Financial Overhaul Bill and Real Estate

Financial Overhaul Bill and Real Estate
Recently, our congress successfully passed new legislation, courageously recomposing century-old U.S. financial rules. It seems our buddies in D.C. have acquired great economic know-how, unseating 80 years of financial thought in a single, 24-hourBCWAP
session. The method of attack dealt with added regulation in derivative trading, and more specifically - Credit Default Swaps. Today, I will explain CDS's, their influence on U.S. real estate, and how this new legislation will drastically
Quick Hitters: side-effects of new bill
-Slow, steady increase in size of middle class
-Fewer home purchases
-Decrease in American home ownership -Increase in the renting community
-Increase in rental prices
-Critical paradigm shift in banking
Most critical to the real estate market is how the bill imposes derivative regulation on all U.S. banks. Certain types of derivatives, Credit Default Swaps, are used by banks to hedge or protect against the risk of default or non-payment on loans. In essence, CDS's reduce some of the risk associated with providing loans, and for our purposes - mortgages. A third party will offer a bank to pay the amount left on the loan if the borrower is no longer able to make the loan payments. To make the third party willing, the bank will pay a premium to the third party, similar to premium payments to insurance companies. Here is an example:
Bank A decides to provide Minesh the Borrower with a 30-yr fixed mortgage of $250,000 to purchase a home. Bank A cannot afford to lose $250,000 if Minesh is unable to pay, but the bank can afford to risk losing $100,000 of the principal on the mortgage. Now, since Bank A still cannot afford to lose the remaining $150,000, it offers to pay a third party company $1000 every three months if the third party company agrees to pay Bank A $150,000 in the event that Minesh Borrower is unable to pay his mortgage. It is similar to insurance, without the insurance regulations - a way for banks to hedge against financial loss from borrower default.
The added security of CDS's to our mortgage lending environment instigates and encourages lending to home buyers, as mortgages protected with CDS's are more likely to be issued, and are more marketable for re-sale. Anything that makes mortgages more appealing, facilitates mortgage approval, and thereby, BCCPSA
makes home purchasing more frequent and attainable. In many situations, loans are not made without credit default swaps.
So, what does this all mean? The added regulation on CDS's may remove their safety net from mortgage lending, increasing associated mortgage-default risk. In order to balance or reduce risk, costs to borrowers will increase. At times, the lack of CDS's will lead to such an increased default risk that any prospects of bank profitability are eliminated, leading to declined mortgage applications.
Why are Credit Default Swaps the target of legislative assault?
How will all this affect the real estate market?
Wave good-bye to the ease once associated with CDS issuance and trading - bye, bye. Banks are no longer to engage in "risky" derivatives trading to prevent catastrophe exemplified by AIG - a situation relying on taxpayers for correction. Now that banks are no longer able to deal in potentially risky derivatives trading, the government is, in essence, lifting the ability of banks to offer mortgages to anyone other than the most capable home purchasers. Effectively, banks will only have the availability to approve mortgages with significant down payments (a minimum of 20%) and borrowers with outstanding credit. Such borrowers are not in need of any form of default insurance, considering the debtor's financial strength.
The Mistake
The stated goal of those drafting our new legislation is to eliminate the use of Credit Default Swaps as a means of speculating the quality of a loan/mortgage, using the AIG example as the evidence of potential catastrophe with speculation in Credit Default Swaps. Oh no no no no, Barney! Mr. Barney Franks! Again you misinterpret the fundamentals of American financing, it was not bank
As a result of the new legislation, the mortgage game will be more challenging, as a loan without the security of a Credit Default Swap is less marketable, and therefore, less attractive to banks. There is little money to be made offBCCPSP
of non-CDS supported mortgages unless the borrower brings accompanying financial strength that dispels the need for added, hedged security. Also, the loans will only be designed with strength, including only financially strong debtors and loans built off strong equity positions (large down payments).
Who's Affected?
Investors
Renters:
Property Managers:
Real Estate Agents: