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Keepin' It Real Estate: The Other Side of the Rock-Bottom Mortgage

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Getting to the "bottom" of the housing market.

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It's wishful thinking that artificially low interest rates alone are enough to rehabilitate the housing market.

The mortgage industry has undergone a swift and ruthless downsizing over the past 18 months. While a necessary part of the corrective process, the market is ill-equipped to handle the onslaught of new loans that regulators are hoping to incite.

Last week, the Wall Street Journal reported the Treasury Department is considering pushing down mortgage rates to levels not seen since the heyday of the housing bubble. Through the recently nationalized mortgage giants, Fannie Mae (FNM) and Freddie Mac (FRE), loans would be offered to qualified homebuyers with rates as low as 4.5%.

The story sparked a wave of refinancing as rates on all types of mortgages tumbled. Coupled with the Federal Reserve's plans to buy agency debt and freshly originated mortgage-backed securities, the stage is set for renewed buying activity.

Although Treasury Secretary Hank Paulson has since denied that he's planning such a move, he did say that he's "always looking at new ideas" and that "the key thing to get us through this period is getting housing prices down."

Whether there's an official program of 4.5% mortgages is immaterial, as Washington is doing everything in its power to push rates as low as possible.

It's hard to argue cheaper mortgages won't encourage buyers to leave the sidelines and jump into the market. However, as Bloomberg noted this morning, layoffs at mortgage companies and banks like Citigroup (C), JPMorgan (JPM) and Bank of America (BAC) have greatly diminished origination capacity. Lenders, having already tightened underwriting standards, have limited resources to process new applications.

Many are hoping low rates will encourage refinancing and help clear out the toxic subprime and Alt-A securities still plaguing the financial system. Unfortunately, the loans originated for securities in 2005, 2006 and 2007 -- the ones causing all the trouble -- were done with minimal down-payment requirements. Falling home prices mean most of these borrowers are underwater - and thus unable to refinance.

Furthermore, any renewed buying is likely to be met with a flood of new supply. There's a concept in real estate known as "phantom inventory," which refers to homeowners who want to sell, but keep their homes off the market while they hope for conditions to improve. Some experts believe actual inventory levels, when these would-be sellers are taken into account, is as much as 25% higher than official data show.

Anecdotally, this makes sense. For each buyer waiting for lower prices to step in, there's a seller waiting for a better market. So any pop in buying activity will offer sellers an opportunity to list their homes in a seemingly stronger market. As foreclosures continue to spread into previously unaffected areas, inventory levels are likely to remain high throughout much of the country.

And while attractively-priced, well-maintained homes in desirable neighborhoods will continue to sell, more of the same will be available in each successive month. Patience remains the best ally for the prospective buyer.
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