s interest to make loans. The agent, the appraiser, the loan officer and the mortgage broker all get paid when a deal is closed and that is the end of it. They get paid and have no risk. The subprime lenders make their fee percentage bundling mortgages and selling them to investors. Investors want these investments because they offer high rates of interest return backed by tangible assets (the house).  

The process of securization, where loans are packaged and sold to investors as "mortgage-backed securities" is a big part of the problem.  As Warren Buffet said: "Once you package those things and sell them through major investment banks, discipline leaves the system".

There are risks for the subprime lenders. In their agreements with investor purchasers of their bundled mortgages there is the right for the investor to require a buyback if a loan goes bad within a certain time.

There were very few buybacks as long as the housing market was appreciating rapidly during the boom (bubble). The boom, the appreciation of housing was fueled in some respects by the easily obtained loans. Many speculators moved into realestate hoping for riches. If a borrower got into trouble (could not make the payments) they could easily sell, take their profit and move on. Therefore, there were very few loans in default. When the market began to slow down and values stopped appreciating there was no way out for these borrowers so they stopped making payments.

When enough borrowers stopped making payments the investors started enforcing their buyback clauses. In time the subprime lenders did not have enough cash to buy those loans back from the investors and the lenders folded.

There was a time when a loan for a house required a twenty percent down payment. The loan came from a local lending institution where they were very concerned about a borrowers ability to pay back the loan. Few bad loans were made and the institution could cover the costs of bad loans with the twenty percent they had already received should something go wrong.

In the subprime lending world there were very few if any criteria required. The loans also often had adjustable rate mortgages that would start off with very low interest payments that would ramp up rapidly in a few years. The state of mind of many borrowers was that they would make so much money off the rise in value of the house that this did not concern them. However, when the market did not allow this many people who had these mortgages could not afford the payments.

How did they get this way? Lets just say they were not well advised when taking these loans. For those facilitating these loans (the crux of the problem?) there was no profit in advising them that they might face serious consequences from an adjustable rate subprime loan.

You may have noticed in the headlines that not only specific sub prime lenders are part of the losses. Major financial institutions such as Deutsche Bank, Merrill Lynch, Morgan Stanley and others got caught in this. You wouldn't think such institutions were so blind to the risks -- they were. They got into the business of packaging mortages as securities to sell to their clients and they invested some of their money also. These packages of mortgage-related securities were sold to investors such as pension funds. The estimates vary greatly though one says that there may be more than $500 billion dollars of potentially worthless paper on the balance sheets of banks.  These loses could affect pension and mutual funds that also invest in these securities.

About 22 percent of all subprime borrowers are currently delinquent on their payments, according to First American LoanPerformance, an industry research firm. There is a bill in congress attempting to freeze interest amounts for sub-prime loans to pre-adjustment rates. That is, only if the loan is not already delinquent. About $57 billion in subprime loans are scheduled to be reset to higher rates before the end of this year according to estimates by First American Loan Performace.

The good news for those of us in Washington State is that we have a low percentage of sub prime loans. The bad news is we are part of the national economy and the woes of the sub prime situation do affect us all.

It is good to remember that the fundamental outlook for Washington State is good.  In June of 2006 Money Magazine predicted that 5 of the to 10 fastest growing areas in the nation will be Washington and 10 of the top 17 areas are in Washington. Olympia is expected to grow by 13 percent compared to a 5 percent growth rate in the nation.

This has to do with the job growth in the area.  The job growth in Washington (2006) was 3 percent . That was double that of the nation as a whole.  There are two parts to this growth.  One is population growth that is nearly twice the national average and the home ownership rate of 64 percent versus 70 percent nationwide.