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What’s an “Exit Strategy” and why does it matter to the housing market?

I originally wrote this and posted it on my new site, Straight Talk About Mortgages – The Bigger Picture, but I’ve been urged to post it here as well.    So, I’m doing that.   Why have I set up another site?   It’s pretty simple…..

The financial and real estate world that we are in are much more complex than most of us have ever experienced in our life times.   As part of what I’m going to be rolling out soon which I’m calling, “Straight Talk Lending,” I believe that it’s important that people have the an understanding of the bigger issues that are and potentially will be influencing their business, lending and real estate decisions.

Typically once a week, I’m going to take an issue and dive into it on a much deeper level.   The opportunity to explore what it really means and how it’s going to impact the mortgage and real estate worlds is an exciting challenge and I hope it will be beneficial for many others as well.

Tom Vanderwell

Now for the post that I wrote:

What is an Exit Strategy? and Why Does It Matter to the Housing Market?

Thursday, July 23, 2009

By admin

Okay, anyone who has watched the news, or at least the financial news in the last week, especially after Bernanke’s testimony before both the Senate and the House has heard talk of an “Exit Strategy.”    I think that it would be well for us to take a few minutes and look at a couple of questions relating to that issue:

  • What is an “exit strategy?”
  • Why is an exit strategy necessary?
  • What does it mean for the housing and mortgage markets?
  • What should I do to prepare myself and/or my clients for what’s coming?

Before we get into those questions, here’s a clip from Bloomberg that talks about an exit strategy and what Bernanke might be thinking and planning.   This interview was done last week and was looking forward to Bernanke’s testimony this week.

Now, time to dig into the details of it.  What is an exit strategy? It’s pretty simple:

How in the world is the government going to get out of owning an insanely large share of the US economy and the US financial industry?

Seriously, we’ve got a big issue.   In order to keep the financial world from melting down completely (and I don’t believe I’m being melodramatic when I say that we were that close to a total meltdown), Bernanke and company had to throw everything they could at the problem to keep it from being a disaster.   So the government now owns large portions of many financial institutions, they are in the process of buying over $1 Trillion worth of Treasury bonds and mortgage backed securities, they are majority shareholders in 66% of the US car makers, and they have guaranteed billions and billions of dollars worth of bonds, mortgage backed securities and other very complex financial instruments.

Now I want to pause for a minute and say something about Fed Chairman Bernanke.   There are many people in the main stream media who like to bring up Bernanke’s comment in 2007 about the problems being contained in the subprime mortgage market and use that as an excuse for saying that Bernanke doesn’t know what he’s doing and shouldn’t be reappointed.   A couple of thoughts about that:

  • Bernanke has a long standing reputation as a scholar and an extremely well educated member of the Federal Reserve, long before he was appointed to the “big office.”
  • One of his main areas of his educational focus has been the Depression, what caused it, what was done during the Depression, and how the “solutions” made it worse than the original problems.

So, we’re dealing with someone who really knows what he’s talking about.   Is he a human?   Absolutely.   Has he made mistakes?  His “contained in subprime” quote is a classic example of a mistake that was made.   But in my mind, he has done more to prevent the terrible financial mess that we’re in from getting even worse than anyone else and deserves way more credit than he’s getting.

So we have a situation where we had to take emergency and heroic measures to save the economy from a total meltdown.   But now we have to figure out, once the market and the economy comes around enough, how do we get out of the situation we’re in:

  • How do GM and Chrysler “buy out” the government from their ownership?
  • How does AIG pay back the multi billions that they got from the government?
  • How do the financial markets pay back the government?
  • How does the Federal Reserve change their interest rate pattern and move it to a more “normal” pattern (rather than .25%) without tanking the economy?
  • How is the Treasury going to change the 0% discount window that they are currently charging to banks to a “normal” rate?
  • And how is the economy going to react as all of these things happen?
  • And what is that going to do to the housing market?

Why do we need an exit strategy?

There are a couple of reasons that we need an exit strategy:

  • Because socialism doesn’t work.   We are in a situation now where the government owns a substantial amount of our financial and auto industries and the long term prognosis of government run industry doesn’t bode well for our economic health.  I know what you’re thinking, “How well did capitalism serve us in the past 5 to 10 years?”   The answer, not so well.   But there’s a substantial difference between having the government institute rules and regulations regarding leverage, capital requirements and so forth, and the government actually owning the industry itself.   The one can work, the other won’t work.
  • Because a 0% interest rate is and will eventually be inflationary. That’s right, the government is currently loaning money at 0% interest and eventually it’s going to come back and become inflationary.   Do I expect the inflation to show up soon?   More on that in the “what to do” section below.
  • Because we have to pay the money back. That’s right, the government is borrowing all of the money that they spent on these bailouts and buyouts and we’re going to eventually have to start paying that money back.   The cost per tax payer would be simply unpayable.   If the amount is unpayable, then liquidation is the only way to go.   So, the government is going to start selling some of the Treasuries, mortgage backed securities and other collateral that they have purchased.

So, what does the need for an exit strategy mean for the housing and mortgage market?

There are a few things that it means looking forward:

  • Bernanke said in his testimony on Capitol Hill this week that interest rates will stay stable and low for a substantial period of time.   I’m in total agreement with that statement.   I believe that we’re looking at most likely 12 to 18 months with stable interest rates.   I believe the overall trend during that period will be slightly higher, but not substantially higher.
  • During that time period, the economy will begin healing.   It will eventually start turning around and become a decent economy.   As soon as that happens, inflation is going to become an issue.   When inflation becomes an issue, interest rates are going to spike and spike dramatically.   Am I willing to say how high?   Nope.   I’ll use the term substantially, but I won’t say how much higher than they are now.   Why not?  Because how high they go will depend in many ways on how the government does at unwinding all of the government interventions that have taken place.
  • The law of supply and demand when it comes borrowing money for mortgages is going to make it harder to get a loan.   What’s that?   A couple of thoughts:  As the government unwinds their position in the Treasury and mortgage markets, they are going to flood the market with debt looking for a place to go.    If there is $100,000,000,000 out there looking for a place to go, it’s going to be easier and cheaper than if there is $500,000,000,000 out there looking for a place to go.    So, an investor has $20 Billion in his account and is looking to buy bonds.   He’s got choices of buying existing stuff from the government or buying new “stuff” that’s coming on the market.    The financial institutions that are coming out with new bonds and mortgage backed securities are going to need to make sure that their stuff is really clean (meaning good quality) and attractively priced (meaning higher rates) so that it can compete with what the government is trying to unload.

So we’ve got a situation where the likelihood is that over the next 12 to 48 months, we’re going to be looking at a government that needs to unwind their current positions in the financial markets and it’s going to create an economic situation where we’ve got higher interest rates, lower demand and the possibility of a double dip recession.

So what do you do to prepare for it?   And what do you tell your clients?   A couple of recommendations:

  • We’ve got 12 to 18 months until interest rates go up. Any consumer, mortgage and business debt that won’t be paid off within the next 2 to 4 years should be moved to fixed rates. Why 2 to 4 years?  Because rates are so low that it’s going to take a little while for the “average rate” that you’d pay on a variable rate to catch up to what rates are going to go to.  Call me at (616) 209-8811 and let’s talk about how to go fixed on your debt.   E-mail me at tvanderwell@straighttalkaboutmortgages.com and we can take a look at things that way too.
  • Take a look at your real estate holdings.   If you own investment properties, the time to look at whether you’ve got the right property and the right loan on it is not next month, next year or when Junior graduates from college.   The time is now.   Call my friend and real estate investment professional, Jeff, “Bawld Guy” Brown at (619-889-7100) or e-mail him at jeff@brownandbrowninc.com to get the input of someone who truly has your best interests and your retirement plan in mind.
  • Take a look at your financial and real estate moves. Do you see the likelihood of wanting or needing to do anything in the next few years?   Buy a bigger house?   Downsize because the kids are moving out?   Move out to the country?   You might want to see if makes sense to adjust and tighten those time frames.

I have a confession to make, I didn’t see the scope and size of this economic crisis coming.   Yes, I felt that certain areas couldn’t continue to go up as fast as they did but the nearly nuclear meltdown, nope, I didn’t see it coming.   I do take some comfort in knowing that I’m not the only one who missed it.

But, I do see the unwinding of what we had to do to keep the ship floating as the source of trouble in the future.   Understanding and being prepared for what’s coming is a large part of handling an incoming storm.   And that’s why an Exit Strategy for the Fed makes a difference to the housing and mortgage market.

Stay tuned, I’ll be writing more in depth articles on Straight Talk – the Bigger Picture in the future to help us all adjust and prepare for the new realities that we are and will continue to face going forward.

Sincerely,

Tom Vanderwell

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  • 16 comments

    16 Comments so far

    1. Al Lorenz July 24th, 2009 11:10 am

      Tom,

      I’ve been thinking about this a bunch lately also. It is comforting to hear you say you think interest rates are going to be stable for 12 to 18 months.

      I’m working on my own exit plan as well as helping clients with theirs. Other factors I’m looking at include the likelihood that capital gains exemptions will end/reduce after 2010 and that real estate pricing will likely lag inflation until inflation moderates and interest rates again come down.

      Thanks! I will refer clients & friends to this post and your “Straight Talk.”

    2. Keahi Pelayo July 24th, 2009 11:51 am

      Wow, thanks for taking on the macro-economics of our financial system.
      Aloha,
      Keahi

    3. Jim Gilbert July 24th, 2009 11:54 am

      Thanks for taking the time to write this article. It is helpful.

    4. Genuine Chris Johnson July 24th, 2009 2:57 pm

      Come the hell on. Seriously, You’re not stupid, don’t proffer stupid arguments.

      Capitalism. Did. Not. Fail.

      Greg calls it rotarian socialism, that’s as good a phrase as any. I call it some mercantilist hybrid. Bottom line: what failed was the tacit promise between Washington and Wall street that the banks were too big tofail.

      The banks got this idea during…the last big S&L bailout, and boom, here it is becoming real.

      But don’t blame capitalism for this, seriously.

      Being “pro-businesS” does this. I’m ‘pro-freedom.’ Big. Damned. Difference.

    5. Rob Chipman July 24th, 2009 3:21 pm

      Thanks, Tom. Good piece. You taught me a lesson with the call to action at the end. My mailouts could use a bit more of that. Specific and solid recommendations. Like it. Like the analysis too.

    6. Tom Vanderwell July 24th, 2009 3:24 pm

      Chris,

      Thanks for stopping by! Good to hear from you.

      I think your comment about me claiming that capitalism failed is in reference to this comment that I made:

      “I know what you’re thinking, “How well did capitalism serve us in the past 5 to 10 years?” The answer, not so well.”

      You’re confusing a statement that says capitalism hasn’t worked so well with me blaming capitalism for this. That’s a big stretch, even for you.

      I agree with you that the “too big to fail” mess between Washington and Wall St was a large part of it.

      I’m not stupid, you’re not stupid, capitalism didn’t fail, but the last 5 years aren’t a shining example of capitalism at it’s finest.

      Call it rotarian socialism, call it mercantilist hybrid, what ever you want to call it, the way the last 5 years have bubbled and popped didn’t work.

      Tom

    7. Tom Vanderwell July 24th, 2009 3:32 pm

      Rob, Jim and Al,

      Thanks for your kind words. They are much appreciated.

      Tom

    8. Brian Stockwell July 24th, 2009 4:40 pm

      Amen Chris.

      Tom, his point is is that we do not have capitalism in this country so you cannot blame this mess on it OR say ‘it hasn’t worked so well’. If we had capitalism in this country and we had this mess THEN you could blame it on capitalism OR say ‘it hasn’t worked so well’.

      “You’re confusing a statement that says capitalism hasn’t worked so well with me blaming capitalism for this. That’s a big stretch, even for you.”

      -Don’t both suggest that capitalism is not the answer (or there is a better way) and we need ‘help’ from Washington/monetary central planning?

    9. Doug Francis July 24th, 2009 8:28 pm

      I feel strongly that mortgage rates will remain in a narrow range for a while since the overall economy has so many pot holes lurking around every curve…

    10. Greg Swann July 24th, 2009 9:32 pm

      > Call it rotarian socialism, call it mercantilist hybrid, what ever you want to call it, the way the last 5 years have bubbled and popped didn’t work.

      But what failed was not a free market composed of mutually voluntary transactions, but, rather, a hodge-podge concoction of special privileges sold at auction to politically-connected criminals. The outcome you decry was no accident. It’s the way organized crime works — disastrously.

    11. Greg Swann July 25th, 2009 12:16 am

      Coming back to this: All quibbling aside, this is a very thoroughgoing analysis, Tom. I admire the ambition of the enterprise.

    12. Missy Caulk July 25th, 2009 6:34 am

      Tom, I appreciate this and the well thought out situation.
      I have been telling this to clients for awhile. For buyers it is a perfect storm. Lots of negotiating to get the right price, low interest rates, abundance of inventory.

      When the rates go up, and they will, IMO and open to what you think…assumable mortgages will be golden. Like FHA and VA.

      Having moved to Mi when rates were 18% we were also thrilled to get a land contract at 11%. When the rates moved up fast for a couple of weeks a month ago, we were overwhelmed with calls from buyers.

    13. Genuine Chris Johnson July 25th, 2009 9:35 pm

      TV-

      Seriously, blaming capitalism for the failures of the oligarchy is not bright. I’ll give you that the last 5 years haven’t been capitalism at its finest.

      That’s because the last bailout (89-91) told Wall Street that there would be more. This bail out is an overture to the next one that will make this one look tiny and inconsequential.

      People will blame wealth, blame ‘capitalism,’ as more regulations are put on banks. The regulations will serve to help big banks at the expense of small banks.

      There will be those who see it coming, like Schiff and his ilk, and those who don’t.

      A new batch of acts, regulations and everything else will skim the froth off of human progress. We’ll be paying Goldman Sachs for years.

      And blaming capitalism.

      But really, let’s get the semantics right. Let’s not call the state of the economy capitalist. I don’t know that it’s ever been capitalist.

      Best to you as always.

      CJ

    14. Tom Vanderwell July 26th, 2009 7:44 pm

      Chris, Greg, Missy and all, Thanks for the comments and the insights. The thing that I love about Bloodhound is that of all of the sites I read and follow, this is one of the very few where the comments are almost as educational (in many cases more so) than the actual posts. The brainpower that hangs out here is quite astounding……

      I’m going to share something that I’ve learned from my wife (who 24 years ago today made me the happiest man in the world by saying, “I do.”) and that is to not worry about things you can’t control. I still do that a lot more than what I should, but I’m learning.

      Why do I bring that up? Because of the reason I wrote about an exit strategy. I didn’t write about it to bring up a discussion about whether we’re a capitalist society, a rotarian socialist society, a society run by organized crime or some mix of the above. I wrote it because I believe the most important thing that we as real estate and lending professionals need to do now is to understand and communicate what’s happening now and help our clients through it.

      There will be a time and a place for discussions about what caused the fire that’s burning down the house. While we’re trying to figure out how to get out of the house alive isn’t the time to talk about what started the fire.

      I’m quite confident that there are things that Bernanke and company have had to do in the last 12 to 24 months that have literally turned their stomachs. They did them because rescue is the important thing now. The time will come to discuss how to avoid repeating it, but that’s not, in my opinion, now. Not a day goes by where I don’t talk to at least 1 or 2 potential clients who are absolutely devastated by the financial pain that has been happening. They need help and advice and counsel now. The blame game is for later.

      Oh, in case you are wondering what I’m doing hanging out on Bloodhound on my anniversary, my wife is a night shift nurse and she had to work tonight. So we had a great day together and we’ll resume the celebration later…..

      Tom

    15. Joe Strummer July 27th, 2009 2:44 pm

      As I head off tomorrow to Raleigh to take the Bar – another example of rotarian socialism if there ever was one – let me chime in by saying that this is a good analysis. But let me also add this thought to Greg’s comment above:

      But what failed was not a free market composed of mutually voluntary transactions, but, rather, a hodge-podge concoction of special privileges sold at auction to politically-connected criminals. The outcome you decry was no accident. It’s the way organized crime works — disastrously.

      True enough. But the biggest of these errors was the credit expansion of the last 15 years. And too many self-proclaimed free marketeers were happy to ignore the general boom in illusory middle class wealth in the form of real estate booms that was the product not of the free market, but of central bank policy.

      Critics of central bank policy have been calling foul since the 1980s at least, predicting the collapse of the dollar. Obviously they’ve been wrong in the timing and the chicken little syndrome has made them less than credible.

      But now, I’m afraid to say, the chickens are coming home to roost.

      Thankfully, assuming that I pass, they can’t outsource my privilege to practice law in the great state of NC (although my briefs could be written by any one with a decent education in Bangalore). So in some ways, I’ve got mine.

      But it is a crying shame what has happaned to this economy and that the “capitalist critique” has not been more thorough-going in the past 20 years.

    16. Moshe Cohen July 27th, 2009 4:08 pm

      I am afraid that part of the exit strategy will be higher taxes on real estate. Let’s get ready to fight it.