I don’t buy into theories that say the economic world is coming to an end, or that a there’s a small cabal directing the world’s affairs. I hesitate to respond to this thread because it seems designed to attract those who have faith in some of these theories. But the point about the GSEs (Fannie etc) being a useful potential tool for our political leaders to minimize a downturn in house prices, and socialize the cost, is valid. Oh, well, here goes…
If housing prices drop enough, regular people will feel that their future plans to spend a lot but save a little are endangered. They will not accept that easily.
Most baby boomers and some in earlier generations have seen fantastic returns for 25 years now from their strategy of buying assets, even while they were still in debt. It’s become expected as part of the culture that you can buy an asset today for $1 worth of goods and services, and expect the rest of the world to supply you with $5 worth of goods and services in return for that asset when you’re older and crankier. It’s also expected that you can borrow that $1 today and repay it with much less than $5 in real value, so it’s always better to borrow over the long haul. There are even articles in respected outlets that say that the national savings rate is much higher than it appears, because the net gains from asset price inflation are not included in the savings amounts.
That’s the political pressure behind keeping home prices high. It’s probably stronger than the pressure to keep inflation low, because a lot of inflation damage is done behind the scenes and to foreigners (investing in US bonds). Inflation at 5-7% for 10-15 years wouldn’t be considered earth-shattering by voters compared to home prices dropping 50% in the next 2-5 years.
So how could house prices be supported using the GSEs? Let’s start with new loans:
1. Increase the qualifying maximum amounts of loan. Let’s throw out $850,000, for argument’s sake.
2. Permit less of a down payment, probably using complicated rules involving higher rates for less downpayment, and distinguishing between various sources of downpayment money. But let’s keep it simple: Allow 2% down, say.
3. Permit lower payments in the early years. Because of the bad smell coming from huge increases in early payments in the very early years on existing ARMs, this would probably be limited to loans with gradual annual increases, let’s say 3-7%, in the annual payments over the life of the loan, with the higher values allowed only in the earliest years.
Would this increase GSE risk? Absolutely. Would stockholders stand for it? Sure, if they got a few % extra dividends today, which would add way less than 10bp to the loan interest rate. if the market tanked, they would get wiped out, but the GSEs’ equity is tiny. Almost all the shortfall would then be picked up by future generations of taxpayers.
How about existing loans?
Offer re-fi rescue loans to homeowners in trouble. Existing lenders have to accept some haircut in their pay-off, and the borrower has to accept continued, though lower payments, and Treasury has to forgo taxes on the debt forgiveness. These loans would have options to pay low amounts today in return for higher payments later. These higher payments could be fixed, or they could be a portion of any future increase in the home equity.
There are lots more ideas out there and I’m sure many more are possible.
Of course, the GSEs are only one policy tool, and many policy tools would be brought to bear at once. Obviously, lowering short-term rates would help keep home prices high, so that’ll happen if the prices drop too much for too many people. The resulting drop in the dollar will have a muted impact, because so many of our costs of production are in yuan, and it’s unlikely the $/yuan rate will be allowed to move much. I’d expect the degree of action to be calibrated to keep inflation less than 5-7% for any one year.
