Disclaimer: I’m not an economist, that’s why I included links, but I find this all fascinating, and a bit scary.
A few weeks ago I listened to an NPR’s Planet Money podcast about the Frankenstein Mortgage. The term described the lily-white 30 year fixed mortgage that we all believe to be the safest bet for a home loan. On the podcast Bethany McLean and Joe Nocera (authors of All the Devils Are Here, a book on the financial crisis) detail the history of Fannie Mae, Freddie Mac and the emergance of the 30 year fixed.
What I learned from the podcast and McLean’s New York Time’s op-ed piece is that without the federal goverments implicit guarantee of the 30 year fixed mortgage (through Fannie and Freddie) it would probably only exist for those with great credit and more money to put down.
Banks and private mortage investors see two major risks associated with the 30 year fixed – credit risk and market risk. 30 years is a long time and homeowners can lose their jobs, get sick, have sick children, etc. And, as we’ve seen in recent years, the market can tank. The creation of Fannie during the Depression, and later Freddie in 1970, tempered that risk by allowing banks to sell their loans to Fannie and Freddie, freeing up money to fund more loans, and reducing long-term risk. Although both are privately held companies, it was understood that the Federal Government guaranteed Fannie and Freddie loans, thus making them more attractive to investors. Banks charge a higher interest rate for “in-house” loans because they lack the federal guarantee. Investors want a higher payback for non-guaranteed loans. Thanks to the financial crisis we, via the US goverment, now own Fannie and Freddie and all of their loans. Now the Feds want to reduce their hold on housing.
This past Friday the White House outlined 3 options to phase out Federal support of the mortgage market. I’m not going to go into detail, but the Wall Street Journal did a great job in an article on Saturday.
What makes me nervous is a quote from McLean’s NYT op-ed piece. “Today, credit risk is anathema, and by shouldering it, Fannie and Freddie are propping up the housing market. The banks that make the mortgages don’t want credit risk, and neither do investors. Indeed, William Gross, the co-founder and managing director of the investment firm Pimco, has said his funds wouldn’t buy pools of so-called private label mortgages — those lacking a government guarantee — unless the homeowners involved had made a down payment of at least 30 percent.” She later quotes “Mr. Gross says that mortgages without a government guarantee would cost at least several percentage points more.”
Isn’t underwriting tight as it is?
The housing market and broader economy are still shakey and the Journal’s article speculates that any major change will be made over the next five to seven years, but everything I’ve read shows bipartisan support for ejecting taxpayer dollars from the mortgage market. I can’t say I disagree, but wonder what the broader implications are for real estate and construction.
What I do understand is that now is the time to buy (if you are in the market) and I really hoping that refi I’m applying for is approved.
