The housing sector's drag on the national economy cannot be understated. Home sales hit a 42-year low in July, and continue to languish. Builders are still liquidating inventories and have simply shut down in many locations. Construction workers have swollen the ranks of the unemployed. Realtors are "significantly underemployed" in many states. The mortgage lending industry has shrunk to a fraction of its former size. Furniture and other new-home amenities are sitting in the stores unsold. Eleven million or 23 percent of all home mortgages are underwater with negative equity, representing $2.9 trillion of troubled mortgages. Increasingly worrisome is the potential for declining house prices to start another wave of loan losses in the already-fragile banking industry.
Free-market traditionalists say that we just have to let nature take its course and wash out the bad loans, allow home prices to sink to a new lower equilibrium so new homeowners can get a great deal, and let the markets recover thereafter. There's a lot of truth in that conventional wisdom, from the standpoint that anything we do that just artificially and temporarily props up the housing market (like last spring's tax credits) will just fall flat when the program expires. America's pro-housing policies and tax deductions for mortgage interest have resulted in overbuilding and overconsumption of single-family housing, and we cannot return to the housing bubble mentality that started this whole mess.
What the traditionalists don't acknowledge, however, is the risk of markets overshooting on the downside -- and the potential devastation to the financial markets through its spillover into wobbly banks. A vast number of potential new buyers are terrified to enter the market and are waiting for yet-cheaper prices. An even larger number of "house-poor" homeowners could benefit from today's low interest rates if they could simply qualify for a re-fi. Only when the legitimate, solvent buyers and borrowers get back into the loan market, will there be enough aggregate demand to buy up many or most of the foreclosures and unfreeze the housing and financial markets. The home-building and banking industries are stuck in limbo until that overhang is eliminated. That could take 3-5 years at the current pace.
Local governments will keep losing property tax revenues until the housing markets stabilize, especially those in the five most distressed housing states of Nevada, Arizona, Florida, Michigan and California. That means more local layoffs which only worsens the unemployment rate and undermines any economic recovery.
House-poor homeowners need to unlock themselves from their current higher-rate loans without undergoing foreclosures or short sales. Those with toxic non-conventional adjustable-rate (ARM) and interest-only (I-O) mortgages from the previous decade need to convert to viable fixed-rate mortgages. The jumbo market is virtually frozen in many localities today as deals can be done only with 30 or 40 percent down payments. Although refinancing activity has increased with lower rates, 30 percent of homeowners with loans outstanding cannot qualify for a re-fi because their home value has dropped below today's underwriting standards. Discretionary spending won't resume until they get mortgages that fit their balance sheets and their budgets.
Fannie Mae and Freddie Mac have become corporate zombies living intravenously on federal injections of bailout dollars. Without mega-billions from Uncle Sam, the two giant federal mortgage companies would both be bankrupt today. Not even the notorious AIG insurance conglomerate has sucked down as much taxpayer money. Nobody envisions them continuing to exist as they did before, with federal franchises to produce private profits subsidized by Congressionally socialized risks. Yet they continue to underwrite the vast majority of new mortgages in this country with now-explicit federal guarantees of the debt they sell. The first step toward reforming those companies is to guarantee the mortgages and not their corporate bonds. That will force them to compete hereafter as mortgage syndicators, not as underwriters with an unlimited corporate credit line from the U.S. Treasury.
Last week the Obama administration proposed a new initiative to enable underwater homeowners to modify their current mortgages on more-favorable terms. This limited measure addresses some of the issues discussed here, relying largely on existing executive authority and Troubled Asset Relief Program (TARP) funding. It's definitely a first step in the right direction. Unfortunately, it won't be enough to fix the problem. Congress should enact a broader and bolder strategy.
A stronger plan would be a broader, 18-month special-purpose middle-class expansion of the good old "Ginnie Mae" (GNMA, the Government National Mortgage Association) program to apply to virtually all 20-percent-down mortgages below $2 or $3 million. GNMA mortgages are guaranteed by the U.S. government and thus trade at very low interest rates; historically they went to veterans and low-income FHA borrowers only, not the middle class. Investors buy pools of these mortgages, including state and local governments and their pension funds. There is already a well-established market for GNMA paper. These mortgages could be syndicated by or through Fannie and Freddie, the Federal Housing Authority, the federal home loan banks, any official HUD designee and by state housing finance agencies. Qualified banks and savings and loan companies could participate directly in this market. This renewed competition would unlock the housing market from the Fannie-Freddie duopoly.
Taxpayer protections. These special GNMA mortgages should apply only to owner-occupied primary residences constructed before 2011 (to discourage speculative new construction). The loans should be full-recourse (borrowers can't just walk away) with a lifetime IRS tax lien on any borrower who defaults. Home buyers who can't qualify with a 20 percent down payment could obtain private mortgage insurance from a qualified company that meets federal underwriting standards for capital sufficiency. A quarter-point annual interest surcharge for national loan delinquencies and costs should also go to Uncle Sam, which avoids using TARP money as the Obama proposal does. These conditions will weed out the marginal borrowers.
Homeowners who want to refinance would face the same repayment rules and personal guarantees, and they must be current ("performing") in their payments on their existing mortgage. Over 5 million owners with insufficient home equity but performing on their mortgages, with a solid employment history and a clean borrowing record, could enter into a shared-appreciation contract that makes Uncle Sam a 30 percent partner in any appreciation in the home's value. They too must obtain private mortgage insurance for all or part of their loan-to-value deficiency, with the private insurers participating in the shared-appreciation formula. The appraisal must show 20 percent equity before cash could be taken out on a re-fi. To win Congressional support from fiscal conservatives, these borrowers could also be made subject to capital gains taxes if the homes are sold at a profit, which will add significant revenue to the U.S. Treasury once the housing market recovers.
Buyers of foreclosed homes? Although this would be more controversial, I would even consider a feature to allow GNMA financing for investors who buy one or two foreclosed or short-sale properties as long as they put down 20 percent in hard cash, sign the required tax lien and document that their remaining liquid net assets exceed the total loan amount. A shared-appreciation feature should apply here also. This would get those foreclosed homes off the banks' balance sheets at higher prices.
Borrowers should be able to obtain 30-year and 15-year fixed-rate mortgages and 10/5 adjustable-rate loans with a 2 percent reset cap after 10 years. In today's low-rate money markets, that will provide cheap financing for anybody who needs it and has the capacity to assure Uncle Sam they will repay the loan -- or otherwise make good to taxpayers on line 59 of their IRS Form 1040 (additional taxes and liens). Those who don't like those terms can say "thanks but no thanks" if they can get a better deal or just sit tight on their existing mortgage.
To further liquefy the housing markets, these new GNMA loans could be assumable and assignable, which allows the next buyer to enjoy the benefits of today's low interest rates. For that to work, the new buyer would have to pony up 20 percent cash for the down payment and meet prevailing qualification standards. oth the seller and the assuming buyer would have to agree to a shared-appreciation bonus for Uncle Sam and the mortgage investor.
An expanded GNMA program won't be a panacea for all that ails the housing market, especially those who should never have been granted a mortgage in the first place. Many of today's delinquent unemployed borrowers will ultimately default and face foreclosure, and most of those folks are sadly beyond help. Refinancing alone won't solve the problem for the unemployed whose property is seriously underwater. But for the 90 percent of American workers who do have jobs, these lower-cost mortgages would give the household budget a big boost, and provide peace of mind to millions of families. Consumer confidence would improve steadily as the American middle class refinances its balance sheets with the cheapest money in a lifetime. Unlike a one-time housing tax credit that simply robs sales from a future month as we have seen, this program will produce long-term improvements in millions of households' budgets at the same time it gets new buyers into homes and clears out the foreclosures.
The Federal Reserve's accommodative low-interest policies would be far more effective if millions of underwater homeowners could gain access to the lower mortgage rates that their current situations preclude. The GNMA window would overcome this structural challenge.
I would also suggest that the modern American expectation that homeowners can simply mail in the keys and walk away from a mortgage needs to change. These full-recourse GNMA mortgages could set a new national standard in the housing industry. Borrowers who want non-recourse loans should expect stiffer terms, higher qualification hurdles and higher interest rates.
State housing finance agencies (HFAs) would then have the choice of selling tax-exempt bonds, or supplying federally guaranteed GNMA mortgages to their borrowers. The state HFAs might still sell tax-exempt second mortgages for those unable to make a 20 percent down payment, perhaps with private mortgage insurance or muni bond insurance. Some of the public pension funds might buy taxable housing authority bonds. Getting the HFAs into the GNMA marketplace as a potential competitor or partner for Freddie and Fannie may have some long-term benefits as well. Several state HFAs including Idaho, Massachusetts, Minnesota and Wisconsin are already taking steps along this line on their own, and could leverage the GNMA financing to expand their impact.
State pension funds could participate in public-private partnerships to provide mortgage insurance or second mortgages if they decide to enter that market as a for-profit business investment. They might also collaborate with the state HFAs, possibly in a national pool to provide better geographical diversification of their mortgage investment risks
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A lifeline for millions of households. This new Ginnie Mae strategy would provide a lifeline to diligent but underwater homeowners who have been swamped by the housing crisis. It's a bold plan that could impact 5 million middle-class households in America with stimulative impact of a trillion dollars at little or no cost to federal taxpayers if the loans are properly secured and priced as I suggest. There should be no moral hazard or give-away stigma, as these government-guaranteed mortgages would have a big string attached - the full recourse loan feature with a backstop federal tax lien in the event of default.
From a housing policy standpoint, this program will begin the inevitable process of weaning Fannie Mae and Freddie Mac of their historical and costly corporate subsidies. From a monetary policy standpoint, the Federal Reserve's low-interest policies would transmit directly into the mainstream economy far more effectively than homebuyer tax credits and other short-term gimmicks. There is no other feasible Congressional action that could amplify the benefits of "quantitative easing" by the Fed as effectively as this strategy.
November politics. Sadly, we have entered the silly season with elections coming soon, so this proposal can't clear the Congress before November. Getting a housing finance bill of any kind through both houses will require active Presidential leadership and bipartisan support -- especially if the Republicans gain controlling seats in November. The president's recently announced initiative suggests that he's willing to push for action in this arena, within limits. Although conservatives will chafe at the idea of federally guaranteed mortgages for millions of Americans, the pragmatic politicians among them might favor a workout plan to ultimately launch Freddie and Fannie into the private sector and phase out new federal guarantees of their "agency" bonds. (The Obama proposal fails to address the still-festering problems at Freddie and Fannie, which this proposal does.) The bank lobby would push hard to shore up their weak loan portfolios, and many Wall Street firms would support this effort despite their ideological predispositions.
Pro-growth advocates on both sides of the political aisle know that without a sub-floor in the housing market, the American economy will continue to limp along with 9 percent unemployment. Sadly, this kind of legislation often languishes in committee until a full-fledged crisis erupts, and we can't wait for that to happen. Most analysts agree that Fannie and Freddie need to be reformed in 2011, which will drive Congress to act eventually. Policymakers and staffers who work in this field need to flesh out these ideas into a workable legislative plan -- and sooner rather than later. Comprehensive legislation will take too long to process, so action on achievable interim measures is a smarter strategy. Waiting for a complete crisis before acting is to invite one.
