Treasury’s Housing Report

[lifeizfunhuh]

Felix Salmon of Reuters just penned the following well written article on Treasury’s plans to reform the mortgage market. The original article (with link to report) is here:

http://seekingalpha.com/article/252439-judging-treasury-s-housing-report

but here is the text of the article:

I’m impressed with Treasury’s long-awaited report on reforming the US housing market. It’s a good length — it comes in under 11,000 words, which makes it shorter than, say, Michael Lewis’s Vanity Fair article on Ireland. It’s written in a very clear manner, laying out in a simple and honest way exactly what went wrong, and what Treasury is proposing. And although it might look as though providing three different options for reform is a bit of a cop-out, in fact they’re not as far apart from each other as you might think, and all of them would constitute a radical change from the status quo.

The message is clear: what we have right now is unacceptable, and we need to do something big; the main choice facing Congress is between a modest government housing guarantee, a tiny one, or none at all.

It’s worth reading the rest of the report, too, not just the section laying out options at the end. One very welcome theme running through the report, from the beginning of the introduction, is that an important part of “affordable housing” is giving people “rental options near good schools and good jobs” which don’t take up an inordinate proportion of total income. This kind of language appears all too rarely in papers on mortgage-market reform:

Today, renters often face significant affordability challenges. Half of all renters spend more than a third of their income on housing, and a quarter spend more than half. And for low-income renters, adequate and affordable homes are increasingly scarce. For every 100 extremely low-income American families, for example, only 32 adequate rental homes are affordable.

The report is also clear-eyed about two aspects of the US mortgage market which seem to be sacrosanct: the pre-payable, 30-year fixed-rate mortgage, on the one hand, and the mortgage-interest tax deduction, on the other. It notes that both are pretty much unique to the US, and cause significant distortions and risks: “tax incentives like the mortgage interest deduction can encourage investment towards housing over other sectors in the economy”, the report says, adding that investment in those other areas “may lead to greater long-term growth or job creation.”

There’s even a nod to the concept of covered bonds — look closely, it’s buried in a subordinate clause at the bottom of page 14, but it’s there. Such things are hard to understand, but they’re very attractive from a policy perspective. The problem is that banks don’t like them, and so it’s going to be hard to implement them given the lobbying power of the banking industry.

But banks are going to have to start putting a lot more of their balance sheets at risk in the housing market whatever happens, if any of the options in this report are adopted. The idea is to replace the current system, where the government guarantees nearly all the mortgages in the country, with a private system where government is involved only at the low-income end of the market or in the event of a major crisis.

If any of the choices are adopted, then mortgage rates will continue to rise — they’re already above 5%, and that’s a good thing, since the cost of a mortgage should reflect the risks inherent in it. It will be harder to get a pre-payable 30-year fixed-rate mortgage. But if you do get one, your monthly cost might not be much higher than it is right now, since as Dean Baker calculates, the headline price of your house is likely to be lower. The obvious cost of such a system, then, is that it would increase the number of homeowners with negative equity, and thereby increase, at the margin, the number of defaults and foreclosures that we’ll be seeing going forwards.

More generally, it’s far from clear that there’s enough private money at all which is willing to fund such a system. The main problem I have with Treasury’s report is that it simply assumes that if government support for the housing market is slowly removed, then private money will come in to take its place — at a higher price, to be sure, but at some price.

The big risk is that private money won’t come in, at any price, if there isn’t a guarantee — that the amount of private funding for the US mortgage market will be substantially lower than the demand for mortgage loans. The result would be a broken, non-clearing market, with people stuck in their homes because they can’t sell them, and the idea of a “market price” being somewhere between a purely theoretical entity and an outright joke.

That’s why my preference would be for Treasury’s third option, where the government guarantee remains extant, just with a lot more safeguards than it has right now, in a system where it’s priced rationally rather than well below market. Fannie and Freddie would go away, and be replaced by private mortgage insurers; the government would reinsure the mortgage insurers, rather than insuring the mortgages directly. And the government would only lose money after the private insurers had lost all of their money.

Are there private-sector players who would step up and insure mortgages in such a system, willingly providing a buffer between banks and the government? Treasury simply says that “a group of private mortgage guarantor companies that meet stringent capital and oversight requirements would provide guarantees for securities backed by mortgages that meet strict underwriting standards” — but it’s not immediately obvious to me who those companies might be. If such companies can be found, and if they’re well-capitalized enough to credibly backstop an enormous proportion of the entire US mortgage market, then this solution is I think a good one. But those are two very big ifs.

There are a lot of financial-sector players who have every incentive to claim that such private-sector companies will never appear, and that a broader government guarantee, like the current one at Frannie, is sadly necessary. As this debate moves to Congress, it’s going to be crucial to be able to examine such claims impartially, and to decide whether Treasury’s optimism regarding the future risk appetite of private capital is justified. Any bright ideas as to how to do that? Because I can’t think of anything offhand.

[patb]

it seems to me there are several kinds of risks in a mortgage

1) Payment risk

2) Inflation risk

3) Return Risk.

Now the Feds sell 30 year bonds, which price the Inflation risk and Risk free return for bonds.

so 30 year mortgages can be priced against 30 year bonds with a small premium for Payment risks.

i would rather see the tax deduction go away then the 30 year mortgage

[patb]

it seems to me there are several kinds of risks in a mortgage

1) Payment risk

2) Inflation risk

3) Return Risk.

Now the Feds sell 30 year bonds, which price the Inflation risk and Risk free return for bonds.

so 30 year mortgages can be priced against 30 year bonds with a small premium for Payment risks.

i would rather see the tax deduction go away then the 30 year mortgage

[patb]

it seems to me there are several kinds of risks in a mortgage

1) Payment risk

2) Inflation risk

3) Return Risk.

Now the Feds sell 30 year bonds, which price the Inflation risk and Risk free return for bonds.

so 30 year mortgages can be priced against 30 year bonds with a small premium for Payment risks.

i would rather see the tax deduction go away then the 30 year mortgage

[patb]

it seems to me there are several kinds of risks in a mortgage

1) Payment risk

2) Inflation risk

3) Return Risk.

Now the Feds sell 30 year bonds, which price the Inflation risk and Risk free return for bonds.

so 30 year mortgages can be priced against 30 year bonds with a small premium for Payment risks.

i would rather see the tax deduction go away then the 30 year mortgage

[patb]

it seems to me there are several kinds of risks in a mortgage

1) Payment risk

2) Inflation risk

3) Return Risk.

Now the Feds sell 30 year bonds, which price the Inflation risk and Risk free return for bonds.

so 30 year mortgages can be priced against 30 year bonds with a small premium for Payment risks.

i would rather see the tax deduction go away then the 30 year mortgage

[CA renter]

IMHO, there would be plenty of money in the private market for mortgages, but it would come at a much higher price (rate), and require a better guarantee (which could be a higher down payment). Yes, housing prices would go down, but I’m not convinced that’s such a bad thing. IMHO, we spend far too much of our incomes on housing, and it’s breaking the backs of American workers.

Affordable housing is a GOOD thing.

One item that does cause me distress is that we’re moving from “everyone should own a home (or two, or five)” to “only certain/rich people should own homes, and everyone else should have to rent from them.” This is just as bad and just as dangerous as claiming that everyone should own. What we need to do is recognize that home ownership is, in general, a beneficial thing for working families, and that we SHOULD encourage prudent home buying. We can do this by *discouraging* speculation and “investment” in housing.

[CA renter]

IMHO, there would be plenty of money in the private market for mortgages, but it would come at a much higher price (rate), and require a better guarantee (which could be a higher down payment). Yes, housing prices would go down, but I’m not convinced that’s such a bad thing. IMHO, we spend far too much of our incomes on housing, and it’s breaking the backs of American workers.

Affordable housing is a GOOD thing.

One item that does cause me distress is that we’re moving from “everyone should own a home (or two, or five)” to “only certain/rich people should own homes, and everyone else should have to rent from them.” This is just as bad and just as dangerous as claiming that everyone should own. What we need to do is recognize that home ownership is, in general, a beneficial thing for working families, and that we SHOULD encourage prudent home buying. We can do this by *discouraging* speculation and “investment” in housing.

[CA renter]

IMHO, there would be plenty of money in the private market for mortgages, but it would come at a much higher price (rate), and require a better guarantee (which could be a higher down payment). Yes, housing prices would go down, but I’m not convinced that’s such a bad thing. IMHO, we spend far too much of our incomes on housing, and it’s breaking the backs of American workers.

Affordable housing is a GOOD thing.

One item that does cause me distress is that we’re moving from “everyone should own a home (or two, or five)” to “only certain/rich people should own homes, and everyone else should have to rent from them.” This is just as bad and just as dangerous as claiming that everyone should own. What we need to do is recognize that home ownership is, in general, a beneficial thing for working families, and that we SHOULD encourage prudent home buying. We can do this by *discouraging* speculation and “investment” in housing.

[CA renter]

IMHO, there would be plenty of money in the private market for mortgages, but it would come at a much higher price (rate), and require a better guarantee (which could be a higher down payment). Yes, housing prices would go down, but I’m not convinced that’s such a bad thing. IMHO, we spend far too much of our incomes on housing, and it’s breaking the backs of American workers.

Affordable housing is a GOOD thing.

One item that does cause me distress is that we’re moving from “everyone should own a home (or two, or five)” to “only certain/rich people should own homes, and everyone else should have to rent from them.” This is just as bad and just as dangerous as claiming that everyone should own. What we need to do is recognize that home ownership is, in general, a beneficial thing for working families, and that we SHOULD encourage prudent home buying. We can do this by *discouraging* speculation and “investment” in housing.

[CA renter]

IMHO, there would be plenty of money in the private market for mortgages, but it would come at a much higher price (rate), and require a better guarantee (which could be a higher down payment). Yes, housing prices would go down, but I’m not convinced that’s such a bad thing. IMHO, we spend far too much of our incomes on housing, and it’s breaking the backs of American workers.

Affordable housing is a GOOD thing.

One item that does cause me distress is that we’re moving from “everyone should own a home (or two, or five)” to “only certain/rich people should own homes, and everyone else should have to rent from them.” This is just as bad and just as dangerous as claiming that everyone should own. What we need to do is recognize that home ownership is, in general, a beneficial thing for working families, and that we SHOULD encourage prudent home buying. We can do this by *discouraging* speculation and “investment” in housing.

[Author]

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