Do Forced Mortgage Writedowns Create Wealth?
Matt Yglesias recently added his voice to the long running calls for principal reductions on underwater mortgages. His argument is that such would create additional spending. Or as he puts it, “I think that if people in Phoenix got a principal writedown on their mortgages, they’d have more disposable income and might go to the bar more.”
What Matt, and others calling for forced principal reductions, miss, or choose to ignore, is that while a mortgage represents a liability to the borrower, it is an asset to someone else. Matt’s logic, which I agree with here, is that an increase in one’s net wealth (via a reduction in one’s liabilities) should increase one’s consumption. To complete the analysis, however, we must extend that same logic to the holders of the asset, so that a reduction in the value of their asset (the mortgage) should reduce their spending. Taking x from A and giving x to B is not going to increase A+B. To assert otherwise is to engage in Enron-style social accounting.
Now if you want to argue that the borrower has a higher marginal propensity to consume than the investor (say, a retiree living off a pension) then provide some support for that position. It is just as likely that those on the losing end will take efforts to protect themselves from this loss, decreasing overall social wealth. So what one has to show is that the marginal propensity to consume for the borrower is so much larger than that for the investor that it offsets any costs from the investor trying to protect his investment from theft.
Now if you simply favor redistribution of wealth for its own sake, just say so. If you hate investors and love defaulting borrowers, then just say so. Personally, I don’t believe the role of government should be to take from A to give to B. I just ask that we stop pretending, in the absence of compelling evidence, that redistribution of wealth is the same as wealth creation.
Do We Need China to Fund Our Mortgage Market?
Earlier this week I repeatedly heard the claim that if the federal government does not guarantee credit risk in the mortgage market, foreigners won’t buy U.S. mortgage-related debt. Before we test whether that claim is true, let’s first determine just how important are foreign investors in the U.S. mortgage market.
For the most part, foreign investors do not hold U.S. mortgages directly, but either hold Fannie and Freddie debt and mortgage-backed securities (MBS) or hold private-label MBS. As the private-label securities lack a government guarantee, we can ignore that segment of the market. The chart below depicts the percentage share of foreign ownership of these securities in recent years:
The chart illustrates that, at times (particularly around the peak of the recent housing bubble), foreign investors have been large providers of capital to the GSEs. In 2007, over 20% of GSE debt was held outside the United States, double the percentage from only a few years earlier. The increase was driven almost exclusively by purchases by foreign governments (mostly central banks for the purpose of currency manipulation). In 2007, this amounted to just over $1.5 trillion.
However, if we went back and looked at a year prior to the super-heated housing market — say 2003 — then this total is about $650 billion. Given that U.S. commercial banks now have about $1 trillion in cash sitting on their balance sheets, it appears that domestic sources could completely fund the U.S. mortgage market without any foreign funds.
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.
Is Buying a House with Cash Bad?
The Washington Post reported today that the increase in January home sales was driven mainly by an increase in all-cash sales. Whereas I would have thought increasing sales, especially driven by cash buyers, was a sign of market strength; the Post and the National Association of Realtors portrayed this as a bad thing. NAR chief economist Lawrence Yun went so far as to call this portion of the market “unhealthy.”
Of course, what NAR and the rest of the real estate lobby were complaining about was that home sales and prices were not being driven by easy credit. For the housing industry, it would seem that the “correct” house price is the price that is propped up by loose credit.
Yun goes on to say that ”investors are taking the advantage of conditions to purchase undervalued homes.” I used to work with Yun, he’s a smart guy, but I don’t think anyone is smart enough to say that the homes being sold are ”undervalued.” Consider that most non-industry forecasters are projecting further price declines.
More cash sales actually means less future foreclosures, because the cash buyers start out with 100% equity from day one. They are very unlikely to walk away, regardless of the future path of prices. Cash buyers also pay prices that are closer to reflecting the fundamentals of supply and demand, which are ultimately driven by income and demographics.
What the high percentage of cash borrowers, at 37 percent, says to me, is that there is a significant demand for housing that isn’t dependent upon massive taxpayer subsidies to the mortgage industry.
White House Right to Oppose Moratorium
With the recent discovery of “robo-signers” and other paperwork problems in the mortgage foreclosure process, several prominent congressional Democrats have called for a national moratorium on mortgage foreclosures. At least one large lender has already started to implement one. A moratorium, however, would be irresponsible and harmful. And the White House is correct to oppose it.
Whatever mistakes might have been made by lenders do not change the basic fact: most foreclosures are happening because the borrower is not paying the mortgage. I recently talked to one large lender who said of their delinquent mortgages that over a fourth have not made a payment in over two years. How exactly is someone who has been getting two years of free rent a victim?
Of course, in the small number of cases where a real mistake has been made and a foreclosure is moving forward against a borrower who is current on their mortgage, the courts have the ability to stop that from proceeding. In judicial foreclosure states the easiest solution to this problem is for the judge to ask the borrower, “When was the last payment you made?” If it has been awhile, say over six months, then the foreclosure should proceed, and proceed quickly.
Its been four years since the housing market peaked. Government policy has continued to delay the needed correction in our housing market. A moratorium on foreclosures only puts off a turnaround in the housing market. And if we ever expect or hope to see private capital come back into the mortgage market, then government needs to stop threatening to steal away that capital once it’s invested. The current efforts by states to use technical mistakes by lenders to allow borrowers to remain in homes without paying could ultimately undermine the very concept of a mortgage: that it is a loan secured by property. Instead, we risk seeing mortgages turned into another form of unsecured lending, which would raise interest rates for everyone.
Obama Proposes Further Delay on Fannie & Freddie
President Obama seems to be slowly waking up to the fact that the American public has grown tired of the endless bailout of Fannie Mae and Freddie Mac. The public has also rejected the talking point that Fannie and Freddie were simply victims of a 100 year storm in the housing market. So what’s Obama’s response? To ask for public comment and have public forums.
This strategy is clearly one of delaying and avoiding any reform of Fannie and Freddie while pretending to care about the issue. Where was the public comment and forums on the Volcker rule? Seemingly the standard is that fixing the real causes of the financial crisis should be delayed and debated while efforts like the Dodd bill, which do nothing to avoid future financial crises, should be rushed without debate or comment.
Even more disingenious is couching reform of Fannie and Freddie under the rubic of “fixing mortgage finance”. This is no more than an attempt to take the focus away from Fannie and Freddie and shift it to “abusive lending” and other non-causes of the crisis.
This isn’t rocket science. The role of Fannie and Freddie in the financial crisis is well understood. The only thing missing is the willingness of Obama and Congress to stand up to the special interests and protect the taxpayer against future bailouts.
Is the Obama Mortgage Foreclosure Plan Legal?
While considerable attention has rightly focused on the failure of President Obama’s various mortgage foreclosure plans to actually lower the rate of foreclosures, few have bothered to even ask whether the plan is allowable under the TARP statute.
Alex Pollock at AEI first raised this issue during testimony before the Congressional Oversight Panel. Alex’s point is that TARP only allows the modification of mortgages that are actually acquired by the government. Recall the original purpose of the TARP was to buy “troubled assets.” In managing those assets, Congress required the executive branch to come up with a plan to assist the borrowers behind those troubled assets.
Apparently unlike the Treasury department, I believe we should go back to the language of the statute in determining what it allows and doesn’t allow. Section 110(b)(1) is quite clear: “to the extent that the Federal property manager holds, owns, or controls mortgages, mortgage backed securities…” Nowhere else in TARP is there any other ability to establish a mortgage modification program. In using TARP funds to pay for modifications of loans not owned by the federal government, the Obama administration is acting far outside of its legal authority under TARP.
Many, including myself, have criticized the TARP as a massive delegation of spending power from Congress to the Treasury Department. Such delegation is, in my mind, clearly unconstitutional. However, even within such a broad delegation, there are parameters in which Treasury must act. Treating TARP as simply a large pot of money to spend however Treasury chooses is nothing short of illegal.
Obama to Increase FHA Risk
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.
The Census Asks Too Much
Everyone in America, I presume, has just received a letter from the U.S. Census Bureau urging us to fill out our Census forms. Seems like a very expensive way to tell us to watch for the form to arrive in the mail. But I’m particularly interested in why they say we should promptly fill out the form:
Your response is important. Results from the 2010 Census will be used to help each community get its fair share of [federal] government funds for highways, schools, health facilities, and many other programs you and your neighbors need. Without a complete, accurate census, your community may not receive its fair share.
Obviously this is a zero-sum game. If my neighbors and I all fill out the form, then you and your neighbors will get less from the common federal trough. But at least we’ll be getting our “fair share,” as the letter tells us twice in three sentences.
But where does the government get the authority to ask me my race, my age, and whether I have a mortgage? In fact, the Constitution authorizes the federal government to make an “actual enumeration” of the people in order to apportion seats in the House of Representatives. That’s all. Not to define and count us by race. Not to ask whether we’re homeowners or renters. Just to ask how many people live here, so they can apportion congressional seats.
I’m not interested in getting taxpayers around the country to pay for roads and schools and “many other programs” in my community. All the government needs to know from me is how many people live in my house. And I will tell them.
More on the census and the Constitution here.
Fannie, Freddie, Peter, and Barney
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.
FHA’s New Stringent Standards
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?
A Double Dip for Housing?
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.
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