As I recall from my time in the Senate, there’s nothing like an energy bill to attract misguided proposals. This week the Senate begins consideration of S.2012 — the Energy Policy Modernization Act of 2015. Among the almost two hundred filed amendments is a proposal (Amendment #3042) from former real estate broker, Senator Isakson, to mandate that the Federal Housing Administration (FHA) reduce the quality of its loans in order to encourage more efficient energy use.
The two most concerning aspects of Amdt 3042 are 1) it would allow “estimated energy savings” to be used to increase the allowable debt-to-income (DTI) ratios for the loan and; 2) require “that the estimated energy savings…be added to the appraised value…”
These changes might not be so bad in the abstract but when combined with existing FHA standards, they set the borrower up for failure and leave the taxpayer holding the bag. Let’s recall that borrowers can already get a FHA mortgage at a loan to value (LTV) of 96.5%, and that’s assuming an accurate appraisal. If borrowers were required to put 20 percent down, then this amendment would be a minor problem, but under existing standards, borrowers would mostly likely leave the table with an LTV over 100%, that is already underwater before they’ve even moved in. Did Congress learn nothing from the crisis?
The increase in DTI might not matter if FHA did not already allow a DTI as high as 43% of income. Under Amdt 3042 borrowers could easily leave the closing table devoting over half their income to their mortgage. Again, did Congress learn nothing from the crisis?
To illustrate that the intent of the proposal is to have the taxpayer take more risk, Amdt 3042 actually prohibits FHA from imposing any standards that would offset this risk. If these new loans perform worse, as one would expect, FHA cannot put them back to the lenders. And let's not forget FHA allows the borrower to have a credit history deep in the subprime range. So you could have a subprime borrower, say FICO down to 580, LTV > 100% and DTI > 43% - what could go wrong?
If indeed energy savings actually increased the value of the home, that would be reflected in the price. There would be no need to mandate such. Not only does this proposal weaken FHA standards, and expose the taxpayer to greater risk, it takes us further down the path of an already politicized housing policy, where instead of relying on market prices, values are dictated by Soviet-style bureaucratic guesswork.
Recently the City of Los Angeles filed suit against JP Morgan Chase. The suit alleges "the bank engaged in discriminatory lending, which the City contends led to a wave of foreclosures that continues to diminish the City's property tax revenues and increase the need for costly City services." So the City's logic basically goes like this: the housing market was humming along just fine, kicking off lots of property tax revenue allowing the City to spend like there's no tomorrow, then evil JP Morgan comes in and lends to borrowers with the intention of pushing those borrowers into default, which pushed down housing prices, reducing property taxes and causing the city to cut "essential services".
So let's start with the facts upon which I assume everyone can agree on. Los Angeles experienced a massive boom in housing prices starting in the late 1990s (see chart below). Rather than see this boom as temporary, the City increased property tax revenues as prices soared. it spent those property tax revenues (have these people never heard of a rainy day fund?). As the boom was building in 2002, according to the Census Bureau Los Angeles collected about $850 million in property tax revenue. At the peak of the market in 2006 Los Angeles was collecting over $1 billion in property tax revenue, an increase of around 17% over four years.
Then the market begins to slow in 2006, prices decline and surprise property revenues decline as well. A central flaw in Los Angeles' logic is that the inflection point in prices came before that in delinquencies. Put simply, Los Angeles has their causality wrong. Price declines drove foreclosures. Yes, I suspect there was a feedback from foreclosures to prices, but the temporal order of events strongly suggests price declines was the driver here.
Now one could argue that loose lending drove up prices in the first place. But then that would mean that LA owes mortgages lenders for all that extra property tax revenue it collected during the boom. Somehow I suspect they aren't interested in sharing the up-side of boom/busts, just the downside. And if LA believes that foreclosures drove down prices and hence revenues, why isn't the city suing all the borrowers who walked away from their homes? After all, under the City's theory these delinquent borrowers cost the City tax revenues. But since some of these borrowers are voters, I doubt we'll see any consistency from the City there.
At the end of the day this suit appears little more than cheap pandering meant to distract from the dysfunctional governance of Los Angeles. If mortgage lenders had any sense they'd just cut off lending to LA altogether, but then they'd probably get suited by DOJ for discriminating. Can't win either way.
The same people who helped create the $180 billion bailout of Fannie Mae and Freddie Mac are now demanding the head of Ed DeMarco, the acting director of the Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac. Some commentators have gone as far to say that the "single largest obstacle to meaningful economic recovery is a man who most Americans have probably never heard of, Edward J. DeMarco." Of course, such a statement shows a stunning lack of understanding of both the mortgage market and the economy in general.
Why are so many upset with Mr.DeMarco? One simple reason: he is following the law. Some believe that broadly writing down the mortgages of underwater borrowers would turn the economy around, regardless of the cost to the taxpayer. While that assumption itself is highly questionable, it doesn't matter. As I've detailed elsewhere, the current statutory language governing FHFA limits Mr. Demarco from doing so. Yes, some proponents have found language elsewhere in the statute they believe allows sticking it to the taxpayer for another $100 billion. But their argument relies on general introductory sections of the statute, not the powers and duties of FHFA as a conservator. Statutory interpretation 101 is that more specific sections trump general introductory sections. General sections have "no power to give what the text of the statute takes away" (Demore v. Kim, 538 U.S. 510, 535). One would expect senior members of Congress to understand that.
Of course, if some members of Congress believe we should spend $100 billion bailing out deadbeats, then why don't they simply offer a bill on the floors of the House and Senate doing so? I'm sure House leadership would be happy to have a vote on the issue. The notion, instead, that an unelected, un-appointed, acting agency head should, in the absence of clear authority to do so, spend $100 billion is simply offensive to our system of government. Not to mention it probably violates the Anti-Deficiency Act, and would be hence subject to criminal prosecution.
Unfortunately, one of the common themes of the financial crisis was outright unlawful behavior by the financial regulators, such as the FDIC broad guarantee of bank debt, which lacked any statutory basis. Mr. DeMarco is to be commended for staying within the letter of the law. If Congress had wanted Fannie and Freddie to bailout underwater borrowers, they could have simply written that into the statute. Congress didn't, regardless of whatever spin any current members of Congress might want to place on the issue.
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.
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.
But let's say we want to keep the option of living beyond our means and have the rest of the world fund a large part of our mortgage market. Would they? Given that foreign investors currently hold over $5.4 trillion in U.S. corporate bonds and equities (not all guaranteed by the U.S. taxpayer), I think it's fair to assume that these foreign investors have some appetite for U.S. assets.
Now does that mean foreigners would buy the debt of massively leveraged, mismanaged mortgage companies subject to constant political-cronyism, without some guarantee? Probably not. But then, it strikes me that a better way to attract foreign investment into the U.S. mortgage market is to deal with those issues, rather than paper over those problems with a taxpayer-funded guarantee.
It is also worth noting that when we most needed foreign support for the U.S. mortgage market, in 2008, foreign investors were dumping Fannie and Freddie debt in significant amounts. And obviously I think we'd prefer that the Chinese Central Bank stop using the purchase of Fannie and Freddie debt to depress the value of their own currency.
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.
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.