Washington’s efforts to keep the housing market afloat are brew ing up another mortgage melt down — except that this time, Uncle Sam will start off holding the bag.
Mortgage rates hit new lows last month as investors gobbled up residential, mortgage-backed securities — MBSs, the very financial instruments that triggered the subprime crisis.
Short-term, that will allow many cash-strapped homeowners to refinance and lower their monthly interest payments — help to the beleaguered housing market. But it represents a ticking time bomb — which will blow up in the face of the taxpayers.
Until April 1 of this year, the Federal Reserve was buying up vast numbers of MBS’s — accumulating $1.25 trillion in total face value. Absent that support, the central bankers claimed, there would be no mortgage market, and thus housing couldn’t recover.
But, when the Fed stopped buying MBS’s, investors jumped into the market with both feet. Why are they flocking to the very investment that spawned the recession? Are they convinced the US housing market has really bottomed?
Hardly. Investors have an eye on the European debt crisis, and see worldwide risk levels as too high — and MBS’s as a chance to earn more than Treasury bonds pay, without any added risk.
Why no risk? Because the US government is now guaranteeing virtually all mortgages.
Between Fannie Mae, Freddie Mac and the mortgage insurance issued by the Federal Housing Administration, Washington now guarantees or insures virtually every mortgage loan being made — about 97 percent of all new mortgages.
With Uncle Sam promising to make good if the borrower defaults, naturally mortgage-interest rates are falling; as of yesterday, down to 4.68 percent for a 30-year fixed loan, versus a yield of just 3.95 percent for a 30-year Treasury.
But what if the housing market double-dips? Many of the government-backed mortgages have razor-thin equity cushions.
The FHA, for example, is now insuring loans with as little as 3.5 percent down. That means that if the housing market falls just another 4 percent, the homeowners of new FHA-insured loans will be underwater — owing more on the mortgage than market value of the house.
And we know from last time ’round that many “underwater” homeowners will eventually default. This is especially so, because several states have “non-recourse” laws that prevent a bank from pursuing the homeowner for any shortfall following a foreclosure sale.
As investors compete to buy MBS’s and rates are driven lower and lower, it pays for more and more homeowners to refinance. That is, you might not bother to refinance from a 5 percent rate to 4.75 percent — but will if rates drop to 4.25 percent.
Right now, all US mortgages total $10.7 trillion, with more than half — $5.5 trillion worth — backed by the federal government. But with rates dropping this fast, and the feds backing virtually all new mortgages, the government’s share is bound to soar.
But federal backing of the mortgage market won’t stop the inevitable correction to home prices commanded by market forces — it only postpones the day of reckoning.
Already, the flood of foreclosed homes listed for sale led to a 30 percent plunge in existing-home sales in May, while new-home sales fell 33 percent.
US taxpayers have bailed out Fannie and Freddie to the tune of $145 billion already. The Congressional Budget Office recently hiked its estimate of what the mortgage giants will cost the taxpayers to $389 billion — but I put the eventual cost at closer to $1 trillion.
By guaranteeing all mortgages, some of which will go into default, Washington will end up being forced to borrow hundreds of billions of dollars to cover FHA insurance claims as refinanced loans default. And this hidden borrowing only helps yield-hungry investors (often foreign banks and sovereign wealth funds) and holders of existing mortgages, whose risks the taxpayers are assuming with the FHA-insured refinancings.
The housing market has to bottom out before it can truly start to heal. Washington’s efforts to support the market don’t just delay that recovery — they guarantee that when we do hit bottom, the taxpayers will bear the brunt of the pain.
Stephen B. Meister is a partner in Meis ter Seelig & Fein LLP.