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07:35 am: How things work: Fannie and Freddie edition

For whatever reason, I never got the complete American High School education experience. Among other things, I missed the day where they taught that there are some problems that are just too big and too complex for me to figure them out. I *have* found some problems that were beyond me – but my default position is that if bright people have figured something out in the past – I ought to be able to get a solid grasp on it.

There’s a lot of talk about government budgets right now – what should be cut – what should be kept. A lot of people seem content to go with their sports loyalty driven “blue team” vs. “red team” understanding. That seems to work out to, “Obama says this is good, so yes,” as opposed to “Obama says this is good, so hell no.” My fear is that this model will lead to a lot of baby getting thrown out with the bathwater.

Let’s dig into a specific example.

Fannie Mae and Freddie Mac are the government sponsored corporations that implement government support of home mortgages. They’re a special kind of corporation, created by congress, to do a specific thing in the economy. The way it works is pretty straightforward:

* The FM’s define the sorts of mortgages that they support, and guarantee that they’ll buy mortgages that conform to their rules.
* Banks go out and issue mortgages under those rules (“conforming” mortgages)
* Banks swap those mortgages around with great confidence, knowing that should they need to unload the mortgages, the government has their back.

Of course, we all know what happened: The rules about issuing mortgages were either too loose or were not followed closely enough. This was a combination of old fashioned greed and poor regulation. Lots of loans were issued that the borrowers could never pay back. Greedy salesmen took signatures from greedy buyers and backed it up with cash from banks who were too busy cashing their profits to bother checking the math. Vast amount of bad debt was created and stuffed into all corners of the economy. Shit went south, and now we’re gonna change everything to make sure It Never Happens Again.

So, what happens if we simply abolish the FM’s?

1.1) Banks will now have to negotiate with each other and / or hold on to their own damn mortgages.
1.2) There will be no central clearing house of rules for loans.

Taken together, this means that:

2) Mortgages (and most loans) become harder to get. It’ll be harder to qualify for a loan and the interest rates will be higher. You’ll wind up giving a blood sample for your mortgage – and you’ll pay a higher interest rates and upfront fees.

However:

3) People will still have to sell their houses.

Whether it’s divorce, death, relocation, or whatever – there is a constant flux in the real estate market. Some people simply don’t have an option about selling – and so they’ll take what they can get. The buyers will be having a harder time raising money, so two things will happen:

4.1) The housing market will “cool off.” Houses will take longer to sell.
4.2) Housing values will drop. The same house will consistently bring less money. The same person will buy the same house, but they’ll only qualify for a smaller mortgage – and eventually the seller will take what’s offered.
4.3) Until housing values finish dropping, more people will rent than own.

Note that none of this is inherently good or bad thing. It’s just one option out of many.

So when you say “get government out of the mortgage market,” you’re supporting dropping housing prices, cooling the housing market, and renting rather than owning. That will *feel* like large money losses, particularly for those of us who hold mortgages right now. However, you’re also going to reduce the perception of the housing market as a money maker – which I think is a good thing.

I think that there are some things that are too important to society to have them serve as engines of profit. I include the basics: housing, medical care, basic food provision for the masses, basic education, and so on. Note that this doesn’t mean “let’s make them into pure social programs.” I’m a big believer in market forces. It’s just that if housing is important enough to regulate – then don’t regulate it for the benefit / profit of the wealthy … regulate it for the the benefit of the majority.

There’s a social engineering aspect here as well. America “supports home ownership.” That’s partly because people who own a house tend to take better care of it and to give more of a damn about their neighborhood than renters. So, we’ve supported home ownership because we like communities of home owners. I’m a fan of that. The other social engineering aspect is that we keep trying to trick our citizenry into saving enough money for retirement. I think that as long as we encourage home ownership – that takes care of itself. You don’t tend to sell your house for retirement, you tend to live in it.

Originally published at chris.dwan.org. You can comment here or there.



Comments

[User Picture]
From:mrgeddylee
Date:February 15th, 2011 02:48 am (UTC)
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To me this is another situation where only a gradual change makes sense. There will always be some fraction of people who need to move in the next couple years, and anything that radically destabilizes the market screws them to no purpose.

I would very much like to see a gradual phase-out of government involvement in the housing market, including elimination of the mortgage interest deduction, but I think those programs ought to be phased out over a very long time frame. I think thirty years would be about right, since (I believe) that's the standard long-term mortgage time frame.

I'm persuaded by the argument that housing will always be fundamentally scarce and aspirational. People will always spend a lot on houses. Efforts to make them more affordable end up moving people up the housing market instead, which amounts to a wealth transfer to those who already own homes. I already own a home and intend to live here a long time, so in theory I stand to benefit from those effects, but in truth I don't see why government needs to spend other people's money to help my house appreciate. I think of my mortgage as a thirty year lock-in on my rent, with an incentive clause that says everything will get a lot cheaper if I live here after that. Reckoned purely in those terms, our house still makes economic sense, so I could cope just fine with losing those other incentives.

I'd appreciate it if some fraction of the increased taxes caused by elimination of the mortgage interest deduction went to reducing income tax in the bottom two brackets. That would have only a modest impact on my finances but it would be a sensible step toward a more progressive tax code.
[User Picture]
From:jrtom
Date:February 15th, 2011 08:20 pm (UTC)
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I will have more to say about this later--I've been thinking about issues related to this a fair bit because we're putting our house on the market in about a month, probably--but there's one bit that I wanted to respond to.

To wit: "people who own a house tend to take better care of it and to give more of a damn about their neighborhood than renters". Maybe so. But, you know, correlation and causation and it's not obvious that someone becoming a home owner starts taking better care of their domicile and to give more of a damn about their neighborhood.

Maybe living in one place a long time has that effect.
Maybe having a voice in neighborhood issues (one of the few advantages to homeowner's associations, IMO) has that effect.
Maybe the people that want to be involved in their neighborhood and keep up a home are the ones that want to buy houses.
Or maybe it's even simpler: people that can afford to buy a house in today's market are more likely to have the time, money, and leisure to keep up their home and be involved in neighborhood issues.

What other motivations can you think of that might get people to take care of their houses and get locally involved?
[User Picture]
From:fdmts
Date:February 15th, 2011 10:23 pm (UTC)

Causality

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I don't think that I posited anything more than correlation. Certainly there's no direct causality there. There's no magical switch in your head that goes to "give a damn," as soon as the property deed is signed. In fact, if the property was *given* to a person, I think that the correlation would be *lower*.

I suspect that all of the things you suggest are factors. I think that the thing that underlies them is (as with long term relationships), the commitment to being in a certain place for a while. Once you decide to stick around for the long haul - you put some personal stake in where you live.

I think that's the thing we want to encourage.
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