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Opinions of Wednesday, 1 August 2007

Columnist: Tsikata, Peter Atsu

The US mortgage meltdown: A lesson for Ghanaian ...

The US mortgage meltdown: A lesson for Ghanaian real estate practitioners and policy makers.

If anyone told homebuyers in the US two years ago that about 2.5 million of them would be losing their homes in foreclosure, they would never have believed it. Today, that is precisely what is about to happen in America and it is sending jitters to Wall Street and reverberations across financial markets around the globe. Today, home prices are falling across-the-board in many parts of the country. Millions of borrowers, particularly those with very shaky credit, are losing their homes because they cannot afford the payments. Most borrowers are quickly finding out that, because of falling home prices, their homes are worth less than their current loan balances. Consequently, they cannot refinance their loans to get out of trouble. Talk about the creation of a perfect storm! The result? Foreclosure!

How in the world did this happen in America? For starters, one can look all the way back to the Clinton Administration whose populist policies popularized and bolstered homeownership in America -- the so-called “American Dream”. President Bill Clinton’s policies leveled the playing field for homeownership by minorities -- blacks and Latinos. FHA loans -- Federal Housing Administration loans that enable lower-income Americans purchase homes -- literally became a household name in America in those days. Pressures from the White House and Congress on the Federal Reserve to lower interest rates to make mortgages more affordable was a constant refrain in those days. Together with the stock market boom of the 1990s, homeownership gradually became one of the backbones of the American economy and, therefore, opened the floodgates for mortgage lenders to become more and more innovative and creative in designing a cocktail of mortgage products to satisfy the rising demand for mortgages. There were all kinds of fanciful names for their creations: Sub-prime, Interest-only, NINA, SISA, 2/28, 3/27 and 100% loans. Name it, they have it! Indeed, the craziest loan program they conjured up recently was the 50-year mortgage. Unbelievable! To sweeten the pie, most of these mortgage products came with hefty prepayment penalties, which literally guaranteed the lender a built-in $10,000 to $15,000 profit if the borrower dared refinance the loan before the end of the prepayment penalty period. All this created more and more credit that enabled more and more Americans, low-income and middle-income, purchase more and more homes. US homeownership generally soared, home prices soared, property values soared and it was a win-win situation for everyone. Easy credit literally became the lifeblood of the housing market and the American economy was booming.

During the housing boom, a lot of mortgage companies originated a record volume of loans, which they bundled together and sold to financial institutions on Wall Street. This is what is called securitization in the mortgage industry. Most Wall Street financial institutions bought pools of these loans and repackaged or “securitized” them into bonds called mortgage-backed securities, which they in turn sold to investors and hedge funds. Indeed, this business became so profitable that hedge fund managers at firms like Bear Stearns bought more and more of the riskier “subprime” mortgages and turned such securities into complex investment vehicles called derivatives; they in turn sold these derivatives to pension funds, insurance companies and foreign investors. These developments practically empowered the lending industry on the ground floor to go out and make more and more risky loans because their enablers on Wall Street made it seemingly so easy and so profitable.

The environment that created the housing boom began to unravel when the Federal Reserve started raising interest rates in the year 2004. Higher lending rates plus soaring home prices naturally made housing less affordable. The market for new mortgages began to shrink. To make more loans, lenders dangled in front of homebuyers and homeowners their fancy mortgage products, which most people swallowed line, hook and sinker. Today, rising foreclosures and mortgage delinquencies have led to tighter lending standards. Lenders are stuck with homes they cannot collect mortgage payments on and delinquencies portend more and more foreclosures in the future. Indeed, it is estimated that 2.5 million Americans will lose their homes in foreclosure within the next one year. Tighter lending standards also mean that more and more potential homebuyers are being pushed out of the market.

So who really is to blame for all this mess? Everyone who had anything to do with real estate and/or mortgages is to blame. We all share the blame. For starters, real estate brokers steered most homebuyers to houses they could not afford. Mortgage brokers did the same with mortgages. Real estate appraisers inflated the values of homes to enable homeowners get the cash-out they wanted through their refinances and mortgage lenders relaxed their underwriting standards, bucking the time-honored tradition of lending to consumers on the basis of their ability to repay. Wall Street bought riskier and riskier loans essentially becoming the principal enabler for mortgage lenders and brokers. Government regulators were also nowhere to be found as long as the government policy of mass homeownership was alive and well. Above all, the real culprits were consumers themselves who saw homeownership as their only opportunity to have a taste of the American dream and went all out with a vengeance to over-encumber themselves. To most of them, the bigger the house or the loan, the better: completely throwing prudence to the dogs!

As I write this piece, Wall Street is in a freefall and financial markets all over the world are responding accordingly. Truly, when America sneezes, the rest of the world catches a cold. A warning from one of the top mortgage lenders in the US, Countrywide Financial, sent the financial markets tumbling. The fear is that in a true credit crunch, with banks tightening their underwriting standards to non-creditworthy customers, fewer loans will be made and sold on Wall Street and fewer people will be able to buy homes on Main Street. The ripple effect on the broader US economy, and therefore the world economy at large, will be tremendous. A true recipe for financial disaster.

Could this happen in Ghana? Yes, it could! It could happen if a secondary mortgage market fully develops in Ghana. For now, Ghana has no secondary mortgage market. The one and only institution originally set up by the Ghana government to operate a secondary mortgage market --HFC Bank -- has itself veered completely into the primary mortgage market and pursued a whole menu of other financial vehicles primarily because there were no loans to securitize for investors in the first place.

Secondly, most Ghanaians cannot afford the high prices of homes in Ghana and this has put a dent on the number of loans the handful of mortgage companies available can originate. There is no scramble for home loans in Ghana. Not at all. Most banks in Ghana would not even touch home loans because of their long-term nature. They would rather make short-term loans to the import-export market. Moreover, most people in Ghana cannot just afford it. Most of the homes being sold in Ghana today are mostly to Ghanaians living outside who literally pay cash for their purchases. Even though it is reported that there is a shortage of homes in Ghana by as much as 600,000 units, this need is gradually being satisfied by government policies and efforts to build “low-cost” homes to ease the pain and burden of high home prices and consequently high mortgage payments.

Ten years from now, if a secondary mortgage market fully develops on our soil, what has taken place in America today could easily happen in Ghana. The excesses of a sophisticated financial environment like America could easily be exported lock, stock and barrel onto our shores. The only reason it has not happened yet is because most loans originated in Ghana are held in the portfolios of the originators and not bundled and sold to investors on a secondary mortgage market. Therefore, originators are extremely careful and conservative about what quality of loans to underwrite and approve. Their loans are truly worth the paper they are written on! In a secondary market environment, it is the duty of policy makers in our homeland to take the necessary steps to police the excesses of the marketplace before they ever get the chance to impact the Ghanaian economy. A word to the wise is enough.

Peter Atsu Tsikata
Los Angeles, California.


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