Relestate Economy and Society, Term Paper Example

Identify and describe three institutions which a society must have in order for it to have a system of real estate finance in which land stands as security for a debt. Explain why each one is necessary.

The three main institutions necessary for a real estate finance market to exist are banks/mortgage companies, Realtors/appraisers, and settlement attorneys/ law firms/legislative. This is largely due to how debt functions within the real estate finance market. Loan agreements issued against collateral are done so in case a borrower defaults on their financial obligation. People finance and refinance their homes. They often take out multiple mortgages on their homes, which require banks/mortgage companies to finance the mortgage. Likewise, the regulations that govern contracts related to housing agreements and loans need to be mitigated by lawyers and law firms. This makes both the public and private legal intuitions vital for the housing market due to the fact the contracts are drafted by the government and contracts are written by lawyers. Realtors and and appraisers play a vital part of the housing market, meaning that the real estate market and appraisers.  It is standard that loans are issued only when collateral is provided by the borrower, and based on this collateral loan approval will be decided by the mortgage company. This places a major importance on the value of that collateral. In situations where the collateral might be the home itself, or another property, or a guarantor’s credit along with the value of the guarantor’s property, appraisers are needed to assess the real value of properties.  Likewise, when borrowers takeout second mortgages on their home legislative institutions and law firms have to sort through the letter of the law regulating which lenders get paid first in the case of a default on their mortgage payments. For example when the lender places a lien on a property, the real estate  laws are established so that if the property is sold, the lender is the first to receive funds, even if there is a second lender on the property in the form of a second lien. This makes second liens risker’s investments for lenders.

Litigation entails the need for legal institutions and constitutes the next step following after parties perform their due diligence and assess all of the needed information. The process of litigation occurs prior to the purchase of a new home and when the borrower defaults on their loan and it can also occur when the borrower wants to sell their home. During the due diligence process, most of the details of financial information required to assess whether borrower is credit worthy to receive a loan is usually handled, which makes these institutions a significant part of the real estate financial process. If it is uncovered during the due diligence process that a security used for collateral is worth more than the actual value of the loan, then it may provide a borrower with bargaining power or the ability to receive a loan without a guarantor. This is why appraisers and Realtors play a significant role in the real estate finance industry.

This is why the three main institutions necessary for a real estate finance market to exist are banks/mortgage companies, Realtors/appraisers, and settlement attorneys/ law firms/legislative.

Compare Becker’s view of economic institutions to Searle’s. Which view more accurately describes the real estate economy, and why?

Becker notes that actions in economics are constrained by time, income, calculating, capacity as well as other limited resources. In respect to constraints Becker notes there are different constraints for different situations (Becker, 2): To provide an example, Becker states, “economic and medical progress have greatly increased length of life, but not the physical flow of time itself, which always restricts everyone to twenty four hours per day. So while goods and services have expanded enormously in rich countries, the total time available to consume has not” (Becker, 2).  Becker identifies family as an institution within the economy with its main assets being human capital. Searle identifies economics, as “the mode of existence of the ‘commodities’and he notes that the methods through which these commodities are disposed is through institutions. He states that “given the centrality of institutional phenomena, it is somewhat surprising that institutional economics has not always been at the center of mainstream economics” (Searle, 4). He further notes that through the creation of a reality based on institutions, human power is increased. He notes that, “by creating private property, governments, marriages, stock markets, and  universities, we increase the human capacity for action” (Searle, 11). He argues that having desires and satisfying them through the use of these institutional structures, like the desire to become wealthy or earn a Ph.D requires a cognition of what he refers to as deotonic relationships, that is an understanding and consideration of relationships that only exist within the institution. He notes that without the consideration of this deotinic relationship there is really no power. Becker notes that, “until the 1950s economists generally assumed that labor power was given and not augmentable. The sophisticated analysis of investments in education and other training by Adam Smith, Alfred Marshall, and Milton Friedman were not integrated into discussions of productivity” (Becker, 4). Becker goes on to note that these changes resulted in the development of studies in human capital as a fundamental aspect of the economy. Becker further states that “human capital analysis starts with the assumption that individuals decide on their education, training, medical care, and other additions to knowledge and health by weighing the benefits and costs” (Becker, 4). This new emphasis on human capital as it’s relevant to the economy resulted in policy makers and economist assessing the value schooling and training played in the process of increasing human capital and improving quality in the labor force. Becker states that, “wants remain unsatisfied in rich countries as well as in poor ones. For while the growing abundance of goods may reduce the value of additional goods, time becomes more valuable as goods become more abundant. Utility maximization is of no relevance in a utopia where everyone’s needs are fully satisfied (Becker,2). The author is keen to note that this type of utopia is not impossible. Becker essentially breaks down the objective of forming a family into the value it contributes to or takes away from the economy. Becker argues that the motive behind why men and women, or same sex couples consider marriage is based on this same economic expectation, specifically whether or not they believe they will improve or reduce their own human capital.

I personally believe that Searle’s view relates more to the real estate market because he touches on the concept of assets being only as valuable as their perception and labeled value within the intuition. This is very similar to the housing market in how the values of mortgages and credit defaults swaps are only as valuable as the market perceives them to be. It’s entirely based on confidence verses panic due to lack of confidence.

Of all the factors which contributed to the expansion of credit, described by the FCIC, which do you consider the most significant and why?

In their text on credit expansion and neglected crash risks, Baron Matthew and Wei Xiong note that the main cause of the economic crisis is credit expansion. The authors notes that, “in a set of 20 developed countries over the years 1920-2012, bank credit expansion predicts increased crash risk in the bank equity index and equity market index” (Baron Matthew and Wei Xiong, 1). The authors attribute this to the fact that despite banks expanding credit, during these instances of credit expansion when one would think the banks would increase their returns, returns actually decline by as much as -25%.  They note that the combination of increased crash risk taken on by the banks through credit expansion in collaboration with the decline in actual returns creates an environment what reduces confidence in the market. The authors attribute the cause of credit expansion to over optimism within the market, and the neglecting the possibility of crash risk by the shareholders. I think over optimism in the market is the most significant contributing factor as this is a factor that leads to neglect of the possibility that once over extended the optimism can fade and the market will be out of the hands of the banks and in the hands of the shareholders. This makes the market vulnerable to panic and it makes over optimism the single most significant cause of credit expansion.

I base this on the fact that, the FCIC report defines the difference between a remote cause of a panic and the proximate cause of a panic which lead to or could be the result of a financial crisis. The report notes that the “remote cause of any crisis is the “expansion of credit” combined with speculation, while the proximate cause is the an incident that causes confidence to decline and inspire investors to sell all of their commodities, like real estate, stock, promissory notes and the exchange of bills. This in turn increases the amount of money the their money holdings” (“FCIC Report 2014,” 83).  The report further breaks down the events that lead to the great financial panic of 2008. The FCIC report argues that the remote cause of the crisis was mainly due to government housing policy that led to the pension of credit through a decrease in interest rates combined with increased lending, which resulted in a significant increase in risky and weak assets which set the financial system up for a crisis. The report notes that these key factors are what resulted in the crisis going from a minor crisis to legitimate panic.  The report notes that the primate cause of the full fledged panic that occurred could be attributed government actions like the bailout “of Bear Stearns in March 2008 and the subsequent failure to rescue Lehman

Brothers six months later” (“FCIC Report 2014,” 83). The report closes by defining these actions by the government as one of the “greatest policy errors of all time”  mainly due to its ultimate cost to the public.

What is the difference between an entrepreneur and a lender, and how does that difference affect the roles of banks and developers in residential subdivision projects?

The entrepreneur is the one with the patent, trademark, LLC, or rights to the business, while the lender is the one with rights to the assets if and only if obligations within the agreement are not met. Essentially the entrepreneur is a borrower. Time is needed to build any successful business, especially a development property. This makes control over the project one of the most important factors to consider, because the necessary to make a business successful sometimes does not line up with the amount of time a lender is willing to wait before getting their money back.  This time period can also differ from the time investors are willing to wait to see a return on their investment. While it would be a substantially smart approach for an entrepreneur to reinvest profits earned back into his company, the fact that they are always at risk of lenders seizing their assets makes that a risky investment. The best approach for the entrepreneur is usually to reinvest all profits back into the business in order to achieve the early growth so important to the later success of the business. The lender has security interest in the business assets and has the right to seize those assets if the business does not meet the obligations of the contract. Outside of that possibility, The entrepreneur owns the rights to the assets.  Investors don’t have security interest to the assets but can represent a substantial source of cash flow and confidence in the company by the market.  On the other hand, an investor may not have that security interest but will likely be looking over the business with a careful eye all the time. This represents the distinct difference between entrepreneurs and lenders and why the real conflict between them is the battle over control, and control is also an issue when dealing with investors as well.

Is it possible for another real estate-based financial crisis to occur? Why or why not?

Yes it’s possible for a real estate-based financial crisis to occur again. This is due to the three core rules that apply to real estate, specifically, “1) Real estate is governed by the law of supply and demand. 2) Real estate is governed by the law of cause and effect. 3)History repeats itself. In any marketplace, you have cycles” (“Understanding Truths that Rule Every Real Estate Market,” 1). While the third rule is the main one that directly answers this question, due to the fact that the real estate market is largely governed by demand and supply and there are no exception to this rule. Confidence in the market and the expectations that comes with that confidence influences buying and selling, which in turn impacts the velocity and activity of real estate market fluctuations. Real estate is also governed by the law of cause and effect, which basically means positive situations result in positive outcomes and negative situations in negative outcomes. For example, the vibrant economic growth of the housing market created a situation where people became overly optimistic in the the housing market until the value of homes were overvalued and there was nothing else for it to do but depreciate in value. The rule that history repeats itself, dictates that another economic crisis will occur due to the real estate market. Cycles exist within all markets, and within this understanding it is a natural economic law that rapid real estate appreciation is followed by period of stagnation or decline. This can cause a decrease or at least a stabilization in housing valuations. An example of this can be seen by the facts related to credit expansion previously mentioned where home loan are provided with low money down, interest only mortgages as the banks gamble on the housing market’s continued increase, which ultimately ends in its decline.

Work Cited

Baron, Matthew, and Wei Xiong. Credit Expansion and Neglected Crash Risk. Workingpaper, 2014.

Becker, Gary S. “The Economic Way of Looking at Life.” Nobel Lecture in Economics. 1992.

“FCIC Report 2014” Financial Crisis Inquiry Commission. 1-123

Maclennan, Duncan, John Muellbauer, and Mark Stephens. “Asymmetries in housing and financial market institutions and EMU.” Oxford Review of Economic Policy 14.3 (1998): 54-80.

Searle, John R. “What is an institution.” Journal ofinstitutionaleconomics 1.1 (2005): 1-22