Construction and real estate account for about 10% or more of the economy.   Construction booms and busts have the lead the economy out and into recessions.  With 10% of the economy paralyzed, it’s fair to say an chance of an employment-filled recovery depends on repairing the sector.  

Three factors suppress the industry: first, lack of confidence, second, lack of qualifying buyers, third bank practices.  They’re all intertwined.

A falling market keeps buyers thinking a better deal awaits – so why buy now?  Buyers will purchase when prices stabilize.  Unfortunately, until buyers purchase prices will keep falling.   Only discovering a sea of oil beneath Montana could create the kind of economic burst to break this psychology.  That’s not likely.

The lack of confidence in future prices is justified.  Too many units were built, banks are squeezing developers to sell their buildings at a discount to pay off their construction loans and the number of qualified buyers is in retreat.   As fewer buyers chase more available properties, values fall, more properties go upside down, banks require more sell offs, and more real estate pours onto the market.  This causes the next round of price drops and the cycle repeats.  

Eventually, if nothing is done a bottom will be reached but it won’t be pretty.  Every piece of real estate will be owned predominantly in cash or will be appraised at the price of a rental.  This applies to everyone who has short-term financing and might have to refinance in the next five years and it includes single family home owners.

The lack of qualified buyers is not predominantly a result of the recession.  Unemployment rose from 7 to 10 percent or considering real unemployment and underemployment it went from 11 percent to 17 percent.  That should mean 6 percent fewer qualified buyers plus those buyers who fear impending unemployment.  This latter group shrinks as the economy sheds jobs and stabilizes.  It also shrinks as we get used to our current circumstances.   In other words, we stop fearing the possibility of unemployment just like we stop hearing a noisy neighbor.   The fear always exists during good and bad economies and eventually the fear factor between these two level out.   

This means that once the job growth begins, the number of qualified buyers should be at most only 6 percent lower than before.   On the other side of the coin, with housing prices falling, a whole lot of Americans with smaller incomes should now qualify to purchase homes.  Only they can’t.

The reason is a crisis in lending.  Bankers have strong incentives not to give mortgages.  First, bank regulators demand that they build their reserves and limit their real estate exposure.  Second, regulators examine their loan portfolios and challenge anything questionable such as home mortgages.  Third, Fanny May, Freddie Mac and FHA dictate home loan qualifications and they’ve raised the standards.

And there’s more: some banks like Bank of America irrationally avoid mortgage risk.  Avoiding risk is not irrational but avoiding low-risk mortgages while taking on higher- risk loans for less return is irrational.  Major enterprises get plenty of money at low rates even though they’ve had their major collapse.  Remember GM?   Bankers act like a herd in a stampede.  The bolt of lighting was the mortgage crisis and they’re still running fearing the cloud of dust they themselves are creating.  

Banks making record profits reinforces this risk aversion.  If you’re making record profits doing what you’re doing, why change?   Banks borrow from the fed at 0% and lend at 5, 6 and 7 percent.  It’s a big slice.  Writing mortgages is a small slice.  Mortgages get sold off and banks only make routine profits.  It requires work the old fashioned way but it’s not worth doing when there’s low hanging fruit at 5, 6 and 7 percent.

Banks have other destructive behaviors: they know they have their real estate developers by the short hairs.  No bank will finance another bank’s construction loans.  In other words, if you’re a developer and you need your loan renewed, you have only one choice, your existing lender.  The result is that banks are squeezing real estate developers with loan renewal costs, interest rates, and the threat of foreclosure.  Banks justify this by claiming the need to replenish their capital reserves.  Developers are easy pray.

The result is a sell off of real estate, a flood of units on the market and lower values which trigger further sell offs.  The banks acting individually destroy real estate values which they end up holding as a result of foreclosures.  Game theory indicates they all would be better off if they changed practices and worked together.   That hasn’t happened which means it’s too much to expect of bankers.

The government needs to intervene or the destruction will continue.   The FDIC has to loosen its standards and raise its insurance rates.  It should focus on unethical and irresponsible business practices and let bankers hold more real estate-related loans in the portfolio.   Fanny, Freddie and the FHA have to get on board, too.  I haven’t had a single foreclosure in the projects I’ve sold but it’s unlikely that half our buyers would qualify under today’s standards.  This means the standards are far too tight. 

Had these buyers not been able to purchase, our construction capacity would have been wasted. That’s exactly what’s happening nation-wide today.

Finally, the fed can stop lending money to all banks equally.  If banks had been making mortgage loans previously, demand that they continue to do so.   Tie their fed loan rates to the percentage decrease or increase they have in writing home mortgages.  A proper formula will make it profitable to write real estate loans.  A flood of new qualified buyers in the market will stabilize prices and create more new jobs than any stimulus program.