What Happens to Housing's 'Turnaround' When Uncle Sam Backs Out?
%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%That massive subsidy of the mortgage market is just the tip of the iceberg of federal (and Federal Reserve) funding. The housing market is in effect totally dependent on government guarantees and purchases of mortgages. The Fed and the U.S. Treasury have directly purchased $1.2 trillion in mortgage-backed securities (MBS), many of which contain high-risk "toxic" mortgages on homes that are no longer worth anything close to the value of their mortgages.
Fully 99% of the $1.5 trillion mortgage securities issued year to date are backed by the government, while a mere 1% ($15 billion) have been issued by banks and other private firms.
No End to the Red Ink
To keep the housing market viable, the government is buying $30 billion of mortgages a week -- a staggering subsidy that dwarfs the contentious aid given to the auto industry last year.
Furthermore, the government effectively owns Fannie Mae and Freddie Mac, which together hold over half the nation's residential mortgages ($5.4 trillion). The financial losses incurred as many of those loans slip into default and foreclosure are increasing. Fannie Mae recently required yet another $15 billion in direct government funding, and virtually no one is claiming that this is the end of the red ink.
Now that Fannie and Freddie have been hobbled by insolvency, the FHA and Veterans Administration have been ramped up to guarantee the vast majority of new mortgages. The result is a doubling of the FHA portfolio in a mere two years to over 5 million mortgages -- more than 10% of all existing mortgages.
The FHA is mandated to hold a meager 2% of its portfolio in reserve, which amounts to 50-to-1 leverage. As FHA defaults rise -- fully one in five FHA-backed loans are either delinquent or in foreclosure -- then the FHA will have to get government cash to remain solvent. (Data can be found on the Housing and Urban Development website.)
Expiration Dates Are Drawing Near
In addition to the trillions of dollars in guarantees and direct purchases of mortgages, the government has spent billions in direct subsidies of home purchases via the recently extended $8,000 "new homebuyer" tax credit. The extension added another direct subsidy to the housing market, offering a $6,500 tax credit to qualified buyers who are "moving up" to another home.
The government support is intended to be temporary, and the programs that have been propping up the housing market with trillions of dollars are set to expire next year. The Federal Reserve will end its mortgage-buying program in March 2010, and the $200 billion budgeted to cover losses in Fannie Mae and Freddie Mac will likely have been spent.
This level of government support is so massive -- the only possible parallel is the Great Depression-era federal agency Home Owners' Loan Corp. (HOLC) -- that many are wondering what will happen when the government finally pulls the plug.
Re-Creating the Subprime Mess?
The signs are not encouraging. Investors refuse to touch any mortgage-related security that isn't government-guaranteed. Such risk aversion makes perfect sense in a housing market where prices are still falling and foreclosures are still rising.
According to the National Association of Realtors, median prices of existing homes fell in 123 of 153 metropolitan areas during the third quarter compared with a year earlier. While prices have stabilized or even ticked up in some hard-hit areas, up to 40% of the sales are of distressed properties sold at significant discounts to their previous valuations.
Some observers are noting that lax FHA lending standards (as low as 3% down) and the agency's rising default rates are a government-backed re-creation of the entire subprime mess that enabled the unsustainable housing bubble.
Indeed, from one point of view, the government has propped up the mortgage market by becoming the buyer of last resort. But the fact that private investors are unwilling to buy mortgages should be a warning sign that the government's plan to act as a temporary prop simply isn't working as intended.
Two Larger Questions
Those who argue that the government-backed mortgage market is healthy and that Washington "is doing the right thing" are ignoring some huge risks. Among them are the FHA's 50-to-1 leverage, low down payments and generous lending standards. That's same path to insolvency taken by the other government-supported enterprises (GSEs, like Fannie and Freddie), which gambled highly leveraged stakes on mortgages.
The larger questions are: How long should the federal government remain the backer of virtually all mortgages in the nation? And, what happens to the mortgage and housing markets when the government cuts back its guarantees, subsidies and direct purchases of mortgages?
Those questions will likely get answered in 2010.