The Government is the Mortgage Market
It's time to ask ourselves a collective question; what have we learned from the economic chaos caused by a collapsing real estate market, which was itself caused by government intervention and easy credit? The answer is unfortunately, an emphatic nothing!
Rather than let the market dictate the appropriate price level of real estate, our government is seeking to re-inflate the bubble, only this time with fire and hydrogen instead of just hot air.
It isn't bad enough that FNM and FRE are in a government controlled conservatorship and own or guarantee over $5 trillion in mortgages. Or that the Federal Reserve is in the process of buying $1.25 trillion in Mortgage Backed Securities. Now we have the Federal Housing Administration (FHA) taking up the slack caused by the lack of faith in the GSEs.
The FHA insures private mortgage lenders against borrower default on residential real estate loans. These loans are then packaged into Mortgage Backed Securities (MBS). The MBS are then insured by the Government National Mortgage Association Ginnie Mae. The FHA is now supplanting the GSEs role in mortgage lending. The agency is now responsible for 18% of new mortgages up from just 1.8% in 2006. The FHA now insures $560 billion of mortgages and according to Money Morning, Ginnie Mae will guarantee over $1 trillion in MBS by the end of 2010. Perhaps the most troubling fact about the FHA is that they only require a minimum down payment of 3.5%! It's amazing we have not learned the lesson that we must require borrowers to have more skin the game.
The Wall Street Journal reported that the FHA's reserve fund dropped from 6.4% in 2007 to about 3% today, putting it dangerously close to its mandated 2% minimum. And according to The Washington Post, nearly 90% of all new home loans are funded by the taxpayer up from 30% just four years ago.
So what have we learned from relying upon; The Community Reinvestment act, Congress, White House, FED, FHA, GSEs, Ginnie Mae, VA...etc.? The answer is how to better manipulate the real estate market while placing the tax payers further in jeopardy. Not only are we on the hook for a staggering amount of government mortgage guarantees, but the taxpayers are also expected to live up to their pledge to back the Federal Deposit Insurance Corp. (FDIC), which will now be responsible for bailing out banks whose FHA-MBS have become a bigger portion of their assets.
The linchpin for the economy and the stock market is real estate values. If they continue to drop, banks will fail at an even greater rate and there can be no healing for the consumer either. But the government now has an increased interest in propping up home prices because they own or guarantee a significant portion of real estate-based investments.
This makes the exit strategy for the Fed in removing excess liquidity extremely difficult and greatly conflicted. Here is what Fed Governor Kevin Warsh said in a September 25th Wall Street Journal opinion piece, "Nonetheless, I would hazard the view that prudent risk management indicates that policy likely will need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary, and taking proper account of the policies being instituted by other authorities." However if they actually raised interest rates aggressively, it would severely erode the value of those MBS held by the Fed while greatly increasing the costs associated with owning a home. Concurrently, it would also dampen the demand for real estate purchases.
The result would be; increased rate of bank failures, a lower stock market, lower home prices, higher unemployment rates and another severe recession -- which will most likely much worse than one we are hopefully coming out of. Given that scenario, one has to ask themselves how credible and politically palatable such a strategy of aggressive interest rate hikes really can be.
But the greater question that needs to be asked and answered is why the government believes the rate of real estate ownership needs to be controlled in the first place? While it may be true that home ownership makes for a better community, it remains out of reach for a certain percentage of individuals. By forcing ownership on those who cannot afford a home, government creates distortions and imbalances that cause huge dislocations in the economy.
It is up to the market to decide the percentage of people who should rent and those who should buy. It is the market who is the arbiter for how much capital should be allocated to real estate.
Meanwhile, if the government still feels compelled to control markets, why not seek to boost the productive capacity of our economy and rebuild the country's manufacturing base. Instead of backing policies that simply reward more consumption and debt.