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Home Publications Blogs Beat the Press The Housing Experts on the WAPO's Rolodex Never Heard of Jumbo Mortgages

The Housing Experts on the WAPO's Rolodex Never Heard of Jumbo Mortgages

Thursday, 02 May 2013 05:00

That's what readers of a Post article discussing the future of Fannie Mae and Freddie Mac would conclude. The piece includes assertions from two experts, David Stevens, president of the Mortgage Bankers Association, and Julia Gordon, the director of housing finance and policy at the Center for American Progress, that 30-year fixed rate mortgages would disappear if the government did not guarantee these mortgages through the GSEs or some other mechanism.

This can easily be shown not to be true by the market in jumbo mortgages. These are mortgages that are too large in value to be insured by the GSEs. A large share of these mortgages are 30-year fixed rate mortgages. Also, while it is less common today, prior to the housing bubble banks did hold a substantial share of their mortgages, typically around 10-20 percent. Since the government was not guaranteeing these mortgages, the banks must have felt the guarantee was unnecessary to get them to issue 30-year fixed rate mortgages.

The issue with Fannie Mae and Freddie Mac is one of the interest rates that people will pay on mortgages, not whether they will exist or not. By having a government guarantee the government is providing a subsidy to homebuyers that comes at the expense of the rest of the economy. The government already provides a subsidy to homebuyers through the mortgage interest deduction, the question is whether it is desirable to provide a further subsidy through this government guarantee.

There is also a question of whether this is the most efficient way to provide the subsidy. The government guarantee can set up a complex system of financial intermediaries that may be difficult to regulate. It may be more efficient to provide any additional subsidy to homeownership through an enhanced tax deduction or credit that would not lead to a bloated financial sector.

These are the issues that should be at the center of the debate over the future of Fannie Mae and Freddie Mac. The Post should have been able to recognize the absurdity of claims about the end of 30-year fixed rate mortgages and have found an expert to clarify this point.


Note: Corrected acronym to "GSE." Thanks to David Stevens.

Comments (12)Add Comment
Eliminating the Subsidies
written by Robert Salzberg, May 02, 2013 6:08
As it stands now, the United States government is subsidizing most loans through Fannie and Freddie and the mortgage interest deduction at a cost to taxpayers of roughly $100 billion a year.

For someone that has a 30 year loan at 4%, who also has a 25% effective tax rate and deducts their mortgage interest, they get a subsidy of around 1% as an effective lowering of their net interest rate.

The federal government has effectively taken over most of the mortgage industry. (Except for the jumbo loan market.) Why not offer government backed loans directly at what it costs the federal government to borrow money plus around 1% administrative costs?

The banks would still make plenty of money from the loans through the administrative fees and not have to take on the risks of the mortgages and we would save around $100 billion a year for taxpayers.
written by skeptonomist, May 02, 2013 7:48
A more direct subsidy than the interest deduction would probably be more desirable if making home ownership available to low-income people is an objective. The deduction only kicks in above the standard deduction, which may be hard to reach without other kinds of major deductible expenditures. The interest deduction probably also tends to boost charitable deductions, which at low incomes may go mostly to churches.
written by liberal, May 02, 2013 8:58
There is also a question of whether this is the most efficient way to provide the subsidy.

By far the most efficient way to go about things is to tax the hell out of land. That way, for the land portion of the house, you write a check to the government; with that money the government can either provide more services, or lower other taxes. The way things stand now, you write a check to the bank, in return for nothing.
written by David Stevens, May 02, 2013 9:08
Dean makes some good points here, aside from the acronym error (it's GSEs not GSAs). The reality of the markets actually still paint a picture against any broadly available 30 year fixed rate as the market sees it today. Here are just a few reasons why the 30 year fixed rate as a broadly available product would likely be significantly curtailed in a future state:

1. Capital: The US mortgage market produces, conservatively, $1.5 trillion mortgages per year in the United States. With a traditional convexity model (one that will be very different in this interest rate environment
ahead) the cumulative ability for the US banking system to hold an aggregated $10+ trillion in Mortgage Backed Securities or whole loans on their balance sheet is simply not possible. Add BASEL 3 into the mix and the portfolio - balance sheet - possibilities of the banking system will be dramatically constrained.

2. Yes, the big banks are holding jumbo whole loans on balance sheet. They are doing so for three reasons. First the spread between their borrowing cost and the yield presents a significant return opportunity in today's fly to deflationary environment. Unfortunately that only works in this climate. I have been in this industry for three decades and remember well the Savings and Loan crisis brought on by lenders lending "long" (on 30 year mortgages) and borrowing "short" matching that asset against volatile liabilities. As interest rates rise in the future, the spread for under hedged portfolios will narrow and at current mortgage rates it won't take much to put portfolios underwater. Second, they have no other outlet for these mortgages. There is not private market of substance that buy these mortgages. For banks with high net worth customers, they need a jumbo product to retain that client relationship. Third, the credit quality of these loans is vastly higher than the broader market. These are low loan to value, high wealth, high credit score borrowers who pose little risk to the institution. The ability and necessity to hold these loans is the result of spread, customer retention, and credit quality. This has its limits though. Regulatory bank capital that can be dedicated to mortgage assets is extremely limited and my greater worry is that less sophisticated institutions may have to follow those with stronger capital markets hedging skills simply to compete, potentially exposing taxpayers to a repeat performance of the S&L crisis of the 1980s.

3. Jumbo lending is high on interest-only hybrid products. 10 year IO loans that adjust after the 10th year are as or more common than fixed rates in this market. BTW, that's because they are easier to hedge.

4. The current fixed rate product enjoyed by America is a 30 year, fully prepayable mortgage that can have the rate locked in months in advance of settlement. The ability to lock the rate in advance is a key to the housing market. Being able to shop for a home and commit to a contract is dependent on financing. Should rates move prior to settlement, without an advance lock, this could create significant uncertainty in the home sales market. This ability to forward lock is dependent on the "to be announced" (TBA) market. This TBA market has created a large, liquid, fungible, system where investors, dealers, traders, and originators can hedge, trade and sell mortgages on a forward basis. This system never existed before the GSEs and only exists in that space. Thirty years ago, in comparison, I worked for a community bank that originated fixed rate mortgages to hold on balance sheet. The rate was only locked 48 hours before closing. Every loan had a three year prepayment penalty, and the rates were significantly higher than a GSE rate.

There are more points, but my overriding point is that I agree fixed rates will still exist - but in no way near the form they are today and the greatest absence of this would be felt by the less wealthy, middle class, first time homebuyer who may not yet be that wealth client worthy of the very best.
written by Jerry Brown, May 02, 2013 12:07
How do you figure that the government guarrantee comes at an expense to the rest of the economy? I understand that it lowers costs to borrowers and could be described as a subsidy, but cant see how this harms the economy in any way. In fact, I would think that it absolutely helps the economy. Has this subsidy required the government to raise taxes? I dont think so. Or are you saying that the government would be more able and likely to do other more beneficial things if it was not providing this subsidy? I dont see that happening. Or is it that the subsidy distorts the owner/rental markets in some negative way?
Subsidies Raise the Cost of Capital to Other Sectors
written by Dean, May 02, 2013 12:23

the point about the cost of government subsidies is pretty straightforward, it diverts capital from the non-subsidized sectors to the subsidized sectors. In a situation like the present, where we are way below full employment, that is not really a problem, but in a more normal economy, if we subsidize housing finance then we make non-housing finance more expensive.

written by Jerry Brown, May 02, 2013 4:37
Dean, thank you for your reply. I think that in our current situation these subsidies are not only not a problem, but are actually benefiting the economy by leaving some people (people who might actually spend)with more disposable income. And I just dont see where the cost of it really is.
I can understand that a bank would be less willing to make a mortgage loan if the bank didnt know it could sell that loan to Fannie or Freddie. But once they sell the loan dont they have all their original capital back? Plus some profit presumably? So the capital that is involved in such a loan would presumably still be available for lending purposes after a short wait? I guess there is an argument that the bank would try to find some other type of loan to make at a lower profit margin but there is no guarantee that they would or could find loans to make at an acceptable risk to them.
Sure its a subsidy to both borrowers and banks and it is worth while pointing out who benefits from all government policies. But if right now, no one is harmed at the cost of some others receiving a benefit, is that a bad thing?
Capital is use of resources
written by Dean, May 02, 2013 7:54

the notion of capital is that you are actually using resources. If you subsidize loans in the housing sector then you will get more homes built which means less resources for other types of investment.
Should the government be encouraging housing ownership at all?
written by John Wright, May 02, 2013 10:06
Possibly encouraging home ownership is not something a wise government should be doing?

For a while it seemed that Americans believed home ownership was a highly leveraged and remarkably low risk method to become wealthy.

And the government provided some fuel for the housing bubble with the interest deduction, favorable tax status when a home is sold and the GSE's to help with financing.

I remember reading that Congress considered allowing home ownership losses on re-sale to be deductible while re-sale gains would be tax free, but decided this was too biased toward the real estate industry.

There was almost a feeling that the US economy would grow by people buying/selling/remodeling/re-financing houses.

However, people learned that home ownership was highly leveraged as they lost their, sometimes quite sizable, down payments.

The interest deduction is of no value if one is out of work and has no income to deduct the interest from.

And a large home is more costly to heat and maintain.

And it is difficult to extract income from a large home except by renting out spare rooms.

And having a home far away from employment opportunities makes finding a job more difficult.

Perhaps the government encourages home ownership because a highly mortgaged population is more docile and easier to control?

written by Jerry Brown, May 02, 2013 10:53
When you talk about real resources, I see your point. Building homes uses real labor and material that might be employed elsewhere. It would be nice to be in a situation where that elsewhere was
GSEs, MBS, & Bank Capital
written by TVeblen, May 03, 2013 7:37
If you go to the FDIC website, click on "Statistics on Banking" and then "Run Report." Under Assets, click on "Securities" and you will see that as of 12/31/2012, the banking industry had about half their securities (about 11% of total assets) in GSE mortgage back securities. So part of the reason that the Fed doesn't want these securities to much value is that it could do real damage to bank net worth.
written by watermelonpunch, May 03, 2013 8:08
Is the subsidy even meant for home buyers? Or is it just meant to subsidize the financial sector?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.