Would eliminating the GSEs doom the 30-year mortgage?
Every asset is salable at a price. Adjusting to a market without government guarantees has a cost, but 30-year mortgages would still exist.
Most people recognize the GSEs should be eliminated because their implied government backing is now explicit. These entities are not private entities, although many private investors would like them to be so they could profit off the government guarantee.
Whenever people start discussing how to reform or terminate the GSEs, invariably someone will try to scare everyone by claiming US housing finance will cease to function, the housing market will crash, or some other nonsensical doomsday scenario will come to pass.
I suspect the current round of fear mongering over GSE reform comes from GSE investors who want these entities preserved and turned over to private enterprise. For whatever the reason, this time around, the scare tactic is the elimination of the 30-year mortgage — a loan product that existed before the GSEs and will continue long after they’re gone.
30-year fixed-rate mortgage
The 30-year fixed-rate mortgage has been popular among progressives and conservatives alike because it is a good loan product. The reason the political left likes the 30-year loan is because it provides a means for average wage earners to acquire wealth. Paying down a mortgage through the forced savings of an amortizing mortgage used to be the primary wealth generating mechanism of the middle class — that is until we allowed everyone to rob the piggy bank with HELOCs.
Opponents of the 30-year fixed-rate mortgage blame it for the Savings & Loan disaster of the 1980s, but that is inaccurate. The heart of the S&L fiasco was an asset-liability mismatch. Banks often borrow with short-term funds and lend on a long-term basis. The 30-year fixed rate mortgage contributes to this problem, but ultimately this is a financial management problem at banks.
Nobody forces banks to underwrite these loans, and nobody forces them to match those loans with short-term deposits. This is a choice banks make that sometimes blows up in their face. Banks could float long-term bonds to match their loans, and they can also offload them to the secondary market; in fact, that is one of the primary arguments for keeping a secondary market in place.
The 30-year fixed-rate mortgage exists because people demand it; People demand it because it’s a good and stable loan product that builds wealth for ordinary Americans. The government supports it because it provides stability in housing markets.
The 30-year fixed-rate mortgage will exist whether it’s supported by government subsidies or not.
IMO, Dick Bove looks like Burl Ives.
Tom DiChristopher, Tuesday, 24 Feb 2015
The Treasury Department is looking to wind down Fannie Mae and Freddie Mac, but without these organizations, there would be few buyers for 30-year fixed rate mortgages, bank analyst Dick Bove told CNBC on Tuesday.
Everyone says they want private capital to form the basis of housing finance, but nobody is willing to accept the consequences of attracting this money: higher interest rates. Right now, the US taxpayer is on the hook for over 90% of the residential mortgage market through the FHA and GSEs. These entities are packaging mortgage-backed security pools, guaranteeing them, and selling them to investors. Without this government backing, investors would demand better returns, and the only way returns improve is if mortgage interest rates rise.
Of course, rising interest rates is the last thing lenders and housing bulls want to see. Higher interest rates would reduce mortgage balances, make housing even less affordable, and ultimately will either halt appreciation or cause prices to decline again. Since the banks are still exposed to hundreds of billions of mortgages without collateral backing, they need prices to rise back to peak levels to prevent billions in losses. As long as the banks have so much exposure, I believe any plans to wind down the GSEs will be put on hold until the banks are solvent again.
Banks would be happy to step in and offer variable rate five- and 10-year mortgages, but those shorter maturities would increase monthly payments for borrowers and lower the overall cost of housing—a situation that would send shock waves through the U.S. housing market, said Bove, vice president of equity research at Rafferty Capital.
Has he completely lost his mind? He is actually suggesting banks would only offer 5-year or 10-year loans without the GSEs. In reality, banks will offer any loan desired in the market if the price is right.
“Is the United States ready to take a shock to housing prices because we’re getting rid of 30-year fixed rate mortgages?” he said during a “Squawk Box” interview.
This kind of ridiculous fear mongering is distasteful.
Bove said banks have admitted to him privately that they cannot make money on 30-year fixed-rate home loans anymore due to new rules on capital reserves and securitizing mortgages.
Consequently, the industry wants to make loans that it can sell to Fannie Mae and Freddie Mac, he said. …
However, the Treasury Department is aiming to phase out Fannie Mae and Freddie Mac by 2018.
“So the question becomes, ‘Who’s going to buy these mortgages?’ And if we’re talking about 30-year fixed rate mortgages, which are yielding less than 4 percent, who’s going to be crazy enough to buy [them] or put [them] on their balance sheet?” Bove asked.
The problem is not the product, it’s the price.
To say that 30-year-fixed rate mortgages do not make sense is to say that housing prices in the United States do not make sense, he said. Currently, he said, Americans buy houses based on the deposit they must put down, and the cost of their monthly payment.
That much is true. Lenders are reflating the old housing bubble using stable mortgages and artificially low interest rates. House prices don’t make sense, but they are what they are for the reasons he describes.
Eliminating Fannie and Freddie would essentially eliminate the 30-year-fixed rate mortgage, leaving shorter-term, variable rate mortgages to fill the vacuum. That would lead to major changes in how much Americans pay month to month, and consequently, the overall cost of a home.
“I don’t think there’s a private market for 30-year fixed-rate mortgages, and I think that’s the issue,” he said.
I honestly don’t know where he comes up with this nonsense. There is a market for any asset at a price. That price may be higher than 4%, but if 30-year mortgages yielding 8% were packaged into securities, many buyers would emerge. If this were not true, why do we have a jumbo market for 30-year mortgages? Those mortgages have no GSE backing, and they exist.
“The issue is not whether they’re good or bad. The issue is you have them. The issue is that a large portion of people in the United States who own houses own them as a result of a 30-year fixed-rate mortgage.”
The United States can switch to a market currently in place in Canada, where the average mortgage has a three-year maturity, but the question is what happens to the housing market when you go from one paradigm to another, he said.
The bottom line is that mortgage interest rates must rise if private capital without government guarantees is going to be the basis of the market. Since the banks can’t afford substantially higher interest rates, I expect to see the GSEs continue in their current form until prices near peak levels and banks finally resolve their outstanding bad loans.