GSE Loan Limits Fell…and Home Sales Went Up
On October first, the Fannie Mae/Freddie Mac maximum loan limit fell (from around $729,000 to $625,000). The Senate later voted to extend that limit until December 2013. Some House members, such as Rep. John Campbell (R-CA) warned that if the loan limits were not raised back to their previous levels, our housing market would “crater.” And of course the special interests in the real estate industry all but implied that if the taxpayer did not remain on the hook, then we’d all be living in caves before too long.
It was easy enough to make such outlandish statements in the absence of data. Now we have some data, and from of all people, the real estate industry. According to the National Association of Realtors (full disclosure: I worked there about 10 years ago):
Total existing-home sales, which are completed transactions that include single-family, townhomes, condominiums and co-ops, rose 1.4 percent to a seasonally adjusted annual rate of 4.97 million in October from a downwardly revised 4.90 million in September, and are 13.5 percent above the 4.38 million unit level in October 2010. [emphasis added]
You read that correctly. The loan limits fell and then home sales actually rose, which is the opposite of crater. I’m not claiming that the decline in loan limits caused home sales to increase, but I am claiming that the housing market did not crater, as was predicted.
‘Monstrous Moral Hybrids’
Sunday’s dinner of the Society for Development of Austrian Economics featured a keynote from George Mason University economics professor Richard Wagner. The talk brought back a lot of memories for me. Wagner was chair of my dissertation committee and it was in his graduate public finance class (back in 1992?) that I first gave any thought to Fannie Mae and Freddie Mac when I wrote a paper on government sponsored enterprises. Little did I know I’d spend much of the following years working to reform Fannie and Freddie.
During his talk, Wagner invoked a term first used by Jane Jacobs: “monstrous moral hybrids.” I suspect Jacobs used the term to describe how Robert Moses managed to wield unaccountable power over development in New York City (Caro’s account of Moses, Power Broker, still being the single best read on city government). Ms. Jacobs describes two distinct moral syndromes, commercial and guardian. Obviously commercial pertains to the market, while guardian can pertain to government. The monstrous moral hybrids are when we get the worst of both instincts combined in one entity. For instance, I generally view competition as a good thing; however, competition underwritten by government guarantees will almost always lead to disaster. Its competition without the discipline of failure.
I repeatedly watched, while working in Senate, Fannie/Freddie invoke their “private” nature in order to avoid regulation while invoking their “public” nature to gain protection and privilege. The result was little accountability from either the market or the government (our largest banks currently enjoy a smaller version). Of course, one of the primary differences in debates over financial regulation is the degree to which one believes that either the market or government provides accountability. Setting aside those debates, we should all be able to agree that companies should be either private or government. That the mixing of the two, government sponsored enterprises, is a recipe for avoiding accountability and transparency. But then I suspect that might have been the intent all along. Monstrous moral hybrids by design.
What’s a Conservatorship Good For?
A central reason that Fannie Mae and Freddie Mac have not played a bigger role in rescuing homeowners, or otherwise handing out “freebies,” is that these two companies are in conservatorship.
Conservatorship is almost like a bankruptcy proceeding, or a receivership in the banking context, but without the power to impose losses. I’ve been criticized for believing that a conservatorship requires Fannie’s regulator to “conserve” the company, and not simply allow it to be used as a slush fund. The basis of said criticism is that FHFA, Fannie’s regulator, has a broad public mission, which could include handing out freebies to underwater borrowers.
Matt Yglesias suggests that “clearly the purpose of creating the FHFA and taking Fannie and Freddie into conservatorship can’t have been to minimize direct taxpayer financial losses on agency debt.” Now, Matt makes a lot of Congress being vague in the statute. And he is correct about it being vague, in some areas, but it isn’t here.
As one of the two people (the other being Peggy Kuhn) who actually drafted that section of the Housing and Economic Recovery Act (HERA) during my time as staff on the Senate Banking Committee, I can clearly say the purpose of the drafters, in terms of conservatorship, was to nurse those companies back to health. Again, how do I know that? Because I was there.
Of course, if one simply read that section of the statute, Section 1145 of HERA, which amends Section 1367 of the 1992 GSE Act, one would clearly see what the purpose, duties, and role of a conservatorship actually is. For instance, what does the law say the powers of a conservatorship are? They are to ”take such action as may be—(i) necessary to put the regulated entity in a sound and solvent condition; and (ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.”
Now, I don’t see anything in there about handing out freebies to underwater borrowers. Citing an agency-written mission statement or a vague “purposes” at the beginning of an act is no substitute for actually reading the provisions of a statute.
End the Mortgage Interest Deduction
The mortgage interest income tax deduction is popular among homeowners (read: likely voters) despite its role in distorting housing and related markets, its contribution to the housing bubble and its enabling of additional household debt. Never mind that there isn’t much evidence that the deduction boosts home ownership in the United States. Consider also that the tax break largely benefits affluent homeowners living in expensive urban areas.
As Mark Calabria notes in today’s Cato Daily Podcast, it’s well past time for the mortgage interest deduction to be replaced by lower marginal tax rates for all earners.
No Hope or Change When it Comes to Fannie Mae
The Washington Post is reporting that President Obama has assigned his staff with the task of designing a new set of government guarantees behind the U.S. mortgage market. Although as the Post also reports the “approach could even preserve Fannie Mae and Freddie Mac.” That’s correct. Despite their role in driving the housing bubble and the already $160 billion in taxpayer losses, President Obama appears to be considering just putting the same failed system in place. Of course, we’ll be promised that it will all work better this time.
Perhaps most offensive is that the Post reports that Obama “officials don’t want to punish the thousands of Fannie and Freddie employees who have specialized knowledge about the mortgage market.” Seriously? What about the many blameless employees of AIG, Lehman Brothers, or Bear Stearns? Or New Century for that matter. Did the janitors and receptionists at those firms really cause the crisis? The truth is that the employees of Fannie and Freddie have been lining their pockets at the expense of the taxpayer for years. What the Administration is really saying is that they wouldn’t want all the political operatives at these favored firms to lose their perks. After all, Obama officials will need somewhere to land after 2012 and Goldman Sachs has only so many slots.
What’s most depressing is that you can’t say Obama hasn’t been given the facts. As the Post makes clear, his economic advisers spelled out the case against massive subsidies for the mortgage market. Austan Goolsbee, chair of Obama’s Council of Economic Advisers, points out: by subsidizing mortgage investments, the government drives capital away from other types of investments. If Obama truly wants to help the middle and working class, then he’d want capital to flow into investments that increase labor productivity, which is the ultimate source of wage growth. Running up asset prices, like houses, does not make us wealthier in the long run.
But then what should I expect. The President has already entered campaign mode. It would be nice to see the economics win over the politics. But it looks like such a thing will have to wait for another administration.
The CAP-AEI Fannie Mae Food Fight
It’s probably never wise to inject oneself into the middle of a food fight, but since I think both sides actually have something right and something wrong, its been a worthwhile debate to follow. That is the ongoing debate between Peter Wallison at the American Enterprise Institute and David Min at the Center for American Progress (at least we can all agree we love America) on the role of Fannie Mae (and Freddie Mac) in the financial crisis. If you can’t guess, Peter says Fannie/Freddie caused the crisis, David says they didn’t.
David makes an interesting point, one I’ve actually argued, in his latest retort. That is, this wasn’t exclusively a housing crisis/bubble. Other sectors, like commercial real estate, boomed and then went bust; other countries, with different housing policies, also had bubbles. True from what I can tell. I will also add that the U.S. office market actually peaked and fell before the housing market, so we can safely say there wasn’t contagion from housing to other parts of the real estate market.
But the problem with this argument, at least for David, is that it undercuts the Dodd-Frank Act, which he has regularly defended. The implicit premise of Dodd-Frank is that predatory mortgage lending caused the crisis, so now we need Elizabeth Warren to save us from evil lenders. But how does predatory lending explain the office market bubble? Do we really believe that deals between sophisticated parties, poured over by lawyers, were driven by predatory lending practices? Do we also believe that other countries were also plagued by bad mortgage brokers? Again, I think David is right about the problem being beyond housing, but he can’t have it both ways.
What is the common factor driving bubbles in commercial real estate, housing, and foreign real estate markets? Maybe interest rates. This was a credit bubble after all. Especially since the Fed basically sets interest rate policy for the world. It is hard for me to believe that three years (2002–2004) of a negative real federal funds rate isn’t going to end badly. This is what I think Peter misses, the critical role of the Federal Reserve in helping blow the bubble. But Dodd-Frank does nothing to change this.
Now there are a ton of things I think both still miss. We could argue all day about what a subprime mortgage is. I think the definitions used by Wallison (and Pinto) are reasonable. There is also a degree, a large one, to which David and Peter are just talking past each other. For instance, there is something special about the U.S. housing market that transfers much of the risk to the taxpayer. In contrast, the bust in the office market didn’t leave the taxpayer to pick up the tab. That has to count for something, unless one just doesn’t care about the taxpayer.
There are a few other issues that make Fannie/Freddie uniquely important in the crisis, but I lack the space to go into them here. Instead, I’ll wrap up by saying that their role in the overnight repurchase (re-po) market is under-appreciated and their ability to essentially neuter the Fed was critical in keeping the bubble going. What’s for dessert?
Exit Interview with Sheila Bair
Sunday’s New York Times Magazine has an interesting exit interview with Sheila Bair, who until this past Friday served as Chair of Federal Deposit Insurance Commission (FDIC). While I haven’t always been her biggest fan, I did find it refreshing to hear a bank regulator state the obvious: we should have let Bear Stearns fail. As she puts it:
Bear Stearns was a second-tier investment bank, with — what? — around $400 billion in assets? I’m a traditionalist. Banks and bank-holding companies are in the safety net. That’s why they have deposit insurance. Investment banks take higher risks, and they are supposed to be outside the safety net. If they make enough mistakes, they are supposed to fail.
I’d be hard-pressed to say it better. Assisting the sale of Bear to JP Morgan created the expectation that anyone larger, like Lehman, would be assisted as well. Perhaps the most interesting part of the interview is that Bair gets right to the heart of the matter: the treatment of bondholders. ”Why did we do the bailouts?” Bair states “It was all about the bondholders.” Again she couldn’t be more correct. If there was anything Dodd-Frank should have fixed it was this, ending the rescue of bondholders and injecting market discipline back into bank. It is also refreshing to hear her admit: ”I don’t think regulators can adequately regulate these big banks, we need market discipline. And if we don’t have that, they’re going to get us in trouble again.”
Where I disagree, besides her misguided take on mortgage re-sets, is whether Dodd-Frank will actually impose losses on bondholders. Bair expresses some optimism that such is the case, but there are just too many holes in Dodd-Frank to make that believable. Plus you pretty much have the same set of rules in place for Fannie Mae and Freddie Mac, yet the last time I checked the bondholders are still being protected at the expense of the taxpayer. If we don’t impose losses on Fannie creditors, even now after the panic, what makes anyone think we will do so to Citibank. Section 204 of Dodd-Frank is quite clear that the FDIC indeed retains the power to rescue creditors. Something that Bair was willing to do during the crisis, even if pushed to do so by Tim Geithner. Despite some errors, the interview is really a worthwhile read and has some real lessons for avoiding the next financial crisis.
Monday Links
- Regulatory privilege is not consistent with competitive markets–that’s why Fannie Mae and Freddie Mac need reform.
- Thank goodness the U.S. Supreme Court found that education tax credits are not consistent with the fictitious notion of a “tax expenditure.”
- President Obama’s budget plan is not consistent with either his own deficit commission’s plan or the Constitution.
- The modern “Executive State” is not consistent with Article II of the Constitution.
- Cyberbullying laws are not consistent with the First Amendment and our concept of free speech:
Fannie, Freddie: Late to the Party?
Debates over the causes of the financial crisis sometimes center on whether Fannie Mae and Freddie Mac were “late to the party” in terms of subprime lending. As it relates to the recent crisis, I address this question elsewhere.
The GSEs and their apologists do claim to have been big contributors to one party: the expansion of homeownership in the United States. Yet the facts suggest otherwise.
The chart below compares the GSE’s market-share, in terms of home mortgage lending (as reported in the Fed’s Flow of Funds data), with the national homeownership rate (as reported in the Decennial Census).
Wednesday Links
- America’s unemployment rate has nothing to do with immigration.
- It’s possible to cut waste in government without succumbing to the Washington Monument ploy.
- Does this anti-obesity crusade make me look fat? (No, the junk science behind it shaping policy does.)
- Did Wall Street greed create the housing crisis? Or did government subsidies incentivize subprime lending by buying up 40% of new private-label subprime mortgages during the height of the housing boom?
The Mortgage Industry-Government Revolving Door
The Washington Post is reporting that current Federal Housing Administration (FHA) head David Stevens, who only last week announced he was leaving FHA, is going to be the new head of the Mortgage Bankers Association (MBA).
When Stevens was first nominated to head FHA, I have to admit I was concerned. FHA has a long history of prioritizing the interests of the mortgage industry over that of the taxpayer. And here was a guy right out of the real estate industry (former Freddie Mac exec). My expectations weren’t exactly high. Maybe because of that, I’ve been largely impressed. As FHA Commissioner, Stevens has taken eliminating fraud seriously, as well as avoiding a taxpayer bailout of FHA (so far).
All that said, it is hard to imagine that in under a week’s time, he interviewed with and was hired by the Mortgage Bankers Association. So while there’s no evidence that he was looking at an MBA job while carrying out his duties running FHA, there is certainly the appearance of such. The appropriate thing to do would be to leave FHA before getting a job with the very industry that FHA regulates and subsidizes.
Again I think Stevens has done a far better job at FHA than many of his predecessors, and I don’t believe he played a role in the financial crisis, but I do believe the cozy relationship between the mortgage industry and our federal government did play a huge role in the crisis.
Are Mortgages Cheaper in the U.S.?
As Congress and the White House continue to debate the future of Fannie Mae and Freddie Mac, one of the oft heard concerns is that if we eliminate all the various mortgage subsidies in our system, then the cost of a mortgage will increase. There certainly is a basic logic to that concern. After all, why have subsidies if they don’t lower the price of the subsidized good. Of course some, if not all, of said subsidy could be eaten up by the providers/producers of that good.
All this begs the question, with all the subsidies we have for mortgage finance, are mortgages actually cheaper in the U.S.? While not perfect, one way of answering that question is to look at mortgage rates in other countries. Although every developed country has some sort of government intervention in their mortgage market, almost all have considerably less support then that provided by the U.S. (For a useful comparison of international differences see Michael Lea’s paper).
The European Mortgage Federation regularly collects information on mortgage pricing by EU countries. The latest complete annual data from the EMF’s Hypostat database is for 2009, with at least a decade of historical data.
A quick glance reveals that mortgage rates in most European countries are not all that different than rates in the U.S. For instance in 2009, the U.S. 30 year mortgage rate was, on average, 5.04; whereas mortgages in France averaged 4.6 and those in Germany averaged 4.29. In the UK, the average was 4.34.
Part of this difference is driven by product type. For instance, in France, most mortgages tend to be 15 year, which one would expect to be cheaper than a 30 year. But the French 15 year rate of 4.6 isn’t all that different from the current U.S. 15 year rate of 4.1. As lending rates are usually bench-marked off the rate on government debt, part of the slightly higher rate in some European countries is due to their higher government borrowing rate. If we instead measure mortgage costs as a spread over government funding costs (as reported by the OECD), then many European countries look more affordable than the U.S. For instance, German mortgages price about 100 basis points over long-term German govt debt; whereas U.S. mortgages price about 140 basis points over long-term U.S. government debt.
I don’t expect these numbers to settle the debate. A variety of other costs, such as points paid or required downpayments, differ dramatically across countries. Unfortunately that data does not seem to be readily available. What the preceding comparison does suggest, however, is that even without Fannie and Freddie, U.S. mortgage rates aren’t necessarily going to be a lot higher.
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