Tag: housing market

Fed’s QEII Offers More Risk Than Reward

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.

Now Is the Time to End the Mortgage Interest Deduction

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.

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.

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.

Housing Market on Government Crutches

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.

FHA Bailout Watch

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’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?