Recently, the Obama Administration seemed to flash a rare sign of laissez-faire thinking when it issued a report calling for the “winding down” of Fannie Mae and Freddie Mac, the two taxpayer-guaranteed institutions now responsible for backing at least 90% of the US mortgage market. In its press release, the Administration acknowledged that the private sector should be the “primary source of mortgage credit,” and that their goal is to “bring private capital back to the mortgage market.”
While such a pro-market stance is welcome, astute observers should recognize the intentions as empty rhetoric. Unfortunately, government domination of the housing sector is already a fait accompli, and any serious attempt to remove artificial support will result in the kind of political pitfalls no politician wants to face.
After decades of federal life support, the US housing market has become an invalid that is unable to fend for itself. When the absurd housing bubble finally popped in 2006, prices logically began to plummet back to earth. After national price declines of some 30%, a wave of “stimulus” dollars stopped the free-fall in mid-2009. But after less than one year of “recovery,” it looks like prices are headed south again.
The widely-followed Case-Shiller Home Price Index fell 3.1% in January; prices are now at their lowest level since the housing market made its first bottom in April 2009. Sales of existing homes were off nearly 10% in February, and new homes sales were at a record low. As the economy worsens, there can be little doubt that housing is headed for a double-dip.
The government’s “make housing affordable” approach to market intervention is the root of the entire problem. To a large extent, this intervention takes the form of mortgage purchases by government-sponsored Fannie and Freddie. Through these entities, nearly all new loans for homes are now destined for public ownership. When these entities buy a mortgage, they are doing so to help the borrower get the needed financing. They have only a casual interest in the investment quality of the transaction. This is very different motivation from the private investor, who is primarily concerned with getting paid back; and on that basis, wouldn't go anywhere near US housing.
Private investors naturally prefer borrowers who are likely to make good on their commitments. Employment prospects figure prominently into this analysis. But nearly one-quarter of the workforce is unemployed or underemployed – that’s millions of people who are probably struggling to pay for groceries, let alone a mortgage. Strike them off the list of potential homebuyers.
Of course, some people do have jobs, but that’s not enough to satisfy those crazy private investors. They also want to make sure the borrower has some skin in the game, via an initial “down payment” of up to 20% of the home’s value. This threshold is a bit of a blast from the past. For most of the last century, a 20% down payment was the standard amount needed to qualify. Just ask anyone older than 55 or so about how they qualified for their first mortgage. I bet the story starts with their struggle to come up with a hefty down payment.
Following these general guidelines, the average American would need to put down $30,000+ to buy a median-priced home in the US. After decades of perniciously low savings rates, Americans just don’t have that kind of money. (To get around this thorny issue, the government is going where private lenders fear to tread by making loans for as little as 3.5% down.) Strike two.
Those few private investors who, despite all of the challenges, might still lend money to borrowers are being prevented from doing so by yet another government-sponsored institution, The Federal Reserve, which has prevented private lenders from charging an interest rate high enough to compensate for the extraordinary risk of lending into a collapsing market. Thanks to Chairman Ben Bernanke, interest rates are being artificially forced lower as part of a grand plan to re-inflate the debt bubble in the US economy. Strike three.
Naturally, all of these headwinds are having a predictable effect on housing prices. Thanks only to a $150 billion handout from the US taxpayer, and hundreds of billions of unprofitable investments at Fannie and Freddie, housing prices bottomed in 2009 and rose into the first half of 2010. But, as noted above, prices have resumed their downward trend, and are now within striking distance of making a new low.
Why is the government support not enough? Quite simply it is because prices were and still are too high. Even with the intervention, house prices have yet to find their natural equilibrium. And no private investor is going to invest in an asset class where prices are clearly headed lower. Strike four (as if we needed another).
The Administration’s stated goal is to extricate itself from the US housing market, in order to make room for private investors. Unfortunately, in the current environment, nobody with half a brain is going to put their capital at risk in this sector.
If you were an investor who saw that nearly one-in-four American adults did not have a full-time job, and those that could find work probably didn’t have an adequate down payment, and even if they did have a down payment, it would disappear into the abyss of falling housing prices, and even if you could find a suitable borrower, you would be forced to accept a below-market interest rate on your loan, would YOU invest in US housing? Neither would I.
I wish the President luck in getting the government out of the housing market. He’s going to need it.
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