Why Banks Don't Have Any Money

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 depositor'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 of loaning a customer money and keeping the loan in-house, 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) keeps the data of the total amount of mortgage-backed securities that are issued and sold 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-- $ 40.5 Billion

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 used 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 make written 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 bankers and they will say "We have lots of money to lend!". One particular bank even has a radio spot using this phrase in their commercial. Not so.

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.

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.

The current system of debt collatarelized security sales has broken down and isn't being repaired. Something new has to come along so that buyers can buy and sellers can sell.

Mike Robinson is Senior Partner with the Castle Rock, CO Law Firm of Robinson & Henry, P.C. Mr. Robinson was assisted in writing this story by Ryan Wood, an Associate with the firm.