A recent report from the Federal Reserve Bank of New York examines the role of speculators in driving the housing bubble. Setting aside the fact that almost everyone who bought a house was “speculating” to some degree, the researchers focus on those who were buying homes they did not intend to live in.

Some have already tried to paint this study as proving the government had little to do with the housing crisis. To their credit, the study’s authors do not go that far. Others, Mark Thoma for instance, show no such constraint:

“This is pretty far away from the (false) story that Republicans tell about the crisis being caused by the government forcing banks to make loans to unqualified borrowers.”

Of course, I’m sure that even Thoma knows that he’s set up a straw-man. Does anyone really believe that the Community Reinvestment Act and the Government Sponsored Enterprises housing goals were the only factors behind the crisis? Perhaps if the New York Fed really wanted to understand the crisis, it should look in the mirror.  It would seem reasonable to me that three years of a negative real federal funds rate might have had some impact on the housing market, particularly in encouraging speculators. After all, the Fed was basically paying people to take money.

None of this takes away from the role that Fannie and Freddie played in the housing market. For mortgages they purchased directly, Freddie’s investor share increased from three percent in 2003 to seven percent in 2007. And this ignores the massive volume of private label mortgage backed securities purchased by Fannie and Freddie. I think its reasonable to believe some of those were investor loans. In addition, the FBI has reported that the most frequent form of mortgage fraud has been borrowers stating the loan was for a primary residence when it was not.  But then it would be impolite of me to suggest we actually prosecute borrowers who committed fraud.

As I argued over two years ago, the relatively high percentage of foreclosures that are driven by pure speculators should make us question the many efforts to slow or stop the foreclosure process. If so many of these foreclosures are speculators, then why do we continue to protect them from losing the homes? They gambled, they lost. It’s time to move on and let the markets continue to adjust.

Now, one can continue to blame private sector actors for following the perverse incentives created by government. After all, the banks didn’t have to make the loans and the borrowers didn’t have to take the money. But it should be the primary objective of public policy to get the incentives correct. It should by now be crystal clear that all of the massive speculation in the housing market didn’t “just happen”—it was the result of massive government distortions in our housing and financial markets.

It Was those Bad Speculators That Drove the Housing Bubble…. is a post from Cato @ Liberty - Cato Institute Blog

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.

GSE Loan Limits Fell…and Home Sales Went Up is a post from Cato @ Liberty - Cato Institute Blog

Last week I offered a few proposals to help move along the housing market. Given the need for brevity, the rationales for each were short. As almost all of them were counter to the conventional wisdom, they do merit a little more explaining, in particular the suggestion to raise interest rates.

Before I could offer a further discussion of the fact that the mortgage market is driven by both demand and supply, Daniel Indiviglio at the Atlantic was quick enough to provide much of that detail. Rather than repeat his analysis here, which I agree with, let’s focus on a few other points.

David argues that “at rates like 4 percent, those loans had better be pristine if the bank wants to ensure that its default risk is covered by the small amount of interest it receives.” Let’s dig a little deeper. What lenders care about are real rates. With inflation running approximately 2 percent, the real return on a prime mortgage today, before credit cost, is around 2 percent. But today about 3.5 percent of prime loans are in foreclosure. Assuming a 50 percent recovery rate, 1.75 percent is needed to cover credit losses. Even in good times, prime loans foreclosure at about a 0.6 percent rate. With subprime foreclosures running about 14 percent, you’d need to charge at least 9 percent to break-even in real terms. At today’s rates, lenders are barely breaking even on prime loans, they’d bleed money if they charge similar rates to subprime borrowers.

But then why don’t lenders just charge higher rates for the higher risk borrowers? After all that’s what they did during the bubble years.  Well a lot has changed since then. For instance, in 2008 the Federal Reserve, under the Home Ownership and Equity Protection Act (HOEPA), lowered the threshold for what is considered a “higher-cost” mortgage, from treasury +8 percent, which excluded much of the market, to prime mortgage +1.5 percent, which under current rates makes anything over 5.5 percent a “high cost” mortgage. When Congress passed HOEPA in 1994, it shut down that segment of the market, due to what is tremendous litigation risk. Now the Fed’s extension of HOEPA has done the same for much of the mortgage market. According to the Fed, 22 percent of the market was “higher-cost” in 2005. After the new regulation, that share had fallen to 2.4 percent in 2010. Yes the housing bubble and credit crisis would have shrunk that market, but by almost 90 percent? And yes, many of those loans we didn’t want to come back, but many we did.

The point here is that the Fed actually does impose, via legal risk, a de facto ceiling on mortgage rates. If we want to bring back housing/mortgage demand among higher risk borrowers, which were a significant source of demand, then the Fed would be wise to suspend its current HOEPA rules. If we don’t want to bring that demand back, then fine, just stop complaining about a weak housing market. As an aside, I was of the view in 2008 and still today that the Fed lacked legal authority for its 2008 HOEPA rule, but then the Fed has rarely let a lack of legal authority get in its way.

Raising Interest Rates to Help the Housing Market is a post from Cato @ Liberty - Cato Institute Blog

In case you missed it, President Obama gave a big speech out in Las Vegas about both his “jobs” plan and a new plan to help underwater borrowers re-finance their mortgage. First, let’s recognize that it is not really “his” plan. The proposal is being issued by the Federal Housing Finance Agency (FHFA), an independent regulator that the President is supposed to have no control over. Frankly, I find it troubling for a president to be so involved with an independent agency. If a president was out giving speeches when the Federal Reserve changed interest rates, we would all call that bizarre. It is no different here. As someone involved in drafting the law that created FHFA, I can say Congress considered, and rejected, the option of having this agency accountable to the president.

On to the substance. Perhaps most striking is that this plan does nothing for the housing market. Does it increase demand for housing? No. Does it reduce the supply of excess homes or help move the massive shadow inventory? Again, No. Does it even help those most in need? No. It is available only to those who have already had a mortgage for over two years, are current on their mortgage, and have missed no more than one payment per year. Basically helping only those that do not need any help.

The logic of the plan is that by reducing mortgage rates, you reduce monthly payments, which would increase consumer spending. The flaw in that logic is that while a mortgage is one person’s liability, it is another person’s asset. So you are simply making one party wealthier while making another poorer. It is not clear that the impact on aggregate spending should be anything other than zero.

Most troubling about the the plan, is that the program it is based upon, HARP, is likely illegal. Both the Fannie and Freddie charters require that if a loan is above 80 percent loan-to-value, it must have mortgage insurance. Yet the heart of HARP is a waiver of this requirement. Apparently FHFA claims these are not “new” loans, but just modifications. In that case why in the world would you modify a loan that is current and does not appear in any danger of default. Sadly one of the many things lost in the financial crisis is a basic respect for the rule of law. Our financial regulators have too often embraced a culture of lawlessness in name of saving our financial system (with little to show for it).

Random Thoughts on Obama’s New Mortgage Plan is a post from Cato @ Liberty - Cato Institute Blog

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.

No Hope or Change When it Comes to Fannie Mae is a post from Cato @ Liberty - Cato Institute Blog

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?

The CAP-AEI Fannie Mae Food Fight is a post from Cato @ Liberty - Cato Institute Blog

As the Federal Reserve Federal Open Market Committee (FOMC) meets today, it is widely expected that the Fed will announce a new round of quantitative easing (QE).  The first round began in March 2009, as the Fed started large-scale purchases of Fannie and Freddie debt and MBS.  The next round is expected to focus on purchases of long-dated US Treasuries.

The objective of QEII would be to reduce long-term interest rates, with the belief that such a reduction would spur investment and consumption, thus increasing employment.   Estimated impacts on rates range from zero to 80 basis points (80/100s of one percent).  

Given the large excess reserves in the banking system, it is likely that much of the monetary stimulus provided by QEII will simply be added to bank reserves, which would correspondingly have little to no impact on either lending or interest rates.  So its likely that we will get very little bang out of QEII.

Even if QEII did lower rates as much as some Fed leaders claim, the impact would still be relatively small, under one percent.  Given that mortgage rates have already fallen by that much over the last six months without changing the direction of the housing market, it is hard to see even a 1% decline in rates moving the economy.  Quite simply, the major problem facing the economy today is not high interest rates.

The real impact, and the greatest risk, of QEII is that it changes expectations of inflation.  It seems pretty clear that the Fed wants higher inflation than we have now.  QEII sends the signal that the Fed will do everything possible to create that additional inflation.  QEII also runs the real risk that the Fed ends up “monetizing the debt” – both reducing the political pressure to address our fiscal imbalances as well as undermining the dollar.  I see these risks as easily outweighing what little bump one might get from a few basis points decline in long-term interest rates.

Fed’s QEII Offers More Risk Than Reward is a post from Cato @ Liberty - Cato Institute Blog

If there is one, almost universal, point of agreement on drivers of the financial crisis, it is that our financial system simply had way too much leverage.  Much of that discussion has focused on financial institutions, leading many to suggest increased capital standards, so that banks have more equity and less debt.  Often lost in the mix is the excessive leverage on the part of home owners.

We know, for instance, that the number one predictor of mortgage default is whether the borrower has equity or not.  And while that should lead us to debate appropriate downpayment requirements, at least when the government backs the mortgage, we should not forget that our tax code encourages excessive leverage on the part of home buyers.  And there’s no bigger incentive to get a bigger mortgage than the mortgage interest deduction.

Some might say we can’t risk removing any props from the housing market.  My friends at the National Association of Realtors, for instance, have in the past argued that full removal would decrease home prices by up to 15 percent.  Such an estimate depends on the level of interest rates (the higher are mortgage rates, the higher the value of the deduction and the greater the impact on house prices).  With the current low level of mortgage rates, the negative price impact should be around 5 percent.

Given the already close to 30% national decline in prices, a further 5% would be less noticeable now than at a time when prices start to rise again.  In addition, a 5% decline would attract more buyers into the market.  Housing is just like any other good — when there’s too much, the best way to clear the market, perhaps the only way, is to drop prices.  Getting rid of the deduction would make housing all the more affordable.  And given current low mortgage rates,there would be far less distortions to do so now.  Of course, all of this should be done in a budget neutral manner, lowering marginal tax rates across the board, which would have its own benefits to the economy.

Now Is the Time to End the Mortgage Interest Deduction is a post from Cato @ Liberty - Cato Institute Blog

The Federal Housing Administration is heading toward a taxpayer bailout, yet the president’s latest mortgage modification plan would further increase the agency’s exposure to risky mortgages. Mark Calabria calls it a “Backdoor Bank Bailout.”

The administration’s plan would encourage borrowers who owe more than their house is worth to refinance into FHA-insured mortgages. Therefore, the risk of a future foreclosure on these mortgages would fall to the government and taxpayers instead of private lenders.

A recent study from economists at New York University found that the FHA is underestimating its risk exposure. One of the problems is that the FHA isn’t properly accounting for the risk to underwater FHA mortgages that have been refinanced into new FHA mortgages. So it’s hard to see how the president’s plan to refinance private underwater mortgages into FHA mortgages won’t further exacerbate the situation.

To get these mortgages in better shape so the FHA can insure them, $14 billion in TARP money is going to be used to pay private lenders to reduce the amount borrowers owe on their mortgages. Some of this money will also be used to cover eventual losses on these loans. As a taxpayer whose mortgage is underwater, and who would rather go bankrupt than accept a government handout, I find it infuriating that my tax dollars are being used to bail out others in a similar situation.

But with government housing programs, it’s standard practice for officials to cannonball into the pool and worry about who gets splashed by the water later. On Sunday, CNN.com reported on “FHA’s Florida Fiasco,” where the collapse of the heavily FHA-insured condo market has contributed to the possibility of a FHA bailout. The FHA has now tightened its condo standards, but once again it’s a day late and possibly more than few bucks short.

The new FHA initiative is the latest in a series of efforts to “stabilize” the housing market with more subsidies. Policymakers seem oblivious that it was government interventions that helped instigate the housing meltdown to begin with. The housing market would stabilize itself if the supply of and demand for housing was allowed to be brought back into equilibrium. There would be pain in the short-term, but in the long-term we would have a smoother functioning housing market. Unfortunately, for politicians the long-term means the next election.

Obama to Increase FHA Risk is a post from Cato @ Liberty - Cato Institute Blog

Last week, after Rep. Barney Frank (D-MA) said that holders of Fannie Mae and Freddie Mac’s debt shouldn’t be expected to be treated the same as holders of U.S. government debt, the U.S. Treasury took the “unusual” step of reiterating its commitment to back Fannie and Freddie’s debt.

If ever there was case against allowing a few hundred men and women to micromanage the economy, this is it.

Fannie and Freddie, which are under government control, are being used to help prop up the ailing housing market. If investors think there’s a chance Uncle Sam won’t back the mortgage giants’ debt, mortgage interest rates could rise and demand for housing dampen. Therefore, Frank’s comments caused a bit of a stir. However, with the government bailing out anything that walks or crawls, investors apparently weren’t too concerned with Frank’s comments as the spread between Treasury and Fannie bonds barely budged.

As I noted a couple weeks ago, the Treasury is in no hurry to add Fannie and Freddie’s debt and mortgage-backed securities to the budget ($1.6 trillion and $5 trillion respectively). Congress certainly isn’t interested in raising the debt ceiling to make room. And as Arnold Kling points out, putting Fannie and Freddie on the government’s books would actually force the government to do something about the doddering duo.

All of which points to what an unfunny joke budgeting is in Washington. Take a look at what current OMB director Peter Orszag had to say about the issue when he was head of the Congressional Budget Office:

Given the steps announced by the Treasury Department and the Federal Housing Finance Agency on September 7, it is CBO’s view that the operations of Fannie Mae and Freddie Mac should be directly incorporated into the federal budget. The GSEs’ revenue would be treated as federal revenue and their expenditures as federal outlays, with appropriate adjustments for the manner in which credit transactions (like a mortgage guarantee) are reflected in the federal budget.

Note that Orszag wrote that statement less than two years ago. And since then, the bond between the government and the mortgage giants has only gotten tighter.

The same people that say Fannie and Freddie shouldn’t be on the government’s books are often the same people who once dismissed concerns that the two companies were headed toward financial ruin. In 2002, Orszag co-authored a paper at Fannie’s behest that concluded that “the probability of default by the GSEs is extremely small.”

Another one of those persons, Congressman Frank, has his fingerprints all over the housing meltdown. In 2003, a defiant Frank stated that “These two entities – Fannie Mae and Freddie Mac – are not facing any kind of financial crisis.” Frank couldn’t have been more wrong. Yet there he remains perched on his House Committee on Financial Services chairman’s seat, his every utterance so important that they can move interest rates.

Fannie, Freddie, Peter, and Barney is a post from Cato @ Liberty - Cato Institute Blog

My house has been on the market for a month and it has drawn a lot more looks than I expected. I’ve been quizzing realtors as they come through, and each one tells me the same story: the government is single-handedly propping up the demand for housing. In addition to the homebuyer tax credit and government-induced low mortgage interest rates, most sales are being done with Federal Housing Administration backing.

As a seller, I’m looking to get out before the tax credit expires and interest rates starting ticking upward. But when I do sell, I certainly won’t be looking to buy a house, particularly since I’ll be selling at a loss. If my situation is representative of other current sellers, the housing market could be in for another tumble if the government crutches are removed. However, if the government instead continues trying to prop up the housing market, the risk that taxpayers will take another bath goes up. It’s a nasty Catch-22 that demonstrates the problems with the government distorting the housing market to begin with.

A recent New York Times article looked at the housing market in the “beleaguered” manufacturing city of Elkhart, Indiana, which has twice served as a prop for President Obama. The Times says Elkhart “symbolizes the failure of federal efforts to turn around the housing slump at the heart of the economic crisis” and that “[h]ousing in this community has become almost entirely dependent on a string of federal support programs.”

The situation in Elkhart described by the Times matches perfectly with what realtors are telling me:

To the extent that the real estate market is functioning at all, people here say, it is doing so only because of the emergency programs, which have pushed down interest rates on mortgages and offered buyers a substantial tax credit. Equally important is an expanded mortgage insurance program run by the Federal Housing Administration, which encourages private lenders to accept borrowers with small down payments. The government takes the risk of default.

The one problem with the Times piece is that it doesn’t completely connect the dots. Namely, the problem the government is trying to solve is a problem that its housing policies instigated: the housing boom and bust. For instance, the article cites a good example of government policies mimicking the irresponsible lending that helped create this mess in the first place:

The programs favor first-time buyers, who have the fewest resources to bring to a deal. Heather Stevens, a 23-year-old nurse here, is closing on a three-bedroom house this week. Since her loan was insured by the Federal Housing Administration, she had to put down only 3.5 percent of the $74,900 purchase price.

“It was a breeze to get approved,” she said.

The sellers are covering her closing costs, which agents say is often the case here. That meant Ms. Stevens had to come up with only the $2,600 down payment, which still took all her savings.

But the best part is the $7,500 tax credit. She will use that to remodel the kitchen. “If it wasn’t for the credit, we would have waited to buy,” said Ms. Stevens, who is getting married this year.

Buying houses with no money down was a feature of the latter stages of the housing bubble. It gave prices a final push into the stratosphere. But buyers with no equity were the first to abandon their properties as the market turned south.

But there’s no mention of the role Fannie and Freddie, HUD, or the FHA played in fostering that bubble.

The article continues:

With housing prices stagnant, bolstering the market by again letting people buy with hardly any money down is viewed in some quarters as a bad bet.

Neil Barofsky, the special inspector general for the government’s Troubled Asset Relief Program, wrote in his most recent report to Congress that “the federal government’s concerted efforts to support” housing prices “risk reinflating” the bubble.

He noted one difference from the last bubble: taxpayers, rather than banks, are now directly at risk in these new mortgages.

I would argue that the mere existence of TARP is proof that taxpayers were directly at risk to begin with. The risk may be more explicit now, but that’s only because the bubble’s bursting washed away a lot of the private sector’s bad actors. But the ultimate bad actor, Uncle Sam, who encouraged the private sector’s risky lending activities, has stepped in to fill the void. Just how badly this turns out for taxpayers remains to be seen.

Housing Market on Government Crutches is a post from Cato @ Liberty - Cato Institute Blog

The Federal Housing Administration has been one of the government’s main instruments for propping up the housing market in the wake of the housing bust. But as has been widely reported, the FHA is in danger of needing a taxpayer bailout because of rising defaults on mortgages it insures.

FHA-insured loans originated in 2007 and 2008 – when Bush administration housing officials were mainly concerned with “winning back our share of the market” – are defaulting at higher rates as this graphic from the Washington Post shows:

FHA officials are optimistic a bailout won’t be needed, but the Post reports that not everyone shares this optimism:

The audit, released in November, found that the cash the FHA set aside to pay for unexpected losses had dipped to historic lows, well below the level required by law. As of Sept. 30, those reserves were estimated at $3.6 billion, down from nearly $13 billion a year earlier. The most recent figure represents 0.53 percent of the value of all FHA single-family-home loans — far lower than the 2 percent required by Congress.

But Ann Schnare, a former Freddie Mac official, said the situation could be even worse. She said the audit underestimates future losses because it does not take into account all loans that are now overdue, only those that the FHA has paid claims on.

To avoid a bailout, the FHA recently proposed more stringent standards, which would include raising the premiums it charges to cover losses. However, even if a bailout isn’t needed and the FHA continues to “make money,” that would only call into question the need for the FHA to begin with. Why can’t the private sector provide all mortgage insurance?

The answer is that the mortgage lending industry likes knowing it can originate mortgages that the government will cover in the event of a default. Heads they win, tails Uncle Sam loses. The president’s new budget makes this clear in addressing concerns about the FHA’s currently low reserves:

However, it is important to note that a low capital ratio does not threaten FHA’s operations, either for its existing portfolio or for new books of business. Unlike private lenders, the guarantee on FHA and other federal loans is backed by the full faith and credit of the Federal Government, and is not dependent on capital reserves — FHA can never “run out” of money.

That’s right – the federal government can simply tax, borrow, or fire up the printing presses.

The government has been propping up the housing market with taxpayer subsidies in the wake of a housing boom and bust it helped create. If policymakers continue to keep the housing market on artificial life support, taxpayer will remain on the hook. If it pulls the plug and the market takes another downward spiral, Washington will probably rush in with more bailouts.  It appears taxpayers can’t win.

See this essay for more on federal housing finance.

FHA Bailout Watch is a post from Cato @ Liberty - Cato Institute Blog

The Federal Housing Administration will reportedly announce more stringent lending requirements and higher borrowing fees. The move comes in response to growing concerns that rising losses on mortgages it insures will require a taxpayer bailout. Although any credit tightening is welcome, the agency will not propose an increase in the minimum downpayment, currently 3.5 percent. (Borrowers with credit scores below 580 will be required to put down a minimum of 10 percent, but most FHA lenders already require a 620 minimum score.)

Yesterday, the Wall Street Journal noted that “home builders are worried” the FHA would propose raising the minimum downpayment. The CEO of a Texas builder said it would be a “game changer,” meaning that it would hinder the nascent housing recovery. However, other industry observers believe otherwise:

In markets where home values are still falling, buyers who put little money down could see their equity wiped out quickly. The FHA is “just manufacturing more upside-down homeowners by the truckload in Arizona, California, and Nevada,” says Brett Barry, a Phoenix real-estate agent who specializes in selling foreclosed homes.

FHA commissioner David Stevens counters that inhibiting lending by increasing downpayment requirements would “perpetuate” price declines. But falling prices are a painful, but necessary, correction needed to bring the housing market back into equilibrium. Government interventions in the wake of the housing bubble’s burst have created an artificial cushion. Thus, any alleged housing recovery could prove illusory when the cushion is removed. In addition, the longer the government tries to prop up the housing market, the greater the economic distortions and risk to taxpayers.

The article cites the example of a 42-year-old air-conditioning repairman who just bought a house with the FHA minimum 3.5 percent downpayment. To meet the requirement he had to borrow part of the money from his father-in-law, which he then repaid with the $8,000 first time homebuyer tax credit. He now has a $1,466 monthly mortgage payment on a $50,000 salary. Factoring in utilities and other homeownership costs, it’s not inconceivable that half of his pre-tax salary will be devoted to just his home. Is it any wonder the FHA is experiencing large default rates?

FHA’s New Stringent Standards is a post from Cato @ Liberty - Cato Institute Blog

Washington is fretting this week over news that mortgage applications fell dramatically in November. Coupled with earlier indications of renewed softening in the housing market, there is growing fear that housing is headed for a “double-dip downturn” that could further damage the economy. As a result, Federal Reserve policymakers are considering additional stimulus, while the National Association of Realtors is suggesting an(other) extension of the “temporary” homebuyer tax credit.

Remarkably, neither policymakers nor the media are asking the obvious question: Given all of the emergency interventions in housing that government has undertaken, and the fact that the housing market continues to erode, do such interventions do much good?

Since the bursting of the bubble in 2006, the great unknown has been whether housing prices will revert to their historical trend (and possibly to below trend for a short period), or stabilize at some permanently higher level because a portion of the bubble (aided perhaps by public policy) would prove enduring. There is good reason to expect reversion to trend, but the economy can surprise us.

Let’s use an example to understand this better. The graph below depicts the course of house prices for my hometown of Hagerstown, MD, an area within commuting range of suburban DC that was hit particularly hard by the bubble and its deflation. The black line is a house price index computed by the Federal Housing Finance Agency for 1989–2009. The red line is an extended linear trendline drawn using index data from the period 1989–2002. (You can do the same analysis for your area using these FHFA data.) The question, then, is whether house prices will fall all the way back to the trendline or will stabilize at a level above the trendline. 

The sharp downward slope at the end of the price line and  the latest housing news suggest that Hagerstown is destined to revert to trend (perhaps after a period below trend). I’ve drawn similar figures for several other locations and they show similar patterns. It looks like the nation’s housing markets, for the most part, are reverting to trend.

When this crisis first began in 2007, Bush administration officials vowed to “stabilize house prices at the highest possible level.” However, despite their efforts and those of the Obama administration, Congress, and the Fed,  reversion to trend appears inevitable. At best, those efforts may have slowed the reversion — in which case, I suppose the Bush goal has been met.

It can be argued that a gentler reversion to trend may be more tolerable than a sharp return. On the other hand, there are fears that a lengthy softening of the housing market will lead to more defaults, less worker mobility, continued weak consumption, and a long period of high unemployment and stagnant wages for those who are working. Perhaps a sharp return would be the quickest way to shed the ill effects of the bubble.

This leaves us with a final question that policymakers, the media, and the public should be grappling with: If all of these emergency housing interventions only result in a slower reversion to trend, then is that benefit worth the cost?

A Double Dip for Housing? is a post from Cato @ Liberty - Cato Institute Blog

Perhaps the worst feature of the bailouts and the stimulus has been that, whatever their merits as short terms fixes, they have done nothing to improve economic policy over the long haul; indeed, they compound past mistakes.

Here is a good example:

For months, troubled homeowners seeking to lower their mortgage payments under a federal plan have complained about bureaucratic bungling, ceaseless frustration and confusion. On Thursday, the Obama administration declared that the $75 billion program is finally providing broad relief after it pressured mortgage companies to move faster to modify more loans.

Five hundred thousand troubled homeowners have had their loan payments lowered on a trial basis under the Making Home Affordable Program.

The crucial words in the story are “$75 billion” and “pressured.”

No one should object if a lender, without subsidy and without pressure, renegotiates a mortgage loan. That can make sense for both lender and borrower because the foreclosure process is costly.

But Treasury’s attempt to subsidize and coerce loan modifications is fundamentally misguided. It means many homeowners will stay in homes, for now, that they cannot really afford, merely postponing the day of reckoning.

Treasury’s policy is also misguided because it presumes that everyone who owned a house before the meltdown should remain a homeowner. Likewise, Treasury’s view assumes that all the housing construction over the past decade made good economic sense.

Both presumptions are wrong. U.S. policy exerted enormous pressure for increased mortgage lending in the years leading up to the crisis, thereby generating too much housing construction, too much home ownership and inflated housing prices.

The right policy for the U.S. economy is to stop preventing foreclosures, to stop subsidizing mortgages, and to let the housing market adjust on its own. Otherwise, we will soon see a repeat of the fall of 2008.

Perpetuating Bad Housing Policy is a post from Cato @ Liberty - Cato Institute Blog

The core of Keynesian economic policy is that the government must come in and replace reductions in private sector demand with public sector demand, therefore bringing overall demand back to its previous level.  One of the many flaws in this thinking is in assuming that the previous level of demand was “correct” and getting us back to that level is the appropriate policy response.

Take the example of the housing market and the government response.  The primary response of Republicans in Washington has been to offer tax credits and other incentives to replace the drop in demand for housing.  Witness Senator Johnny Isakson’s  recent comments on why we need to extend the $8,000 homebuyer tax credit: “If you take that kind of business out of what’s already a very weak housing market, you do nothing but protract and extend the recession.”

This analysis could not be more wrong.  The tax credit largely acts to keep housing prices from falling further.  However, that is how markets are supposed to clear in an environment of excess supply.  If there’s too much housing, the way to address that is to allow housing prices to fall, which attracts buyers back into the market.

We should also recognize that the tax credit does not help the buyer, it helps the seller, by allowing the seller to charge that much more for the price of the home.

Perhaps the worst impact of the policy is that it encourages the continued building of homes, only adding to the over-supply, which itself will “protract and extend the recession.”  Witness the recent news that housing starts in the US just hit a nine month high.  While these levels are still low in historic terms, and housing inventories are declining, we still have an excess of housing.  The damage done by creating a false floor to housing prices is that builders don’t respond to inventory, they respond to prices, and as long as there is a positive gap between prices and construction costs, builders will build.  The tax credit only serves to widen that gap between prices and construction costs.

Back to Keynes: the central flaw in the thinking behind the tax credit proposal is its assumption that we need to re-inflate the housing bubble.  The previous level of housing demand, from say 2003 to 2006, was not driven by fundamentals; we had a bubble.  There will be a correction in the housing market.  Our choices are to either take that correction quickly and move on, or to prolong that correction, maybe even make it worse, by trying to create a false floor to the market.

Republicans Just as Guilty of Flawed Keynesian Thinking is a post from Cato @ Liberty - Cato Institute Blog

Over the last week, speaking at a variety of events, I heard three different representatives of the Left; first a Democrat US Senator, then a senior member of the Obama Administration, and finally a “consumer” advocate, all repeat the same narrative:  all was fine in the housing market until predatory lenders forced hard-working honest families into foreclosure, which reduced house prices, bringing the economy to a crash.  That’s correct, apparently the Left believes we all would still be seeing double-digit home price appreciation if it wasn’t for those evil lenders.

Undoubtedly foreclosures, especially those that result in houses that remain vacant for a considerable amount of time, have an adverse impact on surrounding property values.  Many constitute a serious eye-sore and provide a haven for criminal activity.  But did foreclosures really drive down prices, or were foreclosures first driven by price declines resulting from a bursting housing bubble?  While causality is always difficult to establish with certainty, we do know that the rate of house price appreciation peaked and started declining about 18 months before the dramatic up-turn in mortgage delinquencies.  If one prefers a more rigorous test, economists at the Boston Fed have directly tested if prices first drove foreclosures or whether foreclosures drove prices.  Their results conclude that its was declining prices that matter, and that the price effect of foreclosures is minimal.

Why does any of this ultimately matter?  Because if we craft policies to avoid the adverse impacts of the next property bubble based upon a narrative of “consumer protection” — as is being pushed by the Obama Administration, we will do little to avoid the creation of the next housing bubble and its damaging aftermath.  Instead we should be focusing attention on those policies that contributed to the creation of the housing bubble: expansionary monetary policy and the Federal government’s blind pursuit of ever-expanding home-ownership rates at any cost.

Does the Left Know We Had a Housing Bubble? is a post from Cato @ Liberty - Cato Institute Blog

As discussed in a recent Bloomberg piece, several U.S. senators from both parties are pushing to almost double the recently enacted $8,000 tax credit for first-time homebuyers to $15,000. The same senators are also pushing to remove the current income restrictions — $75,000 for individuals and $150,000 for couples — while also removing the first-time buyer requirement.

The intent of the increase, and the original credit, is to increase the demand for housing and to create a “bottom” to the housing market. The flaw of this approach is that it creates a false bottom, one characterized by government-inflated prices and not fundamentals. It was excessive government subsidies into housing that helped create the housing bubble, additional subsidies to re-inflate the bubble will only prolong the actual market adjustment.

If it were only a matter of prolonging the adjustment, then the huge cost of the tax credit might be easier to justify. Yet by encouraging increased housing production, the tax credit will increase supply when we already have a huge glut of housing. Despite housing starts being near 50-year lows, there is still too much construction going on. The way to spur demand in housing is the same way you spur demand in any market: you cut prices.

Removing the income limits makes clear the real intention of the tax credit, to help the wealthiest households. About three-fourths of existing families already fall under the income cap of $75,000. As we move up the income latter, home equity makes up a smaller percentage of one’s total wealth. The richest families can make do with a decline in their housing wealth and continue spending; they have other substantial sources of wealth. If we have learned anything from the housing boom and bust, it should be that continued government efforts to rearrange the housing market have been costly failures.

Senators Want to Delay Housing Recovery is a post from Cato @ Liberty - Cato Institute Blog