The dream of home ownership traditionally meant that anyone could get ahead using their ability and working hard. Over the past several decades, the United States government created housing policies that created incentive laced housing programs and the tax code that changed the dream for many American citizens. Families began to think of their home as an investment, not just shelter and a place for their families to grow up. When the housing market crashed in 2007, many suffered, homeowners, investors, the working middle class and taxpayers.
Creative robust housing programs initiated by the government have not always helped the poor and middle class. The median net worth of American adults has become one of the lowest among developed nations. It is less than $45,000, according to the Credit Suisse Global Wealth Data book report. That compares with approximately $220,000 in Australia, $142,000 in France and $54,000 in Greece. Almost one third of American adults have a net worth of less than $10,000. Those statistics don’t take into account the pain endured by millions of families who lost their homes.
Recently as of 1980, Fannie Mae and Freddie Mac held, guaranteed or created security for fewer than 10% of U.S. mortgages, an amount of less than $100 billion dollars. Today, it’s $4.7 trillion, yes a “T”, dollars. Add Ginnie Mae’s mortgage guarantees, and the number exceeds $6 trillion dollars. Since 2008, these government agencies were involved in more than 95% of all new mortgages. This massive financial exposure has been justified by statements like: “Housing should be affordable; ownership creates financial independence; government programs sustain the economy by increasing ownership”. But did ownership really increase?
According to the United States Census Bureau, 65.6% of Americans owned a home in 1980. More than thirty plus years and trillions of dollars later, the needle hasn’t budged. Home ownership is still around 65%. Subsidized mortgages, created through the government policies did create 3 things, none of them good:
A. The largest housing price bubble in American history.
Research by Nobel economist Robert Shiller shows that U.S. housing prices declined in about half of the years since 1890. While U.S. stocks during those years enjoyed an average yearly rate of return of about 6% per, the annual inflation-adjusted return on houses was a meager 0.18%. Factor in real estate’s expensive transaction costs and that number turns negative. Nevertheless, in the housing-boom decade before 2007, many home buyers decided that the largest-possible house, with an equally large mortgage, was a better idea than a retirement fund or their children’s education and set out to accomplish that goal.
By contrast, according to CLSA Asia-Pacific Markets, middle-class households in 11 Asian nations spend an average of 15% of their income on supplemental education for their children. Nearly as much as the 16% spent on housing and transportation combined. Americans spend only 2% on supplemental education and 50% on housing and transportation. For American home buyers taking on big loans, there was no margin for error. A job loss or problems with the home that needed expensive repair would be the stick that broke the camels back.
B. Misguided economic priorities caused by housing policies.
The U.S. is unique among nations of the world in that it gives mortgage borrowers a trifecta of benefits: extensive tax advantages, no recourse against the borrowers’ nonresidential assets if they walk away, and typically no protection for the lender if the borrower prepays the loan to get a lower rate.
These policies seemed like a great deal for borrowers for many years, but they were about to crush the financial system. People with marginal, or no credit, were encouraged to finance more than 90% or more, of the purchase price with 30-year mortgages. If interest rates later fell, they could refinance. If rates rose, they could congratulate themselves for locking in a low rate. If prices rose, they enjoyed all the upside and could tap the equity. If prices fell and they faced foreclosure, their other assets were protected because the loans usually had a non-recourse clause.
The Consumer Financial Protection Bureau now wants to tip the scale even more against lenders by asserting the legal theory of “disparate impact.” Consumers can sue if the volume of loans to any racial group or aggrieved class is substantially different from loans to other groups. No intent to discriminate is required, and it’s illegal for a mortgage application to ask the borrower’s race. Financial institutions trying to avoid making bad loans by implementing more aggressive underwriting practices can un-maliciously end up in trouble. A bank forced to pay a fine one year because it irresponsibly made “predatory” loans to people with bad credit can be fined the next year for not making similar loans. Go figure?
C. Damage to the environment and public health.
The size of the average American house grew by more than half, or about 900 additional square feet, over the past thirty years while the number of people in the average house decreased. Larger houses need larger lots that are usually farther from the home owner’s job. Construction, heating, cooling, landscaping and extended commutes consume more natural resources. Because the owners spend more time in cars, they have less time for important things like their families.
Many people of the day understood the important role the home building industry plays in the economy. Homebuilders didn’t create the problems. Policies made in Washington distorted the banking system and discouraged personal responsibility by issuing loans that borrowers couldn’t otherwise afford. This encouraged great housing speculation supported by gobs of financial leverage. Ultimately, we taxpayers got the bill for that miscalculation.
The 2008 housing collapse led to the U.S. Treasury takeover of Fannie’s and Freddie’s obligations even as the Federal Housing Administration increased its guarantees to more than $1 trillion and the Federal Reserve stepped up purchases of mortgage-backed securities otherwise known as home loans. Federal debt surged.
We Americans will eventually end up paying for that through some combination of inflation, higher taxes, higher interest rates or reduced benefits and services or a combination of these things. For now, the Fed is doing what the savings and loan industry did in the 1980s: borrowing short term while lending long term. When interest rates rise, the value of the government’s mortgage holdings will decline. When the government loses money we pay.
Many housing experts and economists believe that a solution is to reduce the government’s role by attracting private investment capital. That’s the capstone of proposals presented to the Senate Banking Committee last fall. Rather than hold or securitize mortgages, Fannie and Freddie would retain only a limited role as secondary guarantors. With the government as a backstop and private capital risking the first loss, mortgage interest rates would undoubtedly rise. But the taxpayer subsidy would fall. It’s a reasonable tradeoff to transfer risk from taxpayers to investors and let the market determine rates. Congress appears to be moving in that direction as it debates various proposals. The only negative here is the likelihood of higher interest rates.
The private sector is well-positioned and eager to assume much of the government’s role. Thanks to well to do capital markets and accommodating central banks, there is tremendous liquidity worldwide. Fannie and Freddie have now paid the Treasury more in dividends than they received in the bailout. Private capital already plays a substantial role in commercial real estate and has the capacity to make comparable residential commitments. It seems like the private sector has a way of getting things done that our government has yet to figure out.
Investments in quality education and improved health will do more to accelerate economic growth than excessive housing incentives. That will give everyone a better chance to achieve the real American dream which is to turn our home back into more than just an investment and back into a place we raise, and spend more time with our families.
Jeffrey C. Hogue