Under Housing’s Weight, Uncle Sam Finally Shrugs

Three years after the housing market’s collapse, the federal government finds itself backing nine out of every 10 new residential mortgages, some of which still require buyers to put less than 10 percent down.

Like Atlas with Earth on his shoulders, Uncle Sam is bearing the weight of nearly the entire housing industry, such as it currently is. If today’s mortgages go bust like their predecessors in recent years, the American taxpayer will have to bear the losses.

With apologies to devotees of Ayn Rand, it seems to me that Uncle Sam has, at last, shrugged.

Last week the Obama administration gave Congress its recommendations – or more accurately, some options – to deal with the financial mess at Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that were at the heart of the mortgage crisis that has so far cost $134 billion to mop up. Together with the Federal Housing Administration, the GSEs have squeezed private lenders almost entirely out of the housing market. You may go to a privately owned bank for a loan, but in all probability the loan will either be backed by the FHA or will promptly be bundled with other loans into securities that are guaranteed by the GSEs and sold to investors.

Treasury Secretary Timothy Geithner presented three options for transitioning to a mortgage market less dependent on the government. They range from getting the government out of the mortgage market almost completely to something much like our current system.

Preserving the current system, however, will eventually take us back to the same place we began. If the government backs everyone’s mortgages, lenders have little incentive to make loans only to those who can pay them back, and investors have less reason to care.

House Republicans seemed relieved, or at least hopeful, in the wake of Geithner’s proposal. Rep. Randy Neugebauer, R-Texas, said he hoped the report would make it easier for Democrats “to embrace some of these principles,” that is to say, principles for reducing government presence in the mortgage market. The fact that all three proposals, even the one closest to the system in place, advocate reducing the role of the government signals an understanding that we need the private sector to return to this business.

Count me in with those who believe the government should not back private, residential mortgages at all – or at least as little as possible. Certain constituencies, like military veterans, seem almost certain to be singled out for special treatment under any alternative.

If Congress does pursue the option that would make the mortgage market almost entirely private, rates would certainly go up. For borrowers with good credit, I believe we can expect an increase of 1 percentage point or so. This would put the rates in line with current rates for those for “jumbo loans” that are too large for Fannie Mae or Freddie Mac to guarantee. Borrowers with weaker credit can expect to pay more.

The people who make their livings building and selling homes want the federal taxpayer to keep subsidizing the flow of customer money, of course. They predict a disaster in the housing market if it does not. While I don’t believe the gradual wind-down of federal involvement would severely harm the market, it certainly would have a lot of side effects – nearly all of them good.

First, Americans would stop buying more house, or houses, than they need. People are most concerned with their monthly mortgage payment, not directly with interest rates, so they will be inclined to take out smaller loans at the new, higher interest rates. While this will help restrain house prices (not a bad thing for buyers in itself), I think the bigger effect will be to steer people, at the margins, toward buying smaller residences, or forgoing a vacation home.

Many Americans are overhoused, especially as the population ages and family sizes get smaller. A more realistic cost of credit will help correct this.

Taking the principle further, fewer people will want mortgages at all. This will lead to a more realistic balance between buying and renting. People will be more apt to buy houses for shelter, rather than as investments.

While it will remain true that renting doesn’t build equity, the upsides of renting will become more apparent when buying is a bit harder. Chief among these is flexibility: If the factory that employs you shuts down, but there’s another job available across the country, it’s much easier to relocate if you do not first need to sell your house.

Despite warnings from mortgage bankers, it is unlikely that the 30-year fixed rate mortgage will disappear entirely, even in a nearly all-private system. Long term, fixed-rate loans will become rarer and harder to come by – as they should, since they pose the greatest risk to the issuers – but buyers who want them badly enough to brave the higher interest rates will still find them available.

The last consequence will be less direct, but no less important. Banks and thrift institutions will get back into the business of making and holding mortgages if they don’t have to compete with GSEs that can borrow at the Treasury’s unbeatable rates. To make these mortgages, financial institutions will need to attract deposits by paying savers a reasonable rate for the use of their funds. This is healthy for a nation that presently saves too little and borrows and spends too much.

Getting private lenders back into the mortgage business, and getting the government out, is an important step to get this country to use its capital more rationally and productively. Besides, with the Treasury’s own debt rising by more than $1 trillion each year, Uncle Sam had better save some debt-carrying capacity for himself. Those shoulders are big and strong, but even Atlas had his limits.

About Larry M. Elkin 525 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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