Now it can be said – the US is officially in a recession, and other countries around the globe are very quickly following suit. Predominating the country’s financial headaches is the real estate meltdown, or subprime crash, as experts call it. The question being asked is, was overinflated real estate the cause of the US and ultimately the global recession? If so, how?


New York Times economics columnist David Leonhardt explains it this way: In 1998, Wall Street started making it easier for home buyers to apply for loans, and packaged those loans to global investors as CDOs, or collateralized debt obligations. To make these investments even more enticing, Wall Street introduced the idea of subprime mortgages - ARM (adjustable rate mortgage) loans with high interest rates packaged in the guise of low initial interest rates.

High interest rates for the borrowers meant higher returns for the investors, while low credit score borrowers now had the opportunity to buy homes despite their normally unacceptable credit picture. The lax lending policies allowed people to borrow as much as 50% more than the real value of the house with a minimal down payment even as the high interest rates pushed prices up, resulting in grossly overpriced home prices. A case in point is San Francisco, where the median home price is currently 11.6% of the median annual salary.

Investors sought to accelerate their earnings by borrowing funds to invest. The extremely high loan interest rates caused many of the borrowers to default on their loans, and as home prices reached the point where borrowers couldn’t afford to pay their loans anymore and people stopped buying because prices were just way too high, the financial village came toppling down, one by one in a domino effect.

First to fall were Fanny Mae and Freddie Mac, the country’s two largest mortgage finance lenders that had bought the loans from the mortgage originators, repackaged them as mortgage-backed securities, and sold them to the global investors. Next came the banks and investment companies with heavy exposures on these sub prime loans such as Bear Stearns and Lehman Brothers, and as the banks fell so did the global investors who had invested in these mortgage investments. As the companies fell, investors panicked and engaged in a wave of selling, causing the stock markets to crash.

Industry insiders say that unless the number of foreclosures goes down, home prices will continue to decline and it will take longer before the real estate crisis bottoms out.

The S&P/Case-Schiller Home Price Indices show that home prices continue to fall – as of May, Phoenix reported an annual decline of 31.9%, Las Vegas was down 31.3%, San Francisco down by 29.5%, Miami down by 28.4%, Los Angeles down by 27.6%, and San Diego 26.3%.

With more and more companies downsizing workforces, it looks like we’re in for quite a long wait. In the meantime, here’s our advice: if you’ve got a home, hold on to it. If you’re in the market to buy a house, do your due diligence and homework – compare prices, read the fine print, and make sure you can afford to pay before you sign that loan.

Too many housing starts means crunch 'may come soon,'Lost amid concern over United States government agencies moving in to support mortgage lenders Freddie Mac and Fannie Mae plus IndyMac Bankcorp, was a warning that Canada could soon face its own mortgage crisis.

Peter Hall, vice-president and chief economist with Export Development Canada, said in a report that in addition to U.S. housing woes, housing starts were down 56 per cent year-over-year during May in the United Kingdom, 18 per cent during the first quarter of the year in Spain and 17 per cent year-over-year in May in France.

Hall noted that housing starts in Canada are "soaring on the strength of the domestic economy and a huge dollop of very well-timed fiscal stimulus," and that a continuing excess of housing starts over requirements means "Canada's turn may come soon" for a housing crisis.

The report came in the wake of the Canadian government's attempt to avoid a housing crisis by no longer insuring mortgages with more than 35-year amortization periods and less than five-per-cent down payments as of Oct. 15.

Homebuyers with less than a 20-per-cent down payment are required to have their mortgage insured through the Canada Mortgage and Housing Corporation -- a Crown corporation -- or a handful of private firms that have entered the mortgage-insurance market.

In 2006, the government extended the maximum amortization period from 25 to 40 years, adding hundreds of thousands of dollars in interest costs. Last year, 37 per cent of mortgages taken out were for longer than 25 years.

Soon after the Canadian changes were announced, the United States Federal Reserve Board tightened up its mortgage-lending policies. As of Oct. 1, the Fed will require lenders to verify a borrower's income in determining repayment ability, to take a lender's ability to repay a loan from income into consideration, to establish escrow accounts for property taxes and homeowners insurance in certain cases, and basically to advertise rates and payments with clear notice if a rate isn't fixed.

One reason why U.S. lenders were willing to give mortgages to people with an unproven ability to make payments was that the lenders were able to package the loans with others and sell them to other institutions. Had the lenders been forced to hold the debt themselves, which is somewhat the case in Canada, lending would have been less reckless.

Rather than abating, the U.S. housing problem grows worse by the day, with foreclosures expected to flood the market with homes for sale early in 2009.

Things have deteriorated so badly in the U.S. that the Treasury Department will extend credit if needed to prop up Freddie Mac and Fannie Mae, two government-sponsored enterprises that hold nearly half of all American mortgages.

The GSEs each include a debt component and an equity component, with the latter falling in value as investors sold off shares due to concern over rising mortgage defaults.

Famed U.S. commodities investor Jim Rogers called the Treasury plan an "unmitigated disaster." Mortgage lenders are "basically insolvent," and taxpayers will be left footing the bill, according to Rogers.

At the same time, U.S. government agencies stepped in to take over IndyMac Bankcorp, after helping to bail out Bear Stearns. That leaves about 90 financial institutions -- out of about 7,500 -- set to go under.

Meanwhile, portfolio manager Adrian Mastracci of Vancouver-based CKM Wealth Management offers sound tips for homebuyers:

- Consider a condominium or townhouse as a starter home.

Remember that in addition to the purchase price of a home, you may have legal and realtor costs, expenses for moving, renovations, furniture, repairs, maintenance, property taxes, insurance and utilities.

- Save 20 per cent for a down payment to reduce extra fees, consider taking money from your registered retirement savings plan through the Home Buyers Plan, and forego making non-registered investments because you would need an 8.9-per-cent return to do better than paying down a 5.75-per-cent mortgage if you're in the 35-per-cent tax bracket.