Lessons unlearned, a correction is ahead

The problems that led to the real estate and financial meltdown have not been fixed, and we are less than a generation away from repeating the mistakes.

When I entered the profession 30 years ago, I was told “all real estate is local,” and for the most part it was—the decision-makers, the banks, the builders.

Little did I know that we were about to witness the greatest real estate boom in the modern world, and that the boom would have a lot more to do with Wall Street than with Main Street. Federal banking regulations that allowed out-of-state banks to do business here linked our industry and Wall Street.

Booms and busts are rooted in the maxim that behavior is driven by economic incentive. Wall Street’s appetite for residential and commercial debt to resell, accompanied by fractional reserve banking, encouraged lending to all with little recourse for bad behavior.

We are now in the early stages of a recovery from the largest destruction of wealth (and jobs) related to this same consolidation of lenders. We have enjoyed tremendous prosperity from these changes, but the boom and its bust were driven and destroyed by leverage.

When you or I make a bad business decision, we pay the economic consequences. But too-big-to-fail lenders were rescued by the taxpayers for their mistakes.

Just when we thought reforms were in place, we learn that British bank HSBC, the largest drug-laundering bank in the world, agreed to a small penalty so it wouldn’t be prosecuted by the U.S. Department of Justice, reportedly because the DOJ feared the financial consequences.

Traders at Goldman Sachs and JPMorgan Chase & Co. defy their own company’s trading limits and put the shareholders and even the global financial system in peril.

All because the consolidation of lending to a handful of institutions has made them dependent upon the outsized returns enjoyed during the mortgage boom.

The failures of the past are causing credit to be tightened so much that an overall economic recovery is being delayed.

If we are to avert similar problems in the future, we must limit the size of these financial institutions and encourage them to lend at the local level.

The only real solution is to put back to the original lenders every bad loan they make, rather than have taxpayers absorb the loss. Unfortunately, the mortgage deeds and notes were separated during the securitization process.

We must also encourage borrowers to have more skin in the game. This is happening in commercial lending but needs to return to residential.

It’s odd that the White House and the National Association of Realtors are promoting low down payments of 3 percent to 5 percent on housing purchases. While I appreciate the importance of a housing recovery, higher down payments teach borrowers discipline and reduce default.

We should encourage higher down payments and the deduction for home mortgage interest should be eliminated.

Are appraisers and real estate brokers to blame for the calamity? I don’t believe they are.

The appraisal process has always been a rearview look at value and much of the correction we have seen is simply regression to the mean over time.

The real estate brokerage community is also not to blame. The industry and its agents provided the market knowledge to assist tenants, landlords, buyers and sellers in navigating the recovery. I see us as informed advisers with boots-on-the-ground advice to help people make informed decisions.

It seems that each of these corrections lasts about a generation, or long enough for the market participants to know little of the prior event.

If banks remain too large to jail, entitlements remain untouchable, and local markets stay dependent on lenders ignorant of their borrowers and their local communities’ needs and capabilities, the next correction is just around the corner.•

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Reller is senior vice president, director of land brokerage for the Indiana Region of Colliers International. Views expressed here are the writer’s.