My favorite economist, Mark Dotzour from the Texas A and M Real Estate Research Center in College Station has some thoughts on the mortgage mess.
DOTZOUR: STEP ONE, RECHARTER FRANNIE
COLLEGE STATION (Real Estate Center) – As long as the federal government continues to indicate they are willing to redraw the promises contained in mortgage loans, investors will be wary of buying more mortgage bonds. Hence the interest rates on mortgages will stay higher than normal. That’s how the Real Estate Center’s Chief Economist Dr. Mark Dotzour sees the recent government takeover of Fannie Mae and Freddie Mac.“Fannie and Freddie were doing a great job of providing low cost mortgages to a large majority of American families for three decades of the 20th Centrury. Somewhere in recent years, they lost track of their mission and morphed into the largest mortgage bond speculators on the planet,” said Dotzour. “They did this by veering away from their mission of ‘packaging mortgages’ into the risky waters of keeping mortgages and hoping they hold their value. That bet has completely failed, and now they become a part of the problem and not a part of the solution to the housing market.”
Dotzour outlines what he thinks should be done.
BACK TO ORIGINAL PURPOSE“First, they (Fannie and Freddie) should be re-chartered to their original purpose of serving as a conduit for mortgages. They shouldn’t be in the business of holding mortgages as investments.
“Second, the government should monitor the spread between FRANNIE mortgage rates and the ten-year treasury rate. Mortgage rates should be about 1.6 percent higher than the current ten-year Treasury. This means that 30-year mortgages should be about 5.1 percent today.”GLOBAL SKEPTICISM REDUCED
Dotzour says there are several reasons why mortgage rates are not down to around 5 to 5.25 percent already.“First, mortgage bond investors have been very skeptical about the truthfulness of the quarterly earnings reports of FRANNIE for years. Now that they have been temporarily nationalized, this global skepticism should be greatly reduced.”
“Second, members of Congress have been suggesting this year that the interest rates on troubled mortgages should be ‘frozen’ so that the homeowners are not hit with interest rate ‘resets’ that make their payments higher.”
“This sounds great for homeowners that bought more house than they could afford, but it sounds terrible if you are a bond investor. When the federal government suggests interest rate freezes, this is like the government just took away part of your private property. You were expecting to get 2 percent interest for two years and then 6 percent interest on your bond and then the federal government threatens to freeze the rate at 2 percent indefinitely. Consequently, you won’t buy any more of those bonds when there is a threat that the contractual promise in the underlying mortgage could be abrogated.”
CRAMMING DOWN HOME VALUE
Dotzour says the new housing law signed by the President recently allows certain existing mortgages to be “crammed down” to 90 percent of the current value of the home.“This sounds great for homeowners as well. Say you bought a $500,000 house with a $500,000 mortgage. Today it’s worth $400,000 and the Federal Reserve and Congress both encourage banks to lower the principal amount to 90 percent of the current value. So the loan is reduced from $500,000 to $360,000.
“Who will want to buy any more U.S. mortgage securities when the government is willing to wipe away value of your investments with a stroke of the pen?” asks Dotzour.
Not mentioned is that this keeps the price of homes artificially high. We need foreclosures to pull prices back to where they’re supposed to be. If everyone in a neighborhood needed a subprime loan to buy a house, than the neighborhood is overvalued. While adjusting the mortgage to their “current value” sounds great from a customer perspective, it keeps the value of neighborhoods way over what they should be.
Mortgage rates are in for some interesting times as several strong crosscurrents impact the market. First, yield spreads should fall as credit markets improve. The first wave of this was seen after the Frannie nationalization. The second wave should occur as credit spreads between financial institutions normalize. This may be offset by the coming jump in Treasury yields. Friday saw historic jumps in Treasury yields on the 10 year bond. This is a result of the governments decision to create $500 billion to $1 trillion dollars of new debt to fund the purchases of illiquid bad debt to clean up the balance sheets of financial institutions. Which will win, spread contraction or underlying rate increases on gov’t bonds? Who knows, but it may be a wash. The third factor which may impact rates and push them lower are the coming economic impacts of the financial crisis. With unemployment rising, households still strapped and lenders in an extended healing process, economic activity and growth should remain below trend for several more quarters. This could have the effect of reducing treasury and other lending rates over the balance of 2008 once the shock of the new debt burden wears off.
Personally, it sure would be nice to see a sub-5% 15 year rate with fairly reasonable credit eligibility with a decent downpayment.
Hi Todd,
Thanks for the excellent analysis and your take on things.
> Personally, it sure would be nice to see a sub-5% 15 year rate with fairly reasonable credit eligibility with a decent downpayment.
That would be a welcome and motivating (for buyers) situation and would certainly get buyers off the fence.
Hope you’re doing well.
Steve
Rates need to go up along with down payment requirements. I cannot believe that rates haven’t moved up more, considering banks need more capital to survive. The only way to attract more capital in this situation is to pay higher interest for the depositors, thus passing on the higher rate to borrowers.
Buyers should only be buying want they can afford and not everyone is meant to be a home owner.
-Anon
I hope that the feds can get it right now. And what about the CEO’s of the companies that were driven by greed who still received bonuses and gold parachutes as their companies went down the drain. That’s the part that bothers me.
The Investors Business Daily had a great article about yesterday about what has happened to Fannie Mae and Freddie Mac since the early 90’s when they were used for political purposes of Congress. Some saw this disaster coming but were ignored. Congress is quick to point the finger at others at Wall Street when they had a hand in all of this.
Yep, Freddie and Fannie were used as political means to appease those who wanted to spread “home ownership” to more Americans. They were forced, through legislation, to start buying subprime loans.
The entire set of moving parts in all of this is at the same time simple and very complicated. One piece of it is certainly the desire of americans to live a lifestyle beyond our means, to buy houses when not financially prepared to do so, to invest in real estate without proper downpayment, and to think that housing prices would rise forever.
Steve