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Stop Subsidizing (and Distorting) the Housing Market

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My fellow columnist, Clifford Rossi, recently made suggestions about how to "reinvigorate the housing market." He advocates convening commissions and designing complicated government interventions.

Don't do anything like that prior to determining what results we want from the housing market—before reinvigorating it to run rampant again in the same, or another, wrong direction. Then identify the path to these objectives that minimizes cost and risk.

Much as we may have benefited from overpaying the finest fruit of our elite business schools to sell mislabeled mortgage securities into Norwegian towns and Dusseldorf banks, that particular free lunch is no longer on offer. Now we'll owe the money to, or steal it from, ourselves. So, what's the goal? 

Do we want more new money spent on housing, and a higher percentage of consumers owning homes? Why should the government be promoting this? Our rate of homeownership, at 65.5%, is only about four percentage points below its all-time high, much higher than in other prosperous countries— more than twice as high as in Switzerland.

Having more of national income spent on education, research or energy independence might do more good for more people than increasing investment in housing. Additionally, if more of us rented we'd have a more mobile and hence more productive labor force, and household wealth and disposable income would be much better shielded from cyclical shocks such as interest rate increases. Rents are far less volatile.

So, let's not again inflate homeownership.  

People with lower income and worse credit can own more of a fixed total number of homes only by displacing those with more income or better credit—just as allocating more of a fixed number of college places to less qualified students denies these places to better-qualified students. 

Do we want higher home prices, as Rossi implies? That isn't compatible with anyone's conception of "affordable housing." It enriches home builders and real estate agents while making housing more difficult, risky and expensive to finance. With 20% of homes underwater, added home value from juicing prices would go 80% to awarding unmerited phantom gains to those homeowners who are already coming out ahead. A very inefficient subsidy to the underwater owners.

And should we subsidize any consumer's housing costs—as opposed, for instance, to medical and education costs? Why would we want to shift more family spending toward housing? The earned income tax credit is an example of successful income supplementation that leaves spending choices to the households.

I believe our long-term goals should include avoiding subsidies favoring owning vs. renting, or housing vs. other family expenses. Maintain economical and stable home prices—avoiding bubbles, steep inflation and Spanish-style mirage wealth. 

Do today what will serve these long-term goals. 

The largest cost of homeownership is interest. This is now setting record lows, even after a hefty increase in the cut taken by the mortgage production oligopoly that, like the other financial services oligopolies, has increased its market share to the detriment of community banks and consumers because of the crisis and the government's confused and misguided reaction to it.

So, with home prices rising rapidly and homeownership still high, what's the "reinvigoration" agenda?

Bernanke fears it's too difficult for creditworthy borrowers to obtain a mortgage. But everything has its price, including risk. If banks now overestimate risk, they will price some creditworthy mortgages higher, rather than reject applications altogether. Even at 200 basis points (more than 50%) above current rates, mortgages would still be reasonably inexpensive by historical standards.

Who's mispricing mortgage risk? 

The FHA guarantees mortgages up to $729,000 with credit scores as low as 580. Down payment of only 3.5% (10% for 500-579 scores)—although collateral value is susceptible to declines of 30% or more.  Sub-subprime.  What rational lender could expect to earn a fair return this way?

The recent audit report shows, unsurprisingly, that the FHA is indeed losing money, headed toward its first taxpayer bailout in 78 years of existence. The resulting taxpayer subsidies serve no justifiable purpose.  

There are glimmers of hope. Federal Housing Finance Agency Acting Director Ed DeMarco, the caretaker of Fannie Mae and Freddie Mac, is phasing them out. The FHA is raising its guarantee fees again. Both are finally pushing for restitution from lenders that cheated them in the past.

Given these halting steps in the right direction, it's not surprising to see the housing lobby pushing back. 

The path toward sound private financing of mortgages is clear and straight. Just cut out the subsidies and the uncertainties generated by complex interventions.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.

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Comments (4)
There are two indelible markers that identify those intent on rewriting the history of the mortgage crisis:
1. They ignore the impact of fraud, which flourished under the Bush Administration's hands-off policy towards those who abused the originate-to-distribute model; and
2. They try to equate private label RMBS with GSE MBS, which is like comparing apples and broccoli.

These bogus premises serve as the foundation for a discredited meme: It was government housing policy that distorted the mortgage markets, as opposed to fraud promoted by mortgage originators and by Wall Street financiers.

Anyone who follows the legal battles among all major banks and RMBS investors knows that fraud went viral during the boom.
Anyone who knows about home lending knows that price appreciation post closing--positive or negative--is the primary driving factor in loan performance. Private label investors risk buying at the peak of the cycle, whereas GSE bondholders, benefiting from a corp. guarantee, always benefit from interest income generated from loans booked before and after the peak.

A few metrics: The credit losses on private label RMBS are quadruple the credit losses incurred by the GSEs, which financed many more mortgages. Most US mortgages are financed by the GSEs, but the large majority of seriously delinquent loans were financed by the remainder of the mortgage market. That doesn't include the losses on $1 trillion from 2nd lien loans extended by private banks.

As always, the biggest driver of credit losses is under water mortgages. Which is why, abandoning all government support for housing threatens to further destabilize the debt markets.

Posted by DavidinNY | Tuesday, November 27 2012 at 1:26PM ET
You might include contribution to wealth inequality as one of these distortions, although, in this case it probably was not unintended. Subsidies have been lavish on upper income households than on low income - a clear example of getting more subsidies by having more income.
See CBO's An Overview of Federal Support for Housing (cbo.gov/sites/default/files/cbofiles/ftpdocs/105xx/doc10525/11-03-housingprograms.pdf )
Housing subsidies has been one of the greatest contributions to wealth disparity since WWII. Ending subsidies without recognizing the need to fix the disparity would compound the distortion by freezing it in place.
Posted by stochastics | Tuesday, November 27 2012 at 1:29PM ET
To paraphrase Emmanuel Kant, man is imperfect so his institutions will be as well But public intervention always increases the opportunities for corruption and fraud, so real or imagined misdeeds of bankers during the subprime debacle aren't a reason to continue subsidizing housing and the housing lobby.
Posted by kvillani | Tuesday, November 27 2012 at 2:39PM ET
Housing has always been an important part of our economy. Government does not earn money it collects taxes. To create revenue it needs a healthy growing economy. When the housing market is healthy and growing the net that is cast throughout the economy is vast. It touches on an enormous number of other businesses and institutions. The additional revenue it can create through this economic growth is an excellent way to help our federal, state and local governments to recover. Subsidizing is not synonymous with fraud. We can subsidize, grow and recover and not allow the out of control condition to happen again. We just need to do it properly and not fear the mistakes of the past. The pendulum always swings to far and fear prevents proper thinking.
Posted by robrose | Tuesday, November 27 2012 at 4:18PM ET
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