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Tuesday, October 18, 2011

Home Prices Could Fall 50% to 80%

The federal government again threatens to delay or exacerbate the national real estate depression, in considering relief to underwater borrowers.

The premise of such relief -- that we must support home prices at any cost, even by stopping foreclosures and allowing people to remain in those homes without paying anything -- is a disaster.

Homes which do not produce income to the lender will eventually hit the resale market.  It is a dangerous myth -- reckless --  to believe that residents paying nothing now will be able, or willing, to pay something more in the future.  But allowing people to stay in homes rent-free forces the banks to endure a prolonged loss of income.

Compelling banks to absorb, and then do nothing to remedy, total income losses makes those banks understandably wary about any other activity involving the risk of loss.  The government's message is that banks cannot do anything to get rid of their loss-producing loans.  There should be no surprise that banks have tightened credit and sought every revenue stream imaginable to offset major mortgage losses both now and the foreseeable future.

Our real estate market depends on bank financing.  If mortgages won't be issued by risk-averse banks and buyers must pay with 100% cash, home prices will plummet, perhaps as much as 50% and possibly approaching 80%, which is the current standard proportion of bank financing (assuming 20% down payments) to the overall price.  Now, I doubt prices will fall that far, because some private lending will come in and seize opportunities.  However, some homes as to which no bank or investor would take a risk due to their condition will risk becoming any price.

The banks -- and more specifically, their upper management -- are hardly  sympathetic and worthy recipients of any taxpayer bailout.  However, the fact remains that banks are for-profit institutions and as such must be comfortable assuming risk in order to lend.  Government policies discouraging foreclosures only force banks to hold on to total losses.  Such policies could not be more efficient in scaring the banks from assuming ANY risk.  As a result, recent government "reforms" may cause an entire generation's main source of wealth -- real estate -- to deflate or evaporate.

Eric Dixon is a New York lawyer, entrepreneur and strategic analyst.

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