1. A bushel of new Virginia laws affecting real estate professionals will be enforced beginning tomorrow. You can download a convenient two-sided legal-size summary (PDF) of the new laws to get more information. If the print is too small for your taste, try the whitepaper version (PDF).
2. Changes to the laws governing property owners associations passed in the 2008 Virginia General Assembly (also effective beginning July 1) are so sweeping, we’ve created a special webcast with VAR’s special counsel Lem Marshall to address them. Watch it here.
3. Related to the property owners association act, VREB has just released an FAQ document about the Common Interest Community Board and the Office of the Common Interest Community Ombudsman. Download it (PDF) here.
4. All real estate brokers with VREB license renewals due on or after July 1, 2008 must complete eight hours of broker management and agent supervision CE in their two year renewal cycle. Download a letter (PDF) from VREB for full details.
5. The IRS raises its mileage reimbursement rate tomorrow to $0.585 per mile.
6. Tomorrow (but not before), you can toast all these new rules and regulations with a glass of sangria at your favorite Spanish tapas restaurant. That’s right, Virginia restaurants can serve drinks that mix beer or wine with liquors without fear of prosecution beginning tomorrow.

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You could be one of a few lucky REALTORS® to win the perfect opportunity to get ahead in this challenging marketplace.

In honor of VAR’s 88th Convention & Expo, registrants numbers 88 (gone) 188, 288, 388, 488, 588, and so on… will receive a full refund for their base convention registration. That’s right, register before September 15 (the discounted early bird deadline is July 18, by the way) and you might just get your entire base registration fee back. Winners will be announced at VARConvention.com and notified by e-mail.

Trying to time this contest is like trying to time the real estate market, so don’t bother trying. Just register today for your chance to attend VAR’s Convention & Expo for FREE!

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“The non-English speaking population in Virginia was disproportionately affected by the foreclosure crisis. In my opinion, mortgage brokers took advantage of these people.”

“Short sales are not for someone who is looking for a quick close. What is more interesting about the process is the same bank that can give you a response on a foreclosure in 48 hours takes 60 days to go through the file on a short sale. We all realize it is two different departments but if you are sitting on a file with all of the required documents and four offers why wouldn’t you respond?”

“Short sales are a great opportunity for investors, but I still believe they should be avoided by people who are looking for a home.”

“It was funny for me to see this [magazine cover]. I had a house listed a few years ago in Austin and advertised it with an upsidedown photo. It got a lot of attention and I got some good calls off of it.”

“This is one of the clearest and most straightforward breakdowns of short sales that I have ever seen.”

“One of the only correct, concise articles I have read about short sales! … Thanks for a great article!”

We’ve also gotten a couple of inbound links from these articles. One comes from the Memphis Area Association of REALTORS®.  The other from Jeff Royce, a Fairfax REALTOR® who was quoted in one of the articles and explained his position more fully on his blog.

In related news, Cindy Jones says REALTORS® should factor in 25% more time to work a short sale listing, based on her personal experience (see the comments). What’s your experience?

Got feedback about this issue? Leave a comment or blog about it and link to us!

Oh, you haven’t read your May/June Commonwealth yet? Now you know what you’re missing.

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We hear ya!

Announcing a social media research initiative specifically for REALTORS®. The Center for Real Estate and Social Technologies (CREST) will be the definitive research and education resource for social technologies in the real estate business, conducting surveys and other projects to generate benchmarks and best practices that REALTORS® can employ to improve their social networking, blogging, and social media marketing efforts. CREST’s surveys will always be in the 10-15 question range, real estate specific, and conducted every 2-3 months so you can spend less time filling out surveys and we can continually release relevant information to you.

Today, CREST launches its first effort, a 14-question survey focused on real estate blogging. We’ll have at least one more survey on blogging before moving on to other social media marketing topics. The deadline to complete this survey is Friday, July 11 at 9 a.m. EDT. The results of this first survey will be simultaneously released at REBarCamp and here at VARbuzz on July 22.

All blogging REALTORS®, no matter where they live or work, are invited to complete this survey. Those who complete it and provide an e-mail address will receive a free copy of the aggregate survey data and an executive summary. You can rest assured that we are taking all necessary steps to guarantee your anonymity in this process.

The survey is embedded below. RSS subscribers may need to click through to take the survey.

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1. $10/gallon gas good for the real estate industry
2. REALTOR® Tools page at VARealtor.com
3. VAR’s Convention & Expo 2008
4. Ethical Considerations in Short Sales webcast
5. HUD Anti-Flipping rule waiver request form

Maybe you missed these items…

1. Want to become more efficient and proficient with ZipForm? Attend one of these two webcasts
2. Be heard on how biosolids affect residential home sales
3. Check out the REALTOR® Code of Ethics in StraightTalk
4. Fundamentals of Technology class (CRS 106) in Harrisonburg
5. Take NAR’s mandatory Code of Ethics training before December 31

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Virginia REALTOR® Leadership Academy (VLA) graduates say it’s the best way to supercharge your real estate career.

“What you learn in this course can be used in all aspects of your life, from home, to business, community involvement, volunteering in the association of REALTORS® or any other organization.” — Rick Cockrill, CRS,GRI, RE/MAX Renaissance, Leesburg

“VLA has given me the opportunity to hone my leadership skills and exposed me to different approaches and ideas…” — Mary Bayat, Principal Broker, RE/MAX Champions, McLean

VLA enrolls 20 emerging leaders per year. Applicants are hand-picked to participate in a nine month program of leadership development training focused on the real estate profession. Participants work together over the course of four retreats in development experiences that combine individual study, group sessions, and actual project experience in using leadership skills. Many graduates go on to leadership roles at their local associations, VAR, and NAR.

The deadline to apply is July 1, so start downloading and filling out your application today!

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A bit unsettling? Good. That’s what we’re going for.

You see, the number of Virginia homeowners getting upside down in their homes may be diminishing, but short sales and foreclosures are present in every market and will be around for the foreseeable future. VAR is here to help you face these current realities.

This issue of Commonwealth features the experiences and perspectives of REALTORS® who have been involved in transactions with distressed sellers, a comprehensive guide to navigating your legal and ethical responsibilities in short sales from Lem Marshall, and a history of fiscal policies and world events that will help you understand the forces that brought us this challenging lending and housing market.

There’s also the ever-popular Legal Lines column and information about the keynote presentations at VAR’s Convention & Expo 2008. Speaking of Convention, VAR’s CEO, Scott Brunner has a little fun with The Last Word.  Read it and you could win a free Convention & Expo registration. But you’ll have to crack the paper copy, arriving in your mailbox this week, to do that.

Two articles from the magazine are posted here at VARbuzz, “Finding the upside in ‘upside-down‘” and “The subprime meltdown.”

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REALTOR®, know thy lender

Lenders today, especially those holding a snootfull of bad loans, are facing unique pressures. A 2002 Tower Group study found that the average cost to a lender of foreclosing, holding, and disposing of
a property was almost $60,000, and that number is likely a good bit higher today.

Adding to lender woes is the simple reality that the market still has a way to go before we see home prices back into historical balance with household incomes. (See The subprime meltdown) A lender might not be anxious to take a property and try to sell it 12-18 months from now, when prices might well be lower.

Lenders are no fans of foreclosures. Taking ownership of a home means it has to add to its reserves, which reduces money available for lending and other income-producing investments. That damages its balance sheet even before considering the cost of maintenance, repairs, and real estate taxes.

Trying to offload REO into a saturated market can further depress values, starting a vicious cycle of
decreased worth and further defaults by borrowers.

So if we do our homework and give the lender a deal it can’t refuse, it will have every incentive to take it.

(There is one thing to be prepared for: Short sales take a long time — anywhere from 30 to 90 days more than a typical resale. With lenders and loan servicers already overworked, it might even be longer. With short sales, patience is not just a virtue, it’s a necessity.)

REALTOR®, know thy seller

Your first task is to get all the information you can about your seller and the property, and determine whether you’re likely to be dealing with a short sale.

That might mean making some probing questions during your initial interview with the seller. You will have done a CMA, of course, but now you’ll need to know how much it will take to clear existing liens and deliver good title.

Often your seller will know, and be willing to speak candidly with you about the facts. Sometimes, however, the seller won’t know all the facts (whether there’s a judgment lien, the amount of late fees, penalties and accrued interest, the amounts owing on credit lines, etc.). Sometimes the seller will know these things, but will not want to give you a candid response to your questions, either because of embarrassment or out of concern that if you know the facts you’ll urge a strategy that leaves the seller well short of the net needed to clear the title.

You’ll also want to know whether he’s current in his payments, and if not, how far behind is he? Has he
received default notice? Has foreclosure begun? If you are not 100 percent satisfied with the answers, consider doing your own lien search, or at least asking the seller to dig out his payment records.

You’ll want to know the seller’s motives for selling, and as much as possible about the seller’s financial condition. Is he unable to make his payments because his ARM has reset? Is he able to make his payments, but just doesn’t want to continue to throw good money after bad?

And don’t forget to ask your seller for a copy of his loan application and any other financial information he gave the lender when applying for the loan. (You’ll see why in a moment.)

You should also get as complete a picture of the condition of the property as possible. You’ll likely have
to structure the purchase agreement differently from the more common resale, and surprises about property condition will not be helpful.

It will also be helpful to know the area. Has it been classified “declining”? Are there nearby short sales? How many foreclosures have occurred in the last six months? With most or all of this information in hand, you can begin to prepare a marketing strategy.

REALTOR®, know thy marketing strategy

Your first decision is pricing, where you’ll run into the first counter-intuitive reality: Your pricing needs to meet your client’s urgencies, but you must be relatively aggressive, at least if you have any time at all to do so.

Why? Consider the lender’s reaction if you present a low offer shortly after putting the house on the market. If the lender is not confident that the offer is reasonable, your change of approval is slim. And most lenders will want to see that you’re making a reasonable marketing effort, especially if there are few other distressed sales in the area.

In fact, you might want to approach the lender as soon as you know you’re facing a possible short sale. Some lenders won’t talk to you if your seller isn’t well behind in his payments, and it’s important to know that up front. And lenders are increasingly willing to discuss strategy and, in some cases, even pricing, early on.

There are other benefits to early contact with the lender. You can find out who your point of contact is, what the lender’s list of requirements for approval are, and, possibly, how long the lender anticipates it will take to approve a request once submitted. (Knowing how long a wait to expect can smooth things over with buyers, too. They’re more likely to show patience if they know how long they will have to wait.) Some lenders will want to deal with the seller directly as well; they may have specific forms and requirements only he can provide.

Once you know what the lender needs, start putting it together. At a minimum that will mean a seller’s W-2 or proof of unemployment, the last two tax returns, financial statements, the last couple of years of bank statements, and a hardship letter. You will almost certainly have to give the lender your CMA or obtain an appraisal of the property as well.

Needless to say, be careful. If the seller obtained a stated-income or no-documentation loan, compare the information on the loan application with the what you are preparing to submit with the request for the short sale. Be especially alert to evidence that the seller falsified or overestimated income and/or assets, or lowballed or underestimated debt. Serving up to the lender evidence of seller’s loan fraud is probably outside the scope of your authority.

Along the same lines, be alert for evidence that the seller has frittered away his earnings or assets on a lavish lifestyle. Lenders respond favorably to legitimate hardship, but frown upon profligacy when they are being asked to take a haircut and forgive debt.

REALTOR®, know thy ethical obligations

Whether you are certain you are dealing with a short sale or just suspect it will take a stroke of good fortune to avoid one, you might be tempted to note in the MLS that this is a short sale. In fact, some MLSs have a field for this information.

You can’t make this decision by yourself, regardless of what you hear from other REALTORS®. The Virginia Code requires you to “maintain the confidentiality of all personal and financial information received from the client during the brokerage relationship … unless otherwise provided by law or the seller consents in writing to the release of such information.” This certainly includes the fact that the seller cannot pay off his mortgage(s) from the anticipated proceeds of the sale.

Your seller will need your professional guidance here. There might be an imperative that he get the best offer he can quickly (if he is already under the gun of foreclosure, or behind in his payments) even if it is well below what he owes. In such a situation, it might make sense to let participants in the MLS know how things stand.

On the other hand, he might insist on trying the market without letting prospective buyers know of his distress. This might be the case if he has hopes of avoiding a short sale, or is hopeful of securing a workout with his lender — if he is moving to take a better job, for instance, and offering the lender an unsecured note for the deficiency.

If you do agree to notify the world of a possible short sale, be sure to get the seller’s consent in writing.

REALTOR®, know thy buyer

When you get an offer on the property, you’ll have to approach things somewhat differently
from how you would with a more routine resale.

In the first place, the lender is not going to waste time on a deal that can’t close. This means
that your buyer will have to qualify to not one but two lenders — his own and the seller’s.

The seller’s lender is unlikely to be satisfied with just approval from the buyer’s lender, let alone a “prequalification” letter. Many payoff lenders will actually require the buyer to make a full-fledge loan application with it — not to borrow money, but to prove he’s actually able to get the loan he’s seeking.

Obviously, the better your buyer’s loan profile, the better the chance of approval. Whomever your buyer is, he must be able to close and convince the payoff lender of that fact. You might as well make that clear from the start of your dealings.

On the other side, if you’re a buyer agent, you’ll want to know your client’s tolerance for a short sale. And, of course, you’ll want to know when you’re about to enter one. If the listing agent has not made that clear in the MLS or otherwise, ask. If you don’t get a satisfactory answer, at least conduct a down-and-dirty lien search to find out if a short sale is in the cards. But don’t blame the listing agent for not telling you up front: he might not be able to.

REALTOR®, know thy contracts

A well-drafted is always central to a successful transaction, but this truth is magnified in a short sale. A contract with contingencies and full of seller concessions and credits will probably grate on the payoff lender’s last nerve.

Do as much up front as you can: get approved, get inspected, and put all necessary credits and seller concessions in the price. A contract that comes to the payoff lender clean stands a much better chance of success. A leaky roof should be your seller’s problem, not the lender’s.

A short-sale contract is going to have a contingency for third-party approval. But how should it read? Most contain a provision along the lines of, “This contract is contingent on approval by seller’s lender.”

What does such language mean? It could mean that there is a ratified contract but that seller’s obligations are contingent on lender approval. In this case, the earnest money deposit must be placed in escrow (with all that means), and the buyer will find it difficult to back out of the deal while approval is awaited.

Or it could mean that there is no contract until the lender approves. In this case, either buyer or seller can back out before approval arrives. It also means that the earnest money should not be deposited until approval is received.

So which is it?

It’s worth considering whether to be crystal clear on this point. The contract might say: “Seller’s obligations under this contract are contingent on approval of seller’s lender” or words to that effect. Or “Acceptance of this offer and creation of a binding agreement is subject to written approval of seller’s lender.”

It’s especially important to consider the language if more than one contract/offer is being presented to the lender. I have heard of several instances recently where seller has received multiple offers, signed all of them, provided that “This contract is contingent on lender approval” and sent them to the lender for consideration.

This can create a great deal of ambiguity as to where the parties stand. In the first place, are all the contracts “ratified” or not? Does each escrow agent have to keep the deposit and await the lender decision and approval of the seller to release the deposit if the contract is not approved? Does the listing agent have to note in the MLS that a contract is pending with contingency?

If you don’t know the answers, you should.

REALTOR®, protect thy commissions

Now we come to perhaps the most contentious issue of all: commissions. Some lenders will require, as a condition of approval, that the listing agent reduce his commission.

Let’s say the seller has agreed to pay the listing firm 600 chickens and that the listing firm has made an offer in the MLS of 300 chickens to the firm that procures the buyer. What happens if the lender requires the listing firm to accept only 400 chickens?

First, let’s dispose of the ethical issue here. Is the listing agent ethically obligated to accept the reduced fee to make his client’s deal happen? After all, the lender is offering to accept a deal that allows the seller to avoid foreclosure and possible bankruptcy, and to salvage something of his credit, if the listing agent will only concur.

The answer here is simple: A REALTOR® is never obligated to reduce the fee he has been promised to make his client’s deal work. You might find it in your interest — compelled by your conscience or your moral compass — but you have no legal or ethical duty, under the Code of Virginia or the Code of Ethics, to do so.

And if you agree to a reduction? Most of the time you’ll want to approach the buyer’s agent and request that she reduce her co-broke fee to 200 chickens from the 300 that were offered in the MLS. Is she ethically obligated to do so? May you even ask her, within the strictures of the Code of Ethics, to accept less than was promised in the MLS?

It comes as a surprise to most REALTORS®, but the Code of Ethics does not prohibit a listing agent from using a purchase offer to renegotiate the terms of what’s in the MLS.

Standard of Practice 16-16 prohibits the buyer agent from using the terms of an offer to renegotiate the listing company’s offer in the MLS, but it does not work the other way around.

But does the buyer agent have a duty to her client to accept the reduction to make the deal happen? Again, the answer is no. No REALTOR® ever has to accept a reduction in the promised fee to achieve a client’s objectives. It’s entirely your decision as to whether to do so.

So if the buyer agent rejects the offer and even refuses to ask his buyer to pay the difference — or if the buyer refuses to pay the difference when asked — what happens to the listing agent? With the lender requiring the reduction, and the buyer and buyer agent refusing to cooperate, can the listing agent count on the seller to support her? Remember that at this point, the listing agent has agreed to accept 400 chickens but finds herself having to pay out 300 to the recalcitrant selling agent, leaving only enough to make a couple of omelets.

Who do you think the seller, seeing only 100 stinkin’ chickens standing between him and foreclosure, is going to support? No, I’m afraid the listing agent is at the mercy of the buyer agent here, and that’s a shame for both.

The problem has not gone unnoticed. Some listing agents have taken to putting conditional offers of compensation in the MLS. They will offer something along the lines of, “300 chickens or one-half of the fee approved by the third-party lender.”

Let me be clear: Such offers do not belong in the MLS and probably violate NAR multiple listing policy,
which has long required that a selling agent be able to calculate, from the offer, the amount of compensation she will receive upon procuring a buyer. When the offer of compensation is essentially “one-half of what I agree to accept” the selling agent has no idea what the compensation, if any, will be.

What principle dictates and what reality dictates can be two different things. The NAR legal staff agrees that NAR policy does not permit this kind of offer. But the market is roiled and many agents are framing offers this way because they’ve been burned by uncooperative buyer agents. Virtually all MLSs are accepting them, so — are you ready for this? —we’ll just have to rely on the arbitration panels to sort it out.

There’s much more to say about short sales — how you deal with second mortgages or other junior lien holders, for example — but then there’d be nothing for you discover on your own. So lets just say that the short sale requires us to know a lot — about lenders, the economic environment, the clients, the property, the neighborhood, the other party, the contract, the Code of Ethics, Virginia law, and ultimately, ourselves. Do we have the stomach for this unique opportunity to show expertise our clients desperately need? The answer is “Yes.” But they won’t last forever, so if you don’t want to miss the fun, you’d better get hopping.

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In a wonderful scene in The Godfather, Don Corleone has convened a meeting to negotiate a peace among the warring crime families. He begins his address to the assembled mob bosses by asking: “How did things ever get so far? I don’t know. It was so – unfortunate – so unnecessary.”

It’s hard not to think of that sentiment when we examine the housing crisis we now face in so much of the country, and in so many parts of Virginia.

How did things ever get so far?

The question invites a history lesson, one that informs so much of what we must do – and must not do – to see our way through.

As we try to make sense of our predicament, it is useful to understand the principal ingredients to economic policy, especially fiscal policy (established primarily by Congress and the president in formulating tax, regulatory and other economic policy) and monetary policy (established by the Federal Reserve through its control of money supply and interest rates). It is the interplay of policy decisions in these areas that provided the fertile ground for the highly questionable decisions of lenders, borrowers and investors that led to the current unpleasantness. So join me in an interesting stroll through recent economic history for the context that we need to understand how REALTORS® should act both individually and as an association in the light of current events.

The power of the Fed

First, however, a brief explanation about how the Fed affects interest rates and money supply. Interest rates are set mainly through the Fed’s mechanism of making funds available to member banks and other financial institutions. The main rate we hear about is the Federal Reserve Board discount rate, the rate at which member banks in need of liquidity can borrow from the Fed. This rate in turn affects everything from credit card rates to fixed and adjustable mortgage rates.

Money supply is manipulated in part by printing money or buying financial instruments (thereby increasing the supply of money in circulation) or selling assets from its balance sheet such as government notes and bills (thereby decreasing the supply of money in circulation).

The Fed’s purchase and sale of interest-bearing instruments such as T-bills and notes also affects interest rates, because rates move directly opposite the price paid for the instruments. Aggressive buying of t-bills, for example, pushes up their price, and thus drives interest rates lower, and the opposite is the case. (To see why this is true, consider that you own a bond yielding 5 percent. If interest rates go up to 10 percent, your 5 percent bond becomes less valuable, and if interest rates drop to 2 percent, your 5 bond yielding 5 percent becomes more valuable. Prices of bonds and their yields – interest rates – thus go in opposite directions.)

One other piece of table setting. In 1944, as the war was winding down, the major economic powers met in the small New Hampshire town of Bretton Woods to establish an economic accord that took its name from that rustic New England hamlet. Because the United States was certain to emerge from the war as the world’s economic powerhouse, the dollar was established as the reserve currency for the world’s economic system, with all other currencies pegged to the value of the dollar. To assure its value, the dollar, in turn, was pegged to the historic store of value – gold. Dollars would be redeemable at the U.S. Treasury at the rate of $35 per ounce of gold. (The U.S. at this time owned about 65 percent of the world’s supply of gold).

throughout the 1950s, economic prosperity returned after the long years of depression and global war. the years of the Eisenhower administration saw average increases in the Consumer Price Index of around 1 percent. But an economic slowdown at the end of the decade prompted President Kennedy to propose a fiscal stimulus in the form of massive tax cuts, and President Johnson secured their adoption. the economy revived, still with low inflation. But the perfect storm was brewing. The U.S. was waging the Vietnam War, the Cold War and the War on Poverty, and the federal budget exploded. the Fed monetized the debt created by this massive increase in federal spending, and supplied huge amounts of new money into the economy. Predictably, inflationary pressures grew, and pressure on the dollar increased. With the world supply of dollars rapidly increasing, and with global confidence in the American economy further eroded by large tax increases pushed through by President Johnson, other countries doubted the dollar would maintain its value, and began to redeem these excess dollars for gold at the low, fixed price established by Bretton Woods. American gold reserves dropped rapidly, and inflation, which had been at less than 1 percent in 1961, reached almost 6 percent by 1970.

Nixon’s responses were historic, and fateful. He slapped on wage and price controls (bringing about all
sorts of distortions in the economy), and, more importantly, abrogated the Bretton Woods agreement. He decoupled the dollar from the gold peg and let it float. Gold prices doubled by 1973, as the dollar slumped against other currencies.

During the remainder the 1970’s, inflation accelerated and the economy, in response to constrictive fiscal policies, began to stagnate. at the same time, commodity prices around the world began to soar. Oil, which had been trading at $12 a barrel in 1970, reached $22 a barrel in 1973. Gold reached $100 an ounce in 1973, and was near $200 an ounce by the time Nixon left office in 1974.

In response to budget deficits he considered too high, and blaming them for the economic troubles of the previous decade, President Carter pushed through the largest tax increase in American history, with disastrous effects for the economy. The Fed, doing what it could to ease the economic pain caused by the fiscal tightening, opened the monetary spigots, and massively increased money supply. The results are almost too painful to recall. By the end of the Carter administration, gold was near $700 an ounce, as the dollar’s value plummeted. Oil, which had cost $22 a barrel when Carter took office, reached $62 a barrel by the end of his term. Inflation hit nearly 14 percent, and interest rates reached 20 percent. We learned a new term: “stagflation.”

Adding to the misery was the fact that the music of the 1970s was really, really lousy. Remember disco? Remember “Disco Duck”?

The Reagan administration and the new Federal Reserve chairman, Paul Volker, promptly reversed course. Sweeping tax cuts were enacted to give the stagnant economy a fiscal stimulus, and the Fed clamped down on money supply to wring the inflation out of the economy. A brief but sharp recession began in 1982, but starting with the tax cuts in 1983, the economy began a generation-long expansion that has continued largely unabated – with the exception of two mild and short recessions – until recently. By the end of the decade of the 1980s, inflation was under 5 percent, interest rates were around 8 percent, oil was $28 a barrel, and an ounce of gold fetched about $350 an ounce, or about half its price in 1981.

The 1990s saw this economic growth continue, with stable prices and low interest rates. Mortgages rates slid to the 6 percent range, inflation averaged a bit over 2 percent, oil traded at an average price of about $20 a barrel, and gold remained in a narrow trading range between $300 and $400 an ounce. With generally responsible fiscal policies from Washington, prices remained stable, interest rates hit new lows, and the economy grew briskly through the 1990s.

A one-two punch

In the last years of the 1990’s, the Fed, under Allen Greenspan, became increasingly concerned about the possibility of a global financial crisis threatened by – do you remember? – Y2K. Policy makers believed that our technology would not be up to the change from 1999 to 2000, and wanted to assure adequate liquidity in case of a financial meltdown as the clock struck midnight on January 1.

At the same time, the technology sector was roaring, and technology stocks were selling at prices that defied reason, in part because of monetary policy adopted to counter the expected effects of Y2K. At one point the tech-heavy NASDAQ hit 5000. When the Y2K crisis failed to materialize, the Fed reined in the money supply, and the tech sector collapsed. Within less than 2 years, the NASDAQ had lost half its value. The collapse of the tech sector sent the economy into recession in the last year of the Clinton administration, and in part to counter this slowdown, President Bush pushed through large tax cuts during his first year.

Then came 9/11 and a real global financial crisis. Stock markets around the world tumbled in response
both to the terrorist attacks and fear of the repercussions. To stem the panic and the global financial crisis, and to assure financial markets that adequate liquidity would be available, the Fed opened the spigots aggressively. The Fed not only kept interest rates low, but continued to pump money into the world economy.

This was necessary, prudent and effective – to a point. Beginning in 2005, however, many observers began to wonder whether the Fed had not overshot its targets. The Wall Street Journal, for example, began to caution that leading indicators of inflation were beginning to signal trouble brewing. The dollar had begun a steep slide against foreign currencies, gold burst through its long trading range between $300 and $400 an ounce, and oil prices hit levels not seen since the Carter years. The signals were clear, and, in retrospect, ominous.

We can now confidently say that the Fed’s decision to keep money supply increasing rapidly throughout the first years of the decade was a historic mistake. It contributed mightily to rapid increases in the price of commodities (including oil), to rocketing gold prices, and to a precipitous decline in the dollar’s value.

A few facts illustrate this. The euro, trading at $.75 in the first years of the decade, now trades at over $1.50. For the first time in living memory, the U.S. dollar is below parity with the Canadian dollar. Gold has recently traded at more than $1000 an ounce, and as of this writing oil is trading at $123 a barrel.

Most importantly, however, Fed policy contributed greatly to a housing bubble that began in 2001 as Fed monetary policy kicked into high gear. Interest rates were at historic lows, as the Fed discount rate hit less that 1 percent. Mortgage rates tumbled, adding to the demand for housing and accelerating price increases already under way.

Beginning in 2004, the Fed began to reverse course by raising interest rates once again, well after the housing bubble had appeared. The discount rate peaked at 5.25 percent in mid-2006 and remained near these levels until the fall of 2007. A byproduct of this effort was the popping of the housing bubble. Since 2007, home prices nationwide have declined by approximately 20 percent from their highs in 2006.

Monetary policy alone is not the cause of our current problems. But most analysts now believe that Fed policy during this time was the sine qua non of the housing implosion we are now dealing with.

The Fed has, during the last 20 months or so, begun a rapid reduction of interest rates to the current 2 percent level, and has throttled open the money supply once again to try to support home values.

The effect? Gold, oil, and commodities are skyrocketing, inflation is hitting very disturbing levels not seen in many, many years, and the dollar is sinking further. Echoes of the 1970s.

Worse, the Fed is probably just pushing on a string. You can make the money available to lenders, but you can’t make buyers buy or lenders lend when they expect the value of the home or the collateral to sink further. This is just what buyers and lenders think, and they are almost certainly right.

Riding the bubble

So where does this leave us? To get the answer to this question, look at the graph, “Home prices and household income”.

The bottom line shows the trajectory of average household incomes since 1999. It shows a fairly steady increase that’s in line with the good economy of the last 25 years. The top line shows average U.S. home prices. You are looking at a classic asset bubble. This graph tells us what we already should know: a situation in which home prices increase faster than the ability of households to pay them cannot – cannot – last.

But this graph tells us much more. Let’s look at it closely. The first thing to note is that home prices have not yet returned to their historic relationship with household incomes; in short, home prices still have a way to go on the downside. Estimates put this number at anywhere from 10 to 20 percent, and that should also inform the decisions of policy makers. We have a choice: we can take steps to reacquire equilibrium as quickly as possible, in a manner consistent with political reality and the need not to send the economy tumbling, or we can delay reaching that necessary equilibrium by taking actions that keep prices artificially high.

One thing is strongly suggested by the graph: in many markets, buyers who are skeptical about buying now are probably more right than wrong. So are lenders who are hesitant to lend to borrowers who don’t have pretty good credit and who are not making a reasonable down payment. It just might be fair to say that anything we do to delay getting back to equilibrium will, per force, keep buyers out of the market. Why? Because in so many places, prices are unaffordable for average households.

The evidence that buyers understand this is compelling. A recent poll conducted for the Associated Press-AOL Money and Finance by Abt SRBI Inc. found that a growing majority say they will not buy a home anytime soon. Sixty percent of those interviewed said they definitely will not buy a home in the next two years, up sharply from the number who said the same thing 18 months ago, at the start of the downturn.

The poll notes that the growing reluctance is at least partly the result of the worry that housing prices will continue to fall. Half of all those interviewed say that homes are still overpriced, a fact borne out by the graph. Not surprisingly, the number of those saying houses are about right has fallen to about a third of those sampled. The poll found that the biggest worriers are those expecting to buy soon. of that group, almost half believe that value will drop in the next two years.

Hard choices

Another thing you’ll notice while looking at the graph is that there are a lot of people on the inside of the bubble. These are people who are nameless and faceless to reporters, who, for understandable reasons, focus on the sympathetic and identifiable families being forced out of their homes. But these people are nonetheless real. They want a home, but they can’t afford one. They were unwilling to gamble during the recent frenzy. And they will not have a home to buy unless someone is willing to sell at a price in line with their income.

One way to think about the “nothing down,” subprime borrower is as a renter. For him, finding another rental is, financially, a reasonable demand if he can’t afford the “rent” on this house. Somehow, subsidizing his payments means to deny the other guy a house he can afford.

Instead, we can ask the current owner to leave, and let the lender put the house on the market at a reasonable price. This, in effect, is what the foreclosure does. As we will also see, it is what the short sale, as a proxy for the foreclosure and sale of the REO, does even more efficiently.

Another thing should also be clear in looking at the graph. Anything that keeps the income line from continuing an upward trajectory will exacerbate the problem we now face. If anything, we should do everything possible to increase the slope of the line, by increasing average household incomes.

So here’s how we might order our thinking, if we understand our history and can believe the evidence
we’re seeing.

• Housing is still overpriced, and needs to return to the levels that history says are sustainable and affordable. In fact, they must logically return to those levels, unless we take action to prevent it. But if we take such action, it will only delay a recovery.
• Until the equilibrium is reached, many buyers will be locked out of the homes they could otherwise afford. Buyers who have the option to do so will stay out of the market, unwilling to buy an asset they believe is likely to decline in value.
• Lenders can read economic tea leaves as well, and will be hesitant to return to normal lending practices while they expect the asset they lend on to decline in value.
• Policy makers should acknowledge the realities we face and do everything possible to permit the orderly correction of the market. Most of all, they should not make it their priority to keep prices artificially high as viewed from the vantage point of family incomes.

If that means the current owners should be allowed to lose the house so it can find its proper level for the benefit of another buyer, that should happen, as truly sad as that might be for the current owner. If that means the lender has to take a haircut, well, the lender made the imprudent loan.

The most maddening policy decision of all would be to rescue reckless lenders from the consequences of their actions.

• Nothing that will cause average family incomes to decline should even be contemplated in Washington or state capitals. In fact, policy should focus of giving the economy a fiscal push, as leaders of both parties have done successfully in recent history.
• Until these things happen, the Fed is unlikely to rein in the money supply and stop viewing its loose monetary policy as the sole bulwark against economic catastrophe. But until that happens every gain we make in one way will be eaten up by the escalating costs of fuel, food and other commodities, as confidence in our currency erodes. Right now the biggest source of damage being done to family incomes comes at the gas pump, the grocery store, and wherever else necessities are bought.

Finally, REALTORS® must do everything within their power – both politically and professionally – to
move policy in the right direction. We must also learn how to deal with the difficulties we face in a
professional manner.

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The Richmond Times-Dispatch hosts a special online chat with VAR special counsel Lem Marshall on short sales at noon on Friday.

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