How to Kill Home Ownership

Levittown House and family circa 1948

Your house is about to become even harder to sell, even more unlikely to appreciate, and even more unaffordable to more people.  Be prepared to go back to the past.   All those young Obama Democrats better love their landlords.  They’re likely to be stuck with them for some time.  Every think you’d see a headline like this for a Democratic President? Here’s one from NPR Today: Obama Administration: Not Everybody Should Own A Home,

For decades, U.S. housing policy seemed to assume that more home ownership was always better.

At one point in the early ’90s, the government launched the “National Homeownership Strategy,” whose stated goal was to “attempt to help all American households become homeowners.”

So perhaps the most striking thing in today’s housing finance report from the Obama administration is the simple idea that not everybody should own a home (emphasis added):

The Administration believes that we must continue to take the necessary steps to ensure that Americans have access to an adequate range of affordable housing options. This does not mean all Americans should become homeowners. Instead, we should make sure that all Americans who have the credit history, financial capacity, and desire to own a home have the opportunity to take that step. At the same time, we should ensure that there are a range of affordable options for the 100 million Americans who rent, whether they do so by choice or necessity.

This is idea, in turn, leads to the Obama administration’s main conclusion: Fannie Mae and Freddie Mac should cease to exist.

I’ve been a critic of the way Fannie Mae and Freddie Mac were managed for about 15 years.  They were packaging up loans and paying bonuses like the worst of the Wall Street set.  This had nothing to do with their basic government franchise agreement which is to provide long term funds to back up home loans.  The packaging and wheeling and dealing were part and parcel of Fannie and Freddie trying to mimic Wall Street and privatization.  However, they both provided products with implied government guarantees.  This implies a higher level of due diligence in underwriting and packaging that they basically ignored.  It’s similar to USDA grade beef.  There was a guarantee that these loans would hold mortgage insurance and be underwritten carefully.   The root cause of the problems were not the attempts to get more qualified people into affordable mortgages, it was to feed Wall Street greed and shovel money to their executives who were frequently just political hacks. They simply did the worst of the Wall Street practices at a much higher volume with a more damaging result because of the US stamp of approval; the implicit guarantee.

Now, we have a back to the gilded age future ahead of us.  What has made these loans work as loans and the securities that back the loans work is the implied low risk with a decent rate of return.  Many, many pension funds and institutional investors  hold huge numbers of Fannie and Freddie Securities because they’ve always had high ratings.  Most of these pension funds and institutional investors are sources of long term funds.  There’s not a lot of a lenders that will lend long these days and that’s going to be a problem for most people looking for a home now more than ever.  My guess is that most home loans will now go down to terms of about 15-20 years or they’ll be completely variable rate.  That means the homeowner will have to bet on the rate to get an affordable mortgage and gamble their incomes will go up to secure the lowest rates and longest terms.   Both of these are highly risky bets.  Past data has shown that most people loose with these kinds of mortgages.

Plus, that’s if they can get the funding at all. Without something similar, I doubt that the major sources of these funds which are usually forced into safe investments will be available.  Either that, or you’re going to lock in to a fixed rate but for an intermediate term loan.  Think about your own house loan and what that would mean for you.   You either double your house payment or take the bet that the rate won’t go up enough to force you to default in the future.  Most people don’t have sophisticated enough knowledge of economics to even make an educated guess.   My guess is that if they take the loan at all, they’ll go for the short term fixed rate loan on a much cheaper house.  This is going to change the complexion of the housing market for ever if it goes through as planned.

This is a President used the gipper metaphor for himself. This is the White House that wants less Government in the Mortgage system.

The Obama administration wants to shrink the government’s role in the mortgage system — a proposal that would remake decades of federal policy aimed at getting Americans to buy homes and would probably make home loans more expensive across the board.

The Treasury Department rolled out a plan Friday to slowly dissolve Fannie Mae and Freddie Mac, the government-sponsored programs that bought up mortgages to encourage more lending and required bailouts during the 2008 financial crisis.

Exactly how far the government’s role in mortgages would be reduced was left to Congress to decide, but all three options the administration presented would create a housing finance system that relies far more on private money.

“It’s clear the administration wants the private sector to take a more prominent role in the mortgage rates, and in order for that to happen, mortgage rates have to go up,” said Thomas Lawler, a housing economist in Virginia.

Abolishing Fannie and Freddie would rewrite 70 years of federal housing policy, from Fannie’s creation as part of the New Deal to President George W. Bush’s drive for an “ownership society” in the 2000s. It would transform how homes are bought and redefine who can afford them.

Treasury Secretary Timothy Geithner said the plan would probably not happen for at least five years and would proceed “very carefully.” In the meantime, he said the companies would have the cash they need to meet their existing obligations.

There are other ways to do this.  Most would have to do with tighter governance of Fannie and Freddie and elimination of private sector practices of bonuses for volume when government guarantees are involved.  Also, a cap for the mortgages to prices more standard through out the country rather than Washington DC would help.  Fannie and Freddie should have no place in the jumbo market.  Here’s a few of the proposals that are in the White House program.

The Obama administration proposals include raising the rates Fannie and Freddie charge to banks for loan guarantees to the same levels as private banks. Private mortgages for so-called jumbo loans, which are not covered by government guarantees, currently cost between 0.5% and 0.75% more than government-backed mortgages. So, if Fannie and Freddie’s fees were to rise to the market level, mortgage rates across the U.S. might rise substantially.

The administration also proposed lowering the maximum value of a mortgage that can qualify to be federally backed from the current $729,750 to $625,500. That’s a widely suggested move that would attract the private sector to make more loans in the upper range of the market. The proposal also called for Fannie, Freddie and the FHA to set a minimum down payment requirement of 10%. Currently, the agencies are authorized to make loans with no down payments at all.

The big issue is what to do about the government guarantee that assures investors who buy Fannie and Freddie mortgage bonds that the U.S. government will pay back the bonds in the event the underlying mortgages default. Because of that guarantee, Fannie and Freddie can offer lower interest rates than the private sector. Investors, especially foreign investors, were burned by subprime bonds during the financial crisis, and now they won’t touch private mortgage bonds without a government guarantee.

There’s obvious problems with Fannie and Freddie but they mostly lie with how it was managed and how it morphed as more up income and high price assets were put into play.  Helping upper income people or expensive real estate markets weren’t originally part of the charter.  Making it more like a bank isn’t going to remove the abuses but add to them.  Bonuses for production quotas lead to reduced quality.

It would be more prudent to take Fannie and Freddie back to their roots rather than to them strip them of their ability to provide affordable mortgages to entry level home owners.  The management got caught up in production over quality of loans because they got bonuses.  That was a huge problem.  The connection to affordable housing initiatives was never the problem.  Churning out crap to feed the investment frenzy of Wall Street and peeling off bonuses for their executives led to their sloppy loan processing.  They caught the same disease that plagued the private sector at a larger volume.  Congress also did a poor job of oversight.

This move will leave a huge gap in two places.  First, it will impact investment portfolios that rely on long term, relatively safe but decent yield-bearing assets.  It will also remove one more route to the American dream for ordinary Americans.  Let’s just say we’re all taking one for the Gipper.