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D. Sidney Potter Headshot

What if Nobody Came to the Government Shutdown?

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Much speculation was bandied about on what the earth would look like if the U.S. government deficit ceiling was in the red come midnight on Oct. 17. As it so happened. It came and went -- the deficit ceiling implosion was averted and the sun rose up over Gotham City in the east.

But what if it didn't? The two biggest concerns for most real estate professionals like myself, who are ensconced in the everyday minutia of real estate transactions and the active engagement of toxic mortgage operational clean-ups that are still spewing nationwide, were two pressing issues. They are the lack of mortgage liquidity in the secondary market and the advent of economic stagnation.

1) The Lack of Mortgage Liquidity in the Secondary Market
From a mortgage operations viewpoint, which is where much of the loan underwriting occurs for those seeking loans to either purchase or refinance a home, the partial shutdown that started this past month and went for 17 days, did in fact cause a slowdown in loan closings.

As a point of curiosity, loan processing centers are typically located in secondary markets where the real estate is cheap, since operations are housed in mammoth facilities that exceed 100,000 square feet in size. Hence, markets like Charlotte, NC, Jacksonville, FL, Des Moines, IA and Phoenix, AZ are your typical facility centers for mortgage processing.

From a boots on the grounds perspective -- and as a consultant who has worked in these facility centers nationwide, this is what occurs. Nearly all loans that are securitized and sold to Fannie Mae or Freddie Mac need tax transcripts.

The form that a borrower will fill out is called a 4506T. (The "T" stands for transcripts, incidentally). This IRS form allows lenders to pull your tax returns to make sure the income you stated matches the income you stated on your loan application. Because of this "new" due diligence in loan underwriting, many a loan broker yearns for yesterday when liar loans were all the rage. But with the recent government slowdown (since calling it a shutdown is not technically correct), the IRS got a mini 2½-week vacation. And with nobody at the IRS, that means nobody got print-outs of tax transcripts. What's a lender to do? Simple! Go to Plan B (and Plan C, if Plan B doesn't work).

When it comes to income verification, the lending industry reacted by underwriting loans without getting tax returns from the IRS. With the IRS on vacation, mortgage lenders had essentially two choices:

Firstly, require a borrower to show them their tax returns. This is what I call the Jerry Maguire request, a la "Show me the money" moment. The fail-safe on this tack is that mortgage lenders planned to confirm the returns when the IRS opened back up for business. The downside of this option (Plan B), is that they might get stuck with bad paper if the borrowers lied about their income. In short, and as a result, lenders were funding their own loans. As one industry professional stated. "If it turns out to be absolute fraud, then we own the loan and we'll have to deal with it," said Fred Arnold of American Family Funding in Santa Clarita, CA.

Secondly, which is Plan C, the lending industry found creative ways to work around the IRS shutdown. This maneuver necessitated getting tax data from other financial sources. Ultimately however, this gave some exposure to the banks, since they were making loans without a complete set of data.

2) The Advent of Economic Stagnation

It doesn't take a genius to understand the ramifications of economic stagnation. As it stands, perception is nine tenths of everything, as I like to tell my real estate colleagues. And hence, without the confidence that consumers can enter loan transactions without a substantially amount of risk, then both lender and consumer will become like two left footed dance partners caught in an awkward embrace.

According to some industry experts -- before and post government slowdown, this was and is a lose/lose dance-a-hon. According to the LA Times, "'How much momentum are our fragile housing markets going to lose?' said Debra Still, CEO of Pulte Mortgage and head of the Mortgage Bankers Association. 'The longer we're shut down, the more it'll negatively affect housing.'"

Irrespective of if the country goes through another fiscal cliff, also known as partial government shutdown, the hyperbole that suggests that the Chinese somehow own us is fairly silly and what narcissistic bobble heads looking for a cheap sound bite say on cable network channels.

The reality of it, is that the Chinese -- or the Japanese and Germans for that matter, aren't about to issue a foreclosure notice on the Statute of Liberty. They don't own the note, nor do they have a second or even third lien position. America owns America. And it will be up to the collective political power brokers to put the house in order and figure out a loan modification plan that won't miss a mortgage payment.