What Is Going On Here?

As markets begin to stabilize, recovery is on the horizon.

Is there one of us today that hasn’t questioned what is going on in our economy and whom to blame?

Or could a recovery already be in sight? These are excellent questions and there may even be some some relatively easy answers.

The bottom line: It’s entirely possible that television’s “talking heads” and print media pundits have turned a normal market cycle into the economic crises of the century. It is time for wiser and cooler heads to prevail.

Let’s take a journey back in time to 1992 as we were welcoming the new Clinton Administration and just beginning to emerge from the recession of 1990.

Interest rates were attractive; with the noticeable exceptions of California, Florida and Boston our housing markets had held up nicely.

Unfortunately, during that economic slowdown homeownership rates dropped to cyclical lows especially among traditionally under-served minority groups such as Hispanics and African-Americans.

In a well-meaning effort to create economic activity and introduce an important and growing population segment to the advantages of homeown-ership, government programs were created through the Federal Housing Authority including Government Sponsored Enterprises (GSEs) such as the Federal Home Loan Mortgage Corp. (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) along with participation by various other state housing finance agencies.

All such programs were specifically designed to encourage banks to lend money for home purchases. In fact, the Community Reinvestment Act (CRA) actually required financial institutions to develop programs to serve the underserved whether as individuals or as geographic markets.

As the recession eased and with all players now in place, the national hom-eownership rate increased 5.5 percent from a low of 63.7 percent in 1993 to a peak of 69.2 percent in 2004. With the availability of huge amounts of mortgage credit and a largely unregulated lending machine, we drove up to the amount of outstanding residential real estate debt to almost $12.1 trillion.

Predictably, as time went on the supply of “qualified” home buyers became depleted, driving a need to find ways to continue to feed an enormous housing and lending machine that had been created. With all the advantages of hindsight, the housing bubble of 2003 was in the process of forming. The expansion of the credit-risk envelope through more generous loan-to-value requirements, the development of the “sub-prime” market and the “new” mortgage instruments that did not consider borrower income levels enabled the burgeoning housing industry to spur demand for housing and continue to feed what was quickly becoming a monster.

Few economic laws are as immutable as that of Supply and Demand. With housing in short supply and demand for housing high, the value of existing houses began to increase rapidly.

In that climate speculation is never far behind. We actually saw house values, which are generally limited to the value of the land plus cost of construction, add a third component, “speculative value” component, which as we have repeatedly and sadly learned in the past, cannot be maintained. The house of cards couldn’t stand forever.

By 2006, with tipping points that included increasing interest rates and an over supply of new housing units, the bubble burst. The vast network of global finance that had funded the growth and appreciation of the United States housing market went into the self-protection mode we find ourselves in today. Where in all this could possibly be the good news? Essentially, what we are seeing is a normal business cycle now in the process of self-adjusting back to a sounder foundation of household formations, housing supply and historically normal mortgage lending standards.

The actions being taken today by the world’s central banks and governments to shore up the financial system and stimulate spending will result in an economic recovery. Our economy, and nation, is much healthier today than at this point in previous recessions. Our banking system is sound and markets for real estate and stocks are beginning to stabilize. Many lessons regarding the lack of appropriate regulation and oversight have been learned. There is a light at the end of the tunnel — the good news is that it’s not a train.