The Federal Reserve (and much of the financial press) is betting on the return of one of the worst economic deals in the world. That is, allowing people to borrow 80% of the money they need to buy a home and then repay that debt over 30 years.
Who in their right mind would lend such money?!
As it turns out, the answer is (almost) no one. That’s why the U.S. government created the Federal National Mortgage Association (FNMA, or Fannie Mae) and eventually the Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac)… and why these programs or something similar will be with us for a long time.
In the years before the Great Depression, home mortgages were straightforward…
A borrower could take out an interest-only loan for 50% of the purchase price and the balance was due in five years. That’s it.
The typical thing was to roll over the unpaid balance of the mortgage at the end of the five years.
Of course, when the Depression hit and mortgages came due, banks either didn’t have the capacity or the stomach to roll over these loans, so they simply called them. And since the borrowers didn’t have the funds to pay off the loans in full, homes were foreclosed and sold, helping to drive the property market into a tailspin.
Franklin Delano Roosevelt recognized in the 1930s what the Fed recognizes today… that home building creates a bunch of jobs and new money through credit extension, so he was eager to get the residential housing sector back in action.
Unfortunately, banks were still smarting from the Depression and weren’t all that eager to make new loans. The idea of lending money to people who might lose their jobs, against assets that could drop dramatically in value, seemed risky.
So FDR did what many government officials do. He supported a program that makes little economic sense to address an immediate economic concern. In 1937, Fannie Mae was born.
The years between the creation of Fannie Mae and its bailout in 2008 were filled with both monotony and excitement. There were times when nothing happened, and there were years when new tweaks goosed the creation of mortgages and therefore spurred the housing market.
Through it all, it’s clear that the politicization of the mortgage industry can have disastrous consequences. And that raises a question…
If lending money for 30 years, to people who can (and do) have dramatic changes in income, against assets that can (and do) change dramatically in value, is a risky proposition, then why do we continue to do so?
Because in the eyes of the U.S. government, we must.
Fannie Mae or Freddie Mac back almost all of the mortgages written today, allowing banks to get them off their own books almost immediately. In a time of tepid economic growth, wage deflation and rising interest rates, who wants to make, and then hold onto, a 30-year loan? No one. Which is why no one else does it.
Now, when I say “no one else does it,” I mean no other country operates this way. Other nations use adjustable mortgages, typically on a five-year term, and with some sort of government backing to keep the banks happy.
With all of this said, one thing is clear: The U.S. won’t go cold turkey in dismantling or otherwise closing up Fannie Mae and Freddie Mac. The economic cost of doing so in terms of a slowdown in the real-estate market would be simply too painful.
But I’d imagine that it goes even further. The economic cost of doing ANYTHING —taking any step, making any change — to make U.S. mortgages more sane (shorter terms, higher down payments, all adjustable) will never happen because politicians control the decisions. And no politician wants to be seen as responsible for diminishing the economy or a market in any way.
Just when it seemed the situation couldn’t get more surreal, the Fed came along and began buying up almost every scrap of mortgage-bond debt available through its quantitative easing efforts.
So now taxpayers get the joy of knowing that not only are they still on the hook for dubious mortgage programs, but they are also financing those mortgages by having their saved dollars nicked every time the Fed prints more money to buy the mortgage bonds that back the loans!
You just can’t make this stuff up.
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Ahead of the Curve
During December, I explored the state of the housing and mortgage markets with you. To cut a long story short, things are not as rosy as Main Street’s telling you.