The Case for 30 Year Mortgage is Deteriorating

COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary

Notable Quotes:

Even if we forget about the gigantic near-term problem — namely, that the federal government is in the housing market mainly because most banks simply won’t issue mortgages that can’t be guaranteed by Fannie, Freddie or the Federal Housing Administration — there’s the fact that federal involvement in housing has been a constant since the 1930s. A market without government support would almost certainly involve the demise (for most of middle-class America) of that populist favorite, the low-cost 30-year fixed-rate mortgage.

be wary of politicians bearing promises of a perfect world where average Americans can get the mortgages to which we now all feel entitled and the government is nowhere to be seen. It’s a mirage.

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Editor’s Note: This article deftly points out the inherent problem with our mortgage market — one that existed long before securitization ever raised its ugly face. The problem is that people want and are accustomed to getting 30 year fixed rate mortgages. On the other end investors/lenders worry about two things -the risk of non-payment and risk of interest rate changes that could make a lender regret that they ever made the loan no matter how likely it is that it will be paid.

SO it is concluded that the government will always be required to be  involved for at least the non-payment risk, and that the interest rate risk is headed for some sort of boiler plate adjustment every five years or so. I agree, but I think that one element is missing here: education of people who think that a thirty year mortgage is the greatest thing since Swiss cheese.

The fact is that at 18 years, the entire financial premise changes. If you were to take out a mortgage for 18 years it would only be marginally more in payments than the 30 year payment. It was the banks who suckered us into that one too because they realized that from their perspective the remaining 12 years was all gravy to them.

Now the lenders/investors are taking a more serious look at this and coming to different conclusion. Borrowers should do the same and see if they don’t come to the same conclusion. Problem solved.

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Who Wants a 30-Year Mortgage?

By BETHANY McLEAN

AS we all move forward with our New Year’s resolutions, it’s a good time to remember the promises our politicians have been making about the American mortgage market. The Obama administration, at a conference last August on the future of housing finance, pledged to have, come January, a plan for Fannie Mae and Freddie Mac, the mortgage giants that are now wards of the government. Congressional Republicans, in their recent position paper, made an even bolder resolution: to build a mortgage market that “does not rely on government guarantees” and “does not make private investors and creditors wealthy while saddling taxpayers with losses.”

This latter promise is pleasing populist rhetoric. The problem is, it may be neither politically nor practically feasible. Even if we forget about the gigantic near-term problem — namely, that the federal government is in the housing market mainly because most banks simply won’t issue mortgages that can’t be guaranteed by Fannie, Freddie or the Federal Housing Administration — there’s the fact that federal involvement in housing has been a constant since the 1930s. A market without government support would almost certainly involve the demise (for most of middle-class America) of that populist favorite, the low-cost 30-year fixed-rate mortgage.

For a homeowner, a mortgage with a 30-year fixed rate (especially one that he can pay off early without a penalty) is a wonderful thing. For lenders and investors, however, it is a financial Frankenstein’s monster, an unnatural product filled with the potential for losses. Absorbing some of the risk of those losses is a large part of what the government does in the housing market.

Fannie Mae and Freddie Mac, for instance, were created by the federal government to buy up mortgages from lenders, thereby enabling them to turn around and issue more mortgages. Among other things, this allowed the lenders to get off their books the two kinds of risk that a mortgage carries. We’re all now sadly familiar with one kind, credit risk — that is, the danger that a borrower won’t pay back the mortgage. The second is interest-rate risk, the danger that interest rates will rise sharply after the mortgage has been made, thereby burdening the bank with money-losing loans. (Interest-rate risk was the root cause of the savings and loan crisis.) The longer a mortgage lasts, the more difficult it is to manage both of these risks. And 30 years is an awfully long time.

With the advent of securitization, or the ability to package up mortgages and sell them off as securities, the market found some investors — bond funds, insurance companies and others — that were willing to take on interest-rate risk. But even in those halcyon days when credit risk wasn’t supposed to be an issue, the majority of investors still didn’t want it. So Fannie and Freddie solved the problem by guaranteeing the payment on mortgages before the securities were sold off to investors. (In the non-government market, the ratings agencies provided a solution, by stamping large pieces of securitizations with the supposedly ultrasafe triple-A rating.)

Today, credit risk is anathema, and by shouldering it, Fannie and Freddie are propping up the housing market. The banks that make the mortgages don’t want credit risk, and neither do investors. Indeed, William Gross, the co-founder and managing director of the investment firm Pimco, has said his funds wouldn’t buy pools of so-called private label mortgages — those lacking a government guarantee — unless the homeowners involved had made a down payment of at least 30 percent.

The proposed Fannie-Freddie reform that has gotten the most traction recently — various iterations of this have been endorsed by Hank Paulson, the former Treasury secretary, among others — calls for new private-sector entities that would continue to provide credit guarantees on mortgages. These guarantees would not be entirely private, however, because they would be explicitly backed by the full faith and credit of the United States.

There are various proposals for how this could be done with less risk to taxpayers than Fannie and Freddie pose, but, obviously, we’re still talking government involvement. And there’s something perverse about creating companies that would be saddled with exactly the same kind of risk — credit risk — that took down Fannie and Freddie in 2008. Furthermore, we’re kidding ourselves if we don’t think that once the memory of the housing bubble begins to fade, these new creatures won’t find themselves under political pressure to keep the price of their credit guarantees low, in order to help keep the price of the 30-year mortgage low as well.

Wouldn’t a better solution be for banks and other financial institutions to offer mortgage products that they actually want to keep on their own books? Maybe these would take the form of 15-year mortgages with a rate that would be adjusted after five years so that the banks wouldn’t have to worry about long-term interest-rate risk. This might not even mean the disappearance of 30-year fixed-rate mortgages — the private market has historically provided them to consumers whose mortgages are too big to qualify for a Fannie and Freddie guarantee. But these are usually issued only to the wealthiest, most credit-worthy consumers.

And therein lies the rub. Almost certainly, any 30-year product would be offered on a more limited basis and at a higher price than it is today. How much higher, it’s hard to say. In the pre-crisis days, Fannie used to argue that its guarantee enabled consumers to pay one quarter to one half of a percentage point less in annual interest on their mortgages; today, Mr. Gross says that mortgages without a government guarantee would cost at least several percentage points more. If his numbers are right, then mortgages — and 30-year mortgages in particular — would be far more expensive, and the pool of American homebuyers would shrink.

This may well be the right long-term answer. After all, other countries manage fine without the widespread availability of 30-year fixed-rate mortgages. But is there an American politician alive who would accept responsibility for depressing the housing market further?

In any case, even a willingness to have more expensive mortgages would not get the government out of the housing market completely. Recall that, before the bubble burst in 2007, the private sector didn’t do much better than the government-sponsored entities at monitoring mortgage risk. What would happen years down the road if one of our increasingly large banks, one that is critical to the mortgage business, ran into trouble? Even assuming that we’d solved the issue of allowing such banks to be too big to fail, there’d still be deposit insurance. Taxpayers would still be on the hook.

So be wary of politicians bearing promises of a perfect world where average Americans can get the mortgages to which we now all feel entitled and the government is nowhere to be seen. It’s a mirage.

Bethany McLean is the co-author, with Joe Nocera of The Times, of “All the Devils Are Here: The Hidden History of the Financial Crisis.”

16 Responses

  1. DyingTruth and THE A MAN

    Last on this–

    1) agree demise of American manufacturing started quite some time ago.
    2) agree it was subsequently replaced with an economy that produces nothing
    3) agree deregulation caused much fraud in the financial industry sector that was promoted by Congress to replace economy with consumption – since they gave away manufacturing to the rest of the world by Free Trade Agreements — which are not really free – because other countries manipulate.
    4) Agree many do not know their current creditor — and we would love to sit face to face with them (for many reasons)..
    5) Agree current system in US has abandoned the middle-class and just getting a voice is extremely difficult — if not impossible.

    So — where is the two angles??.Always open to opposing views, and learn from them — just have to know what I am opposing – and if there is opposition at all. Do not think there is.

    But enough of this — much much more to discuss..

  2. ANONYMOUS,
    Remember, opposing views can be beneficial, if you’re trying to get a better picture of something as a whole and looking at it from different “angles”.
    Just so long as you maintain your focus on the overall objective.

  3. ANONYMOUS, THE A MAN,

    No I’m saying that’s a Good thing, not a bad one. But yes misinterpretation should be clarified.

  4. DyingTruth

    Truth to that — but often just misinterpretation. Have to clarify when that happens. Do not think there was opposing views (2 angles) here — just misinterpretation.

  5. THE A MAN,

    “I think on this one both are angles make the picture clearer”

    YES!!!!!!

    That’s what I was talking about when I told you why I was so outspoken about my perception and why healthy open debate amongst people who express their, and share each other’s views not only further develope their further intellectual capacity themselves and each other but also the more diverse you all are, the more clearly defined all of your perception of whatever subject/object becomes.

    SO many people, from early childhood indoctrination stay brainwashed and socially dysfunctional (mostly from TV). The further you step back to look at the bigger picture, the more you see that society’s designed and kept in a chaotic state to take advantage of all the confusion. But a common sense question EVERYONE should ask themselves when ANYTHING of significance goes wrong is:
    WHO BENEFITS FROM IT?
    Long term, Short Term. Directly, Indirectly and Cause & Effect (events that are triggered with an intended reaction)

    You gotta keep yourself openminded (regardless of who it offends) and unattached. If everyone is looking in the same direction, then you’re/we’re all bound to get blindsided.

    😉

  6. THE A MAN

    Ok. Not sure what your clarification is – but OK.

    Again — my point is — years ago creditors worked with borrowers to resolve any borrower setback. That is not the case today — a couple of missed payments and entire debt is immediately demanded in FULL.

    Congress helped financial services by watering down any consumer protection laws – and government agencies have ignored the massive fraud for years. Congressional motive was to fuel a consumption driven economy. It backfired.

    Anyway — still friends.

  7. I’ve heard there are also ways to pay off a 30-year mortgage in seven (7) years !!

    Of course, banks don’t want us to know these strategies.

  8. Anonymous I am on your side. But some clarification does’nt hurt.

    I think on this one both are angles make the picture clearer

    Be Strong and Courageous

  9. THE A MAN,

    I am on your side. Always have been — always will be.

  10. THE A MAN,

    Not just discovering America — am quite aware of the decline. Point is- THIS IS ALL WE HAVE LEFT — and Dying Truth is right — we no longer produce anything. I have long been outspoken about this both personally and professionally..

    Aunt was able to NEGOTIATE because she dealt DIRECTLY with the owner/lender of the loan. The bank simply added on missed payments to life of loan — it was not a freebie. Nowadays — if homeowner misses one payment — WATCH OUT. And, just try finding your creditor.

    I am not talking about the size of the banks, credit unions, etc. I am saying that if you took out a loan – years ago — with any neighborhood bank — it STAYED with that bank. This is not to state securitization is all bad — but it is certainly not good when fraud is used from origination to foreclosure —- and you never know WHO is your CURRENT creditor.

    Securization existed long before the years 2000 — but it was deregulation that allowed the market to go wild. Not knowing who owns your loan — and invalid mortgage title — was UNCOMMON before 2000. And, it was this decade – that promoted free trade agreements- that put the nail in the coffin for future American growth. All that was left to fuel a now consumption economy — was financial services fraud.

    Not only have people lost their homes to foreclosure fraud — they have lost the right to negotiate DIRECTLY with their current and true creditor. Massachusetts decision has a “Concurring Opinion” – but statement at bottom by one of the judges — (he was the one to watch) — he states – “no apparent actual unfairness here to the mortgagors”. But, in addition to the fraud, of course there was — your right to know your creditor was denied. Your right to negotiate was denied. That is my point. And, the concealment of the current creditor is deliberate.

    And, if we do not return to manufacturing — we are finished.

  11. When they eliminate the mortgage/interest deduction on tax returns, the 30 year mortgage will be a thing of the past.

  12. What Anonymous you just discovered America?

    America has been phasing out low quality manufacturing since the mid to late Eighties. Especially in California.

    Anonymous the reason the banks did not foreclose on your Aunt because the banks knew that your aunt or her husband had a real pension or job to return too. Now they don’t. It has nothing to do with community banking and knowing them. It has to do with High or medium Paying jobs.

    The myth of the community banks is a myth I have friends that are being foreclosed on by credit unions etc….. Much faster than the big Banksters. They also used MERS and friends. They are smaller and more efficient.

    The only thing I learned from all this is to go to a big Bank that is out of control to get a loan. Like Countrywide etc… Because of their disregard of the law their paperwork is messed up.

  13. Test – subscribing to the site …

  14. Dying Truth is right — “The largest sector of our economy produces absolutely nothing.” This caused a shift into “investments” — such as the home and “debt” owed. An economy cannot grow on such investment. This is the time to rethink our country’s future and return to “producing something.”

    I can remember (hate to say this as it was a long time ago) — that if one had trouble making a mortgage payment due to job loss etc. — the bank would work with you. My aunt actually was allowed to STOP mortgage payments for a year — no one foreclosed. But, this was twenty-five years ago.

    This was when your mortgage lender was your friendly bank down the street. While neighborhood banks would lose on some older loans if interest rates rose — they would gain on new loans.

    The Savings and Loan crisis did cause problems. Savings and Loans tried to gain market share by dropping rates too low — too fast. But, the crisis was no where near what happened today — and, therefore manageable.

    The home is a necessary function for our culture and society. While lenders should expect some profit by their lending, there should not be such leveraged investment on your debt by which investors bank on your hardship to fund their portfolio. This is nothing but a shift of wealth from the middle class to “investors” — who produce nothing to add to US economic growth.

    Dying Truth — very good point.

  15. This is BS the longer the loan the more interest is made on money that over 3/4 was created out of thin air. The longer they collect interest, the longer their living off of the person paying it and won’t have to do any actual work. The largest sector of our economy produces absolutely nothing. That should tell you something.

  16. Investors and lenders can always invest in the MAKING of the homes. Then the government backs the actual mortgages.

    Why is that so complicated?

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