Chapter 5 Modern Residential Finance

Chapter 5 Learning Objectives n Understand the major forces that have changed and shaped the residential mortgage market since the end of World War II n Understand how changes in the inflationary environment forced changes in the types of institutions that originated mortgages and in the types of mortgages they offered

History Of Real Estate Finance n 1940s –Preoccupied with World War Two –Veterans Administration created n 1950s –Decade of S&L expansion and stability –Maturity mismatch because of the wide acceptance of the 30-year fixed-rate mortgage –Increased interest rate risk because of fixed-rate mortgages

History Of Real Estate Finance n 1960s –Creeping inflation –Disintermediation –Maturity mismatch –Expansion of secondary mortgage market –Government National Mortgage Association (Ginnie Mae) created in 1968

History Of Real Estate Finance n 1970s –Inflation increased from 6% to 13% –Interest rate increases decreased housing affordability –Development of Adjustable-Rate Mortgages –Creation of Federal Home Loan Mortgage Corporation (Freddie Mac) in 1970 –Approval of new mortgage designs: VRM, GPM, and RAM

History Of Real Estate Finance n 1980s –Regulatory and tax law changes –Economic Recovery Act in 1981 produces the Accelerated Cost Recovery System (ACRS) of depreciation –Tax Reform Act in 1986 created the Modified Accelerated Cost Recovery System (MACRS)

History Of Real Estate Finance n 1980s –S&L debacle –Due-on-sale and creative financing –Zombie theory –Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) in 1989

History of Real Estate Finance n An Era of Creative Financing –Late 1970s and early 1980s –Advantages of FHA and VA Loans –Assumable loans –Wraparound financing –Owner financing

History Of Real Estate Finance n 1990s –Subsiding inflation resulted in lower mortgage rates –Refinancing craze –Baby boomers trading up increasing demand for up-scale housing –Internet made mortgage lending national in scope

History Of Real Estate Finance n 1990s –Rapid growth of secondary mortgage market, primarily Fannie Mae and Freddie Mac –Tax Act of 1993 eased passive loss rules and extended non-residential depreciation from 31.5 years to 39 years –Taxpayer Relief Act of 1997 set long-term capital gains tax rate at 20% and maximum depreciation recovery rate at 25%

History Of Real Estate Finance n 2000s –Housing craze – Single-family homes entered the speculative investment market –Rapid rise in house prices through first half of decade –2006 house prices up 87% from 2000 level –Mortgage lending standards relaxed –Rapid growth of secondary mortgage market through Fannie Mae, Freddie Mac, and Wall Street –Massive bailouts of Fannie Mae, Freddie Mac, and Wall Street

History Of Real Estate Finance n 2000s –Housing bust of 2007 resulted in deluge of mortgage defaults –September 2008 U.S. Treasury took control of Fannie Mae and Freddie Mac –Changing market as house prices fell and lenders tightened standards –Borrowers began to show willingness to walk away from speculative housing investments –S&P downgraded large number of residential mortgage securities as toxic mortgage debt poisoned the global financial system