Risk the Credit of the Republic for Homeowners
Yesterday, I was contacted by UrbanDigs, one of my regular readers, and he asked:
UrbanDigs Says:
December 3rd, 20087:10 pm at Edit
David, Can you please email me, its provided on this comment.
I would like your opinion on an alternative to stimulate housing instead of the govt meddling with rates to 4.5% and buying up loans from GSE’s..
Its such a bad idea and they are digging this country into a debt ridden hole.
Why not tweak the tax code for investors from a 1031 deferrement to a 5 YR qualification primary residence like exemption?
http://www.urbandigs.com/2008/12/instead_of_meddline_w_rates_wh.html
GRANT THE PRIMARY TAX CAPITAL GAINS EXEMPTION BENEFIT TO INVESTORS AND CHANGE THE QUALIFICATION TERMS SO THAT THE PROPERTY PURCHASED BY THE INVESTOR MUST BE HELD FOR A MINIMUM PERIOD OF 5 YEARS
Thoughts? As an alternative to help the hoousing supply problem without the unintended consequences of govt meddling, moral hazard, taking on more risky assets, and trying to convince people to buy for the wrong reasons, like 4.5% rates.
Okay, here are my thoughts:
1) Regarding taxation, my view is that all income should be taxed equally and regularly. I’m not generally in favor of deferring or exempting taxes on asset classes of any sort.
2) The Federal Reserve is buying up mortgage assets. Now the Treasury is thinking of subsidizing mortgage rates. Don’t we do enough in the US to overinvest in housing?
Call me a skeptic here. In credit crunches, the value of the collateral is far more important than the rate charged. I care more as a lender about the return of my money, than the return on my money. Lending to entities where the loan-to-value is high is fraught with peril. Losses occur with little regard for the interest rates charged. Life events matter more: death, disaster, disability, divorce, and dismissal from employment. Negative life events cause borrowers to choke on interest payments when refinancing is impossible.
Lowering the mortgage rate to 4.5% will subsidize borrowers who can refinance through conventional mortgages, but will do little good elsewhere. The subsidy will also add to the financing needs of the US Treasury, which is getting stretched.
The efforts of the Fed and Treasury may lower mortgage rates for a time, but as the government borrows more, there will be pressure for rates to rise. For now, it may seemingly work, but it will eventually fail, and the outcome will be worse than if they hadn’t acted.
So I’m not crazy about government action here. Why should we risk the credit of the Republic over homeowners? Let real estate prices find their levels where ordinary people con afford ordinary homes without incurring a boatload of debt.
December 4th, 20089:29 am at
wow, David. Certainly surprised to wake up, get my coffee, read the paper, and see my blog at the top of yours here. Im glad the topic is worthy.
The govt wants to peg rates to 4.5%, buy loans from GSEs, take on more risky assets, cause they truly think that 5.5% mortgage rates are unafforadable.
Here’s the thing.
IF YOU CANT AFFORD TO BUY HOME WITH RATES AT 5.5%, THEN YOU SHOULD NOT BE BUYING ANY HOME AT ALL!
Clearly they are going to do something because there is an adverse feedback loop in effect here. Housing prices fall further, securities value falls further and spreads to higher quality securities, downgrades come, capital raising must occur, banks get in more trouble, lend even less, and on and on and on.
This cycle has to play out, and there are plenty of investors out there waiting to put money somehwere in the system; stocks, bonds, corp debt, commodities, housing, etc..
We should at the very least consider alternatives if the govt is adamant on doing something to stabilize house prices to slow down the loop. Why not consider enhancing the 1031 deferrment benefit to an exemption with CONTROLS, that would entice investors to buy distressed houses from supply, buy foreclosures, fix them up, and rent them out. Prices will still fall because the market forces will always win out. But this may slow the 2nd derivative or pace of declines, in a supply side manner without govt meddling with mortgage markets or buying up loans from GSEs.
Im with you, but Im afraid the govt is going to do something anyway, and it seems to me that there should be alternatives considered to stimulate housing. I think this is one such idea.
December 4th, 200811:16 am at
UrbanDigs, I agree with your point that if you can’t afford a mortgage at (name the threshold rate), you shouldn’t own a home.
Here’s my logic: as the interest rate gets lower, it allows increasingly marginal borrowers to buy, most of whom are really stretching to make even that reduced payment. When there is economic stress, they will be among the first to be insolvent.
The other effect is bailing out the solvent through refinancing. Lots of articles on that today:
http://www.ritholtz.com/blog/2008/12/mortgage-refinancings-soar/
http://www.portfolio.com/news-markets/top-5/2008/12/04/treasurys-housing-plan
http://online.wsj.com/article/SB122833771718976731.html?mod=testMod
Weird stuff — we are not only going for the hair of dog that bit us, we are trying to consume the whole pooch/hooch.
December 4th, 20085:59 pm at
David,
A few questions on this.
1) Couldn’t the risk of the government getting its money back be ameliorated by insisting on, say, 80% or less loan-to-value ratios? Granted, only a subset of borrowers will qualify, but that’s still a big subset, and the hundreds of dollars of extra cash those borrowers will have in their pockets every month will give the economy a fiscal stimulus that can ameliorate the recession.
2) If these mortgages are restricted to L-T-V ratios of 80% or less (with the “V” based on current, post-bust appraisals, of course), then these mortgages would represent legitimate assets for the U.S. government, no? Shouldn’t that help assuage the concerns of the Treasury market, particularly since — even at 4.5% — the government will still be earning a positive spread on these loans, given that its current 30-year borrowing costs are ~3%?
3) More broadly, why isn’t this — taking advantage of 50-year low government borrowing costs — to buy legitimate assets — a useful tack to slow asset price deflation? If the Treasury market realizes that the U.S. government is acquiring assets that will likely retain their value or increase in value over the next decade (e.g., first mortgages with 80% or less L-T-V ratios, investment grade corporate bonds and stocks, municipal bonds, etc.), then won’t the bond market respond to these investments more benignly than it would if the federal government just increased expenditures (e.g., on transfer payments as a form of fiscal stimulus) without acquiring assets in return? Do you think, for example, that a basket of U.S. equities or investment grade corporate bonds, for example, purchased at current prices won’t increase in value over the next three decades? Do you think most investors in Treasury securities doubt that?
December 6th, 20081:30 am at
Mauldin’s latest blog called “The Velocity Factor” is stimulating: http://www.frontlinethoughts.com/pdf/mwo120508.pdf
I’d be interested in your comments since you have written several times on related topics.