Over the past few years we’ve seen all kinds of problems with “innovative” mortgage products. Subprime, Alt-A, Neg-Am, and Interest-only mortgages have all seen high rates of default. While a poor economy has caused higher rates of defaults for prime mortgages as well, the 30 year fixed has shown itself to be a safer option. There is now a great deal of talk about reforming Fannie and Freddie and reducing the guarantees they provide. Many, like the National Association of Realtors, fear that without government interference, that old “bread and butter” product, the 30 year fixed mortgage, will be lost. [Thanks L!]
For a vast number of consumers, access to affordable, simple, 30-year fixed-rate mortgages requires government backing. Look at the virtual collapse of mortgage funding for commercial real estate and jumbo loans at certain times to see what can happen without government backing.
The San Francisco Chronicle is also gloomy about the potential problems if there is no longer government backing for the 30 year mortgage, seeing it as a threat to the middle class and the vibrancy of cities:
Economically, the middle-class loses out, because without the extended loan and corresponding lower payments, middle-income buyers are priced out of the market. Of course, one could argue that the middle-class has already been cut out of the real estate market in San Francisco. However, even upper-income buyers might balk at a million dollar plus mortgage with a 15 year amortization table; so, certainly, those middle-class residents who make up the majority of any city, including San Francisco, will have almost zero chance of home ownership, and that may force them to seriously consider relocating.
. . .
Mass emigration from American cities has a predictable outcome: suburban sprawl. With sprawl returns a reliance on the very things we most need to use less of, both for the economic reasons and environmental ones, like cars, roads, bridges, oil, and gas– all of which commuters need to get back into the city to their jobs. Sprawl is also famous for inefficiency, what McMarrow calls “temples to environmental waste because they force residents to use cars, and burn oil, to access the sorts of basic goods that are reachable by foot or bus or subway in urban settings.” Yet if families cannot afford cities, they could very well feel forced into “temples of waste.” On the other hand, people committed to the vibrancy of a city plus lowering their proverbial carbon foot-prints may give up on home ownership all together, and adjust to the idea of lifetime renting.
For those who believe that the end of government backing means the end of the 30 year mortgage and spells doom for the middle-class, I recommend this article by Edward Pinto, President and CEO, Courtesy Settlement Services LLC and former executive vice president and chief credit officer for Fannie Mae. He agrees that without the government guarantee the 30 year will be more expensive, but not prohibitively so, as many are contending. Pinto worries about the higher cost of the government backed 30 year mortgage– for taxpayers:
Those who seek a continued government role in housing finance frequently contend that the 30-year fixed-rate mortgage will not be available without a government guarantee. On its face, this is not true, since anyone can go to the Internet and find lenders offering jumbo fixed-rate thirty-year loans which, by definition, have no government backing.
It is true that a 30-year fixed-rate mortgage is somewhat more expensive than a government-backed 30-year, since the lender is taking a longer-term risk on interest rates, but the lower cost of the government mortgage simply means that the taxpayers–as well as all other mortgage borrowers who are not taking thirty-year fixed-rate mortgages–are providing a subsidy (in the form of government guarantees and eventual taxpayer bailouts) to the person who wants a government-backed mortgage with these terms.
Given two spectacular failures of U.S. housing finance tied to the thirty year fixed rate mortgage in the last 20 years, and the attendant cost to taxpayers of two massive bailouts, the housing industry should be required to show why it needs government support again.
Pinto also states that not only does the government backed 30 year mortgage not provide the stability that its proponents claim, but it is in fact a destabilizing influence:
- 30-year fixed mortgages have caused a roller coaster of mortgage origination volumes (that is, new refinanced mortgages) depending on whether the home owner could or could not extract money from the existing loan by obtaining a new lower mortgage rate. When rates are lower, borrowers treat their homes like ATMs and withdraw equity through serial refinancings. When rates go up, mortgage originators try to increase volume with loosened underwriting in an effort to maintain market share.
- The 30-year loan amortizes slowly; keeping the homeowner’s equity low and debt level high for the early portion of the loan when the risk of default is the highest.
- Rampant refinances cause the resetting of a substantial portion of all outstanding mortgages at the then current nominal market value. The volume of mortgage origination grew from $1 trillion in 2000 to $4 trillion in 2004. If the millions of borrowers who took cash out in 2003-2007 had to sell their homes to access their equity, the resulting over-supply of homes for sale would have caused a collapse in prices. Owning a home became akin to owning stock on margin. When prices fell, millions of homeowners experienced a margin call.
- This same roller coaster origination volume caused excessive loan prepayments which translated into volatile mortgage-backed securities values and a need for hedging to offset potential losses from these fluctuations. Fannie and Freddie’s respective 2004 and 2003 scandals related to hedging their massive portfolios of 30-year fixed rate mortgages. Later in 2008, the two GSEs suffered a liquidity crisis as the rate they had had to pay on short term debt to finance their $1.6 trillion portfolios spiraled upward, thus necessitating a taxpayer bailout.
- Wall Street traders enjoyed all this churning since they made money on each trade.
- This same volatility caused sizable and rapid fluctuations in the market value of mortgage servicing rights
- .Delinquency rates were kept deceptively low as seasoned loans were constantly being replaced with unseasoned ones. These misleading pricing signals instilled a false sense of confidence in investors.
- Deceptively low delinquency rates depress the accumulation of loan loss reserves which are tied to loan charge-off rates.
- Last but not least, all of this led to the two largest bailouts ever experienced by the taxpayers.
Pinto goes on to show that the costs are much lower than government backed proponents claim. I recommend the rest of the article– as well as getting tax payers out of the mortgage subsidy business. Maybe with the savings, we could more easily afford to pay our own mortgages.