Dallas Home Mortgage Assistance

If you have been paying any attention to the news lately (and it is probably safe to say that the majority of folks with a Dallas home loan have been), you’ve probably heard people talking (debating) about the concept “Mark to Market” and whether or not changes need to be made.

What is Mark to Market and why does it matter? Is this going to have any affect on the general housing market, and more importantly, directly on your Dallas home mortgage?

We are going to do our best to give an overview of it below in the hopes you will better understand it, and more importantly, comprehend how it has played such a powerful role in today’s economic crisis, including the Dallas mortgage market. It may come as a surprise to discover that this accounting requirement (i.e. law) has significantly more to do with the today’s economic crisis than quite possibly anything else.

Before we even look at how Dallas mortgage rates are affected, we’re first going to discuss why Mark to Market even exists

To get a grasp on Congress’ inspiration behind making this accounting rule, we have to look back at the stock market crash that happened in 2000 to 2002.

At that time, before this rule was created, companies such as Enron, Arthur Anderson and others figured out ways for ‘cooking their books’ in order to make their balance sheets look a lot healthier than they actually were. This, in turn, made their stock prices to be falsely inflated,playing into the creation of the ‘bubble’ that, as we all know, eventually burst. When that occurred,many people lost tons of money. To say they were unhappy is more than an understatement. Something neededto be done.

The idea of “Mark to Market” accounting was created in an effort to make things more transparent and to ensure fair valuation of companies and all their assets. To summarize, what it means is that all assets have to be valued exactly as if they were to be sold on a daily basis. For anyone who decided not to do this conservatively, they risked possible jail time.

Let’s now have a look at how this regulation can create a problem affecting the whole economy, including Dallas mortgages.

Between the enormous amounts of money handled by banks – and the wide (and odd) variety of financial instruments they use, – it can be challenging to try to get one’s mind around exactly what they do. It will be simpler to describe how this accounting strategy works using an analogy more realistic to the average person.

We’re going to pretend you live in a neighborhood and all the houses are worth about $200,000. Let’s also imagine that your neighbor owns his house free-and-clear.

All of a sudden you neighbor has some serious, major medical expenses and has to sell his house in order to pay forit. He is in need of his money right away and doesn’t have the time for a Dallas refinance, and he’s in no position to wait for the best offer he can get. So rather than wait, he sells his house for $150,000 to make it move fast, even though it’s obvious that the property is worth considerably more than that.

If you lived next door in a very similar home, does the fact that your neighbor’s house sold for $150,000 indicate your home just lost 25 percent of its value? No, of course it doesn’t. If you wanted to sell your house, you would take the time necessary and get a fair price for it; you wouldn’t be forced into a “fire sale” situation.

On the other hand, if you were a publicly traded company and it was mandated by law to abide by the Mark to Market accounting rules, you, and all your neighbors too, would now be forced to claim that your house was only worth $150,000 and not the $200,000 everyone recognizes to be the real market value.

Let’s take a look at how this would apply to a bank.

Allow me to stretch the hypotheticals a bit further.

We’re going to pretend you have decided to begin a brand new bank, let’s call it YOUR BANK. You begin with a $2 million initial investment to get Your Bank started. Your strategy to make money as a bank is to bring in the public’s money as deposits, and pay then a low but safe rate of return on that, and then use that money to create other loans, such as Dallas home loans, that pay you a higher rate of return. The difference between the two rates is the profit you keep.

Let’s say that from our $2 million of deposits, we created $30,000,000 of loans. Our Capital Ratio (the ratio of loans to actual capital on hand) is at a comfortable 15:1 ($15 million in loans for every $1 million in deposits). This ratio is completely acceptable by banking standards.

We’re going to imagine that you run your bank by extremely conservative standards, and the Dallas loans Your Bank agrees to make are limited to those of only the very highest standards. For example, you require a 30 percent down-payment (the industry average is usually 20% or even less), a credit score of 800 or higher (this would be a VERY high credit score), you require full documentation of all income and assets and only allow a debt to income ratio of 10 percent (40% is the industry norm).

It is clear, Your Bank will only engage in the highest quality Dallas loan. And it’s evident. All of your borrowers are paying on schedule, everyone is happy and Your Bank is making plenty of money. This makes Your Bank stock price go higher and higher.

Very quickly, the Dallas real estate market starts to slow down and go soft, and Dallas home values begin to drop (however, your borrowers continue to make all their payments on time, no problem).

The problem is, with the overall reduction in home values, you are forced to re-assess your loan portfolio valuation. Now, rather than the loans being 70% of the value of the home, they’re at 90% (your equity position in the home went down a lot). This means these loans are now much riskier than back when you had a lot more equity, and because they’re more risky investments, the market is less interested in buying them than they were before and because of that they have less value.

Your accounting team now informs you that, according to law, you are required to “Mark to Market” if you don’t want to risk a serious penalty (like JAIL!) In their Mark to Market analysis, they estimate your value is now at $1,000,000; it has been reduced by half!

Now remember, not one thing has changed as far as your borrowers or your loans (everyone continues to pay on time so the money is still coming in like it always has). The difference now however, is that you now have to reflect the fact that your ‘value’ has been cut by 50% to only $1,000,000.

Here’s the thing; you still have $30,000,000 of loans out there, and with a valuation of only $1,000,000, the capital ratio is now at at 30:1 which is a LOT different than 15:1.

Alarms begin to go off all over the place because it’s possible that with just a couple of bad loans that you would be forced to cover, you might quickly run out of funds. This would place depositorsin danger of losing their savings.

Now you have a situation where the FDIC is starting to look into Your Bank and next the SEC (Securities and Exchange Commission) begins asking all sorts of questions. Your Bank stock begins to to tumble. All the financial news networks hear of the situation and just add fuel to the fire.

Your Bank is in serious trouble.

The problem is, Your Bank is ‘over leveraged’, and to make up for that you are going to need to start selling some of your assets. (You could try raising capital, but when you think about the way the situation appears and your capital ratios totally out of balance, no one in their right mind is going to be willing to lend you the million dollars you need).

Since you need to get that money as soon as possible, you find yourself in a situation very similar to that of your neighbor who was forced to ‘dump’ his home very quickly at a below-market price. As you sell as many assets as possible to raise capital, it simultaneously reduces the value (i.e. quantity) of your remaining assets, further skewing your capital ratios even further.

This is the kind of death spiral that is very hard to stop once it starts. The other issue is, the problem doesn’t stop with just Your Bank.

Now let’s imagine that my Dallas mortgage company (we will call it “My Bank”) purchased those assets from you. You were unloading them at such a discount that My Bank felt we were receiving such a great deal that we could not resist, so we bought a lot of them.

The trouble is, with the Mark to Market rules, the assets My Bank just purchased from Your Bank at such a discounted price need to be used as comparables that all the other financial institutions also use in order to value their assets. So each $200,000 Dallas mortgage loan that My Bank holds (not limited to just the ones I got from Your Bank) are now only worth $150,000 each even though they were loans that were performing perfectly.

Now we have a situation where the value of My Bank also goes down. As this occurs it negatively affects My Bank’s capital ratios and causes me to sell assets as fast as possible so as to generate money… and so the cycle goes on.

It’s easy to see how quickly and wide-spread the problem becomes, even though there was not necessarily any ‘bad business decisions’ made. It’s all due to good intentioned, but over reaching, accounting law.

If you think about the situation described above, you might ask, “Why not have everyone just quit buying the discounted assets from the other banks and just make the cycle stop?” This is a good question.

If the cycle is stopped, not only do some financial institutions go under, but the flow of money in general just stops. This is what is referred to as the ‘credit freeze’. When there is no credit available at all, mortgage lending comes to a crawl, car and truck sales essentially stop, people are laid off their jobs and the economy goes into a recession.

We have been in, and gotten out of a recession in the past. Why don’t we do the same thing we did to get out the last time?

The minor recession of 2001 recovered relatively quickly in large part because the Fed brought down the interest rates and mortgage lending standards were more relaxed, which led to nearly $3 trillion worth of funds being extracted in the form of home equity and put right back into the economy.

In today’s world, loan guidelines everywhere (not just the ones Dallas mortgage brokers are dealing with) are far more restrictive, house values are a whole lot lower (and have been headed in the wrong direction for a while). And as was mentioned earlier, the unfortunate truth is that there is just not very much money flowing out there for Dallas mortgage companies to access for either home purchase loans or for a Dallas mortgage refinance.

However…

A bit of good news for a change!

4/2/2009 – The Financial Accounting Standards Board (FASB) voted favorably in regards to relaxing the Mark to Market standard. They have decided to allow financial institutions to use alternatives such as cash-flow analysis to value assets. This change is going to significantly reduce the write downs banks have been forced to take on assets and investments like mortgages. This could very well mean more money will soon be available to your local Dallas mortgage companies. We definitely hope so.