Why Banks Don't Have Any Money

Castle Rock, CO 80108

In the depression era movie It's a Wonderful Life, Jimmy Stewart runs a building and loan company that suffers a run on the bank. He tries to explain to a depositor that the depositer's money is tied up in another customer's home. Even back in the 30's, banks didn't sit on money. They moved it by loaning deposits to others and making an interest spread profit for their efforts.

Here in the 21st century, banks still don't sit on their money. Starting in 2000, a new method of doing banking business came to the forefront. Instead ofloaning a customer money and keeping the loan inhouse, banks started moving aggresively into packaging the loans and selling them off to others. In the housing market this took the shape of private mortgage-backed securities. The federal government has had similar programs since Fannie Mae (FNMA) was started in 1938 but this packaging always stayed within the federal system.

When private securities sales took off, they really took off. A Trade Publication, The Securities Industry and Financial Markets Association (SIFMA) keepsthe dataof the totalamount of mortgage-backed securities that are issued andsold to investors. The numbers for private mortgage-backed securities from 2000 to the present are pretty sobering. Take a look.

Private Mortgage-related securities issuance

in $ Billions from 2000 to the present

2000 -- $101.7 Billion

2001-- $218.8 Billion

2002 -- $ 288.5 Billion

2003 -- $ 440.6 Billion

2004-- $ 532.7 Billion

2005 -- $901.2 Billion

2006 -- $917.4 Billion

2007 -- $773.9 Billion

2008-- $40.5Billion

The bottom fell out last year. For 2009, the year-to-date numbers are even worse; off 76.5% from the meager 2008 figures. Since banks now sell off their loans and there is no market to sell, there is no money to lend. It is not any more complicated than that.

The market for second mortgages has dried up even more. Fannie Mae and the feds don't play in this market so it is private investors only. From a high in 2006 of $483 billion, by 2008 it had shrunk to less than $4 Billion, a 99% drop. The housing boom use first and second mortgages together to take care of down payment issues.

Right now, virtually the only entity left that is buying up mortgages is the Federal Government. Because of the restrictive nature of these entitiies we have the dried up home sale market we see today.

It isn't that Americans don't want to buy homes. They do and they drive around looking at homes with their realtor and they makewritten offers to buy complete with an earnest money check. This is called a Pending Sale. The problem is with converting it into an actual closing and sale. No money available = no sale. If you look at the chart above, you can see the problem.

Ask any banker and they will say "We have lots of money to lend!". One particularbank even hasa radio spotusing this phrase in their commercial. Because average people.

The National Association of Realtors (NAR) publishes statistical data on home sales. The NAR gets its info from the Realtors themselves. One interesting comparison can be made between pending home sales and existing home sales. When someone wants to buy a house, they make an offer. If the offer is accepted, there is a pending home sale. When the closing actually occurs, we have an existing home sale. Usually, a pending sale becomes an actual, existing sale about a month or so later.

A disturbing gulf is now developing between these two home sale figures. The currently published number from the board of Realtors shows an increase in pending sales but a continuing drop in existing sales. For the last published month of April, the pending sales have shown a year over year increase while the existing sales have continued to deteriorate. This gulf has been showing up in the latest months of 2009. All of the news media have trumpeted the increase in pending sales as another of the administration's "green shoots". For some reason, the news media has ignored the continued drop in actual home sales.

Something is wrong here.

Many news outlets consider pending sales to be a "leading indicator" that predicts improvement in housing sales; they assume that the majority of houses currently under contract will actually sell within a few months. If more people are shopping, then prosperity must be "just around the corner." What happens if the sale falls through? The current enthusiasm will quickly turn into disappointment if too many of these pending sales fail to blossom into actual sales - a likely prospect considering the sorry state of mortgage financing.

Anyone can enter into a contract to buy a house, but not everyone will be able to qualify for the scant number of mortgages available. As underwriting standards become more strict and banks have even less money to lend, those who previously would have been able to buy a house will have no choice but to back out of their contracts. Even those who can qualify for a mortgage may have difficulty finding financing, especially if they are seeking a loan greater than the FHA limit of $417,000. The pending sales numbers indicate that there are plenty of willing buyers and sellers, but a shortage of willing lenders will render the parties' contracts meaningless.

Every state in America has real estate commission-approved forms for use in home purchases. One such form is the Contract to Buy and Sell Real Estate, a relatively uncomplicated document that uses boilerplate language to outline the parties' obligations during the transaction. Most buyers and sellers pay little to no attention to the standard terms of the Contract; they focus instead on closing costs and the purchase price and leave the other details to their Realtors or attorneys. In the past, once buyers and sellers agreed on a price, the house was as good as sold - sellers could begin packing boxes and buyers could begin measuring for new drapes.

Under the current housing market, however, one often overlooked provision in real estate contracts is having a big impact on home sale numbers. The "Financing Conditions" or "Loan Conditions" provision states that the purchase of a home is conditional upon the ability of the buyer to obtain financing. If the buyer is not able to get a new loan, the buyer can cancel the contract. In the days when lenders were handing out money to anyone who had a pulse, "Loan Conditions" were a non-issue. As funds become scarce and banks become more selective in their lending, fewer and fewer "pending" home sales are becoming actual home sales.

The real estate market, like any other market, is governed by supply and demand. Unfortunately, although both are present in the current market, many buyers are unable to fulfill their demand and sellers are unable to deliver the supply. Unless both sides can find a way to get what they want in spite of the broken mortgage lending system, many pending real estate contracts will become nothing more than souvenirs of broken dreams.

The clash of the pending/existing sales figures is easier to understand when you look at the clash of ballyhoo vs reality that is coming from the Obama Administration. You have the Dept. of the Treasury pouring out money to buy mortgages and making a grand production of their efforts, which includes an $8,000 incentive to first time buyers. Then you have the actual detailed requirements to get one of the Geithner/Obama mortgages. The prospective homebuyer doesn't know these requirements when they make the offer. They find out when the deal falls through. This quiet tragedy is happening all over America.

Because people still want to buy homes and the lending machine is broken, new vehicles are needed. Perhaps banks aren't the best way to go.

Mike Robinson is Senior Partner at Robinson & Henry P.C., a Castle Rock, CO Law Firm. Ryan Wood, an Associate at the firm, contributed to this story.