Abstract: The boom-and-bust cycle of the real estate market may well be a thing of the past. In the 21st century the real estate market has a way of correcting itself and moving on.

During the 20th century much of the real estate market was a case of boom and bust cycles which repeated themselves without anybody ever learning anything. This certainly was the case of the boom-and-bust cycle of the seventies and then the repeat of that in the eighties.

The nineties however appeared to introduce a different story. Real Estate prices started to rise gradually and steadily, credit became increasingly cheaper and easier to obtain, the price of many items fell as globalisation introduced the notion of negative equity and many home owners opted for the good life and took out second and third mortgages releasing equity stored up in their homes and deciding to live the good times.

The 21st century, it seemed, would be a time for enjoying life to the full without having to worry about huge fluctuations in the markets. But money does not just come from nowhere. Borrowed money needs to be paid back which seems to argue that, at some point, the party has to stop and someone will have to pay the bill.

The cynics amongst us will say that this is exactly what is happening with the current tightening up in credit and an increase in the number of properties going to foreclosure and being sold off with their owners’ credit rating seriously damaged for a long time.

But that is not the real story nor is it true at any rate. Yes, foreclosures are on the increase and, in all likelihood will continue to rise for some time but what is really happening here is that the overheated housing market is undergoing a correction with house prices not falling (the bust part of the old cycle mechanics) but stabilising in a slower growth which more closely reflects their true value and affordability by those who are now looking to purchase a home.

Unlikely as this may seem this is actually good news. Foreclosures release homes which are trapped in the housing market at an artificially high price which had been fuelled by demand and make them affordable again for first time buyers. In addition, because there is a greater supply of more affordable homes than before the low prices attracted by foreclosures have a dampening effect on the rest of the housing market which then stops from growing faster than the ability of the underlying credit to support it.

Don’t get me wrong. Foreclosures are never good news for anyone but, as part of the real estate market’s and mortgage lenders’ activities, it is yet one more market correction mechanism that is in place. We should neither under nor overestimate its impact and we should see the figures for what they are: an inevitable consequence of a market that was over-stretched, now bringing itself back to level ground.

Abstract: The latest news on house buying coming out of the Bay Area in California signals that lenders are getting twitchy and more foreclosures may be just around the corner.

In real estate everything is linked and every single action is followed by an opposite and sometimes equal reaction. The news that Bay Area sales of new homes have slowed to their lowest point in 15 years signaled a ratcheting up of tension as lenders began to nervously examine their lists showing those borrowers who have fallen behind on payments.

Let’s take a moment to examine why one area should be affecting the other. Lenders make their money by doing what they do best: lending money to borrowers who pay it back with interest thereby leading to a hefty profit. There is a certain remorseless logic of specialization in this area which occurs by default.

What I mean by this is that lender’s are happiest when they lend money and collect payments because that’s what their business is really geared up to do profitably. Borrowers are, well borrowers and need to borrow money at a rate they can afford to repay it.

Now the moment you have house sales dipping and borrowers defaulting lenders begin to get nervous. They get nervous because they sense that the economy is taking a dip which means that those borrowers who are teetering on the edge and are just managing to make the payments and have now fallen behind, are finding it tougher to make ends meet. You would think, at this point, that the fact that lenders have lent money with a house as a collateral would be enough to take the edge off their nervousness. After all, logic tells you, the moment a house owner cannot make payments and the loan goes into default (and remember these two things do not happen simultaneously, there is a lengthy process involved) the lender will take possession of the house, call foreclosure upon it and get their money back.

Ok, logic here is wrong. Here’s why: Lenders have specialized. Taking possession of a home and selling it is the worst case scenario for them because they know the have no specialized staff to do this, it is a costly exercise for them in terms of administrative costs and, because they are not geared up for selling houses, what they will get back in most cases is going to be well below the house’s market value. That means that the moment a lender decides to play hardball with a house owner who can no longer make payments and take possession of the house, they are losing money all the way and are only trying to decide what is an acceptable loss.

This neatly leads me into the Bay Area news which is bad for those home owners who have fallen behind on their payments and those lenders who have loaned money to them. A slow down on house sales means a slow down on the economy which means a dip in house prices and a buyer’s market. For a lender who has taken possession of a house because the owner defaulted on the payments this means that house prices are dropping and their loss is increasing. This makes it more likely for them to foreclose on properties which have not yet reached the normal default stage simply because the lender does not want to risk waiting and having to sell the property six months later at a greater loss.

This is bad news for borrowers struggling to make ends meet because the lenders are getting trigger happy and are less likely to listen to a home owner who has fallen behind on their payments. Suddenly, the news coming out of Bay Area is a clear signal that suddenly there is a very cold wind blowing in the home buying business and lenders are getting twitchy.