Since the recent real estate boom went bust, banks and lending institutions have implemented credit and underwriting policies that have acted as an accelerant to the free fall of property values.  These policies, intended to protect the financial organizations, are causing a great deal of harm to those same financial institutions and to the public at large.  One such plan adopted by the majority of loan committees has been the primary catalyst for stricter lending procedures causing degenerative cash flow positions for the financial markets.  The idiom used to justify that vehicle, a vehicle that siphons much needed liquidity from the parched equity markets, has become a well established phrase in the vernacular of real estate professionals: soft market. 

A definition for soft market cannot be found on Merriam-Webster Online, and the results from searching Google (www.google.com) and Librarians' Internet Index (www.lii.org) are less than satisfactory.  As a finance professional, I define soft market as a real estate expression, an idiom, used by the collective lending community to describe a region where property values are in decline.  A market is said to be in decline when the current property values in a specific area are presently less than the values reported in the preceding calendar quarter.  If property values in a particular area have decreased from one calendar quarter to the next that area is identified as a soft market.  Typically, these market conditions are caused by supply and demand, when there are more people selling real estate than buying real estate.  When an area has too many people selling or not enough people buying it creates a surplus of property for sale on the real estate market.  Many sellers become desperate to sell; to motivate buyers to buy, sellers lower their asking prices causing further decline in property values.

Lending institutions have specific procedures for soft markets called soft market policies, which include tightening lending guidelines for the area considered a soft market.   These soft market policies may require borrowers to have a larger down payment, require borrowers to provide additional income documentation, limit the type of loan a borrower may obtain, or any combination of procedures with the purpose of providing the lending institutions an additional level of comfort.  When lending guidelines are tightened it removes borrowers, consequently buyers, from the market causing an even greater imbalance in the buyer-seller ratio.  This imbalance causes property values to fall even further, and fall at a quickened pace.  As home prices continue to fall, lenders tighten guidelines again and again removing more and more borrowers, fostering a degenerative cycle. 

The impoverished neighborhoods are the first to feel the affects of soft market policies while the affluent may not realize the impact.  For example, when compared to the affluent or the middle class, those with lesser means have minimal savings, if any at all, and disposable income is an unknown luxury.  Logically, stricter guidelines that require additional down payments or greater disposable income remove more lower-income borrowers from the market.  This elimination puts additional strain on the sellers in those neighborhoods, forcing prices even lower while raising the risk of foreclosure for those sellers who are in dire need.  The middle class is also affected, but it is those with the least in society who areharmed the most.  While the poor drown and the middle class struggles to tread water, the wealthy float along without great concern.  As such, the wealthiest in society have the greatest means to withstand the additional requirements imposed on the market, but others do not. 

Sellers are not the only individuals affected by soft market policies.  A homeowner may have qualified to refinance his/her home last quarter, but not now.  Due to shrinking home values compounded with the lending institutions soft market policies of reduce loan amounts, the borrower cannot refinance.  Borrowers who are stuck in their current loans may be damaged if their current loans include a feature called an adjustable rate and their interest rate adjusts to a higher rate.  If this borrower is unable to refinance they may be forced to sell, thereby continuing the cycle by adding yet another seller to a market already glutted with sellers.  Removing borrowers from the market not only removes buyers from the market, but also adds sellers throwing the buyer-seller ratio further out of balance.

Soft market policies were designed to curb the financial losses to lending institutions, and to alleviate potential risk in the market.  Not only do these policies hurt homeowners by evaporating home equity, they are also causing greater losses to those same financial institutions implementing these procedures.  A bank tightens guidelines to mitigate risk; not to be undone other banks quickly follow the same trend.  Again, the cycle is degenerative.

In conclusion, soft market policies have damaged, and continue to damage, lending institutions and individuals alike.  The process of removing buyers from the marketplace again and again through additional requirements has not helped to curb falling home prices, and it has only caused additional strain on the property market.   The American financial markets are the most innovative in the world, capable of producing a more viable option to protect the interest of corporations and individuals while promoting the best interest of both.  Simply stated, soft market policies don't work. 

Do you think soft market policies are working?  Is there a better solution?  Please let me know by sending me an email to dustin.burke@adonaifinancial.com.

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Copyright © 2008 Dustin R Burke | All Rights Reserved

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