Why You Should Live in a Van Down By the River: You Can Move It.

I read a lot of economics blogs and columns, in part because I am a masochist but I also really like to see what economists are saying or not saying about housing.  At Marginal Revolution today there is a discussion about theories behind the involvement of Fannie and Freddie in the mortgage market.  The post states that the old consensus was that the GSE's were in place to make housing more affordable.  EPIC FAIL ALERT.  The notion that Fannie Mae, Freddie Mac, and the Federal Reserve have ever made housing more affordable is ludicrous and comical.  If you define affordable as low interest rates then you can definitely argue that they succeeded but you are ignoring the most important factor in whether housing is affordable:  your income.

We used to consider housing affordable if you spent roughly 25 percent of your gross monthly income on housing.  During the peak of the housing boom, Fannie Mae was routinely backing loans at 65 percent of  people's gross monthly incomes.  If you expand your definition of affordable to mean, "at the cusp of bankrupting you" then well done, Fannie.  You made housing more dangerously affordable than ever.

What we have in many parts of this country is a mismatch in the supply of housing with what consumers can actually afford, you know, given their crappy job prospects.  The government inflated housing bubble changed what we view as affordable and made a 3 bedroom house in the suburbs with granite countertops seem like a public good.  It's not.  We have a vast amount of homes that are affordable to a small amount of people.  This cannot be fixed by government intervention, it will require rising incomes and economic growth which will increase demand for what is currently, unaffordable housing.

HUD projections show that in my region, housing demand will be for homes in the $125,000 to $200,000 price range.  This is affordable given our median income levels and these are the homes that are actually selling right now.  What we have is a plethora of homes priced from $250,000 to $350,000 that even if you have 20 percent to put down (a modern miracle), once you factor in taxes and insurance you would need income in excess of $72,000 a year to afford.  This is assuming that you don't have any other debt.  If you have a car payment, student loan, and an average credit card balance this ups your income requirement to $100,000 a year to afford the payment.  Better get on the The Ladders website.

On the other end of affordability we have many families that are working class, what is quickly becoming a class of the working poor.  They may have combined incomes of $45,000 per year and they have consumer debt and spend virtually all of their incomes monthly.  For this family, an affordable house carries a mortgage payment of  $1125 including taxes and insurance.  For this family, a home that costs $150,000 is affordable.  Unfortunately, many of these families are living in $250,000 houses because they qualified for twice what they could actually afford with the help of Fannie, Freddie, and the Federal Reserve.

We have a number of housing problems which are exacerbated by our poor economy.  People underwater on their mortgages are trapped unless they say screw it and walk away and why wouldn't they; what incentive do they have to stay?  Do you really think people struggling to stay afloat are going to put the virtue of their word over a rational economic decision?  Didn't think so.

A bigger problem exists for unemployed homeowners.  Because economies tend to have local and regional agglomeration characteristics in particular industries, you end up with a lot of unemployed people in one area with similar skill sets.  If these unemployed people were mobile, as in able to sell their house and not take a complete financial schlacking, they could move to where their skills might be employable.  Unfortunately, we have a labor force that is very immobile right now which makes unemployment even worse.  Being a renter right now has tremendous advantages, particularly if you can move to take advantage of opportunity.

Perhaps, the Banks should become landlords and turn short sales and foreclosures into rentals.  This would slow down the decline in housing values because the properties wouldn't go to market and then drag down appraisals for the next two years for other homes in the area.  Bankers would make great Slumlords, they wouldn't even require training.

Just when you thought it couldn't get worse....

This article in the WSJ is today's reason that I am fast tracking my plans to become a pirate.  Here is the opening sentence:

"The U.S. government will likely continue to play a role in guaranteeing mortgages, but policy makers must figure out how to design a system that doesn't lead to a rerun of the collapse of mortgage-finance giants Fannie Mae and Freddie Mac, Treasury Secretary Timothy Geithner told attendees at a housing summit convened on Tuesday."

Arggh.  My immediate irritation is with the word "design".  The government couldn't design an exit strategy from a wet paper sack yet they can design a system to prevent financial ruin?  No, they cant and the fallacy that you can design a system to control a spontaneous order like our market economy is mortifying and dangerous.  I was even more disturbed to find out that two economists I greatly respect  seem to be throwing support to Geithner on their blog.

The argument pervasive at the moment is that without government backing there will be no private capital in the mortgage markets and this will lead to a further decline in housing prices, more underwater homeowners, and more stress to the economy.  Currently, the government is involved in backing 90 percent of mortgages whether implicitly or explicitly.  As far as I can tell the idea is to wean the government out of its involvement in the business of housing by temporarily increasing its role, an idea that is so profoundly crazy I cannot believe it is being taken seriously by smart people.

I agree with the ultimate goal that the government (read taxpayers) will not be intimately involved in every loan made for housing.  The problem lies in the fact that once the government is involved, it changes the expectations of the private players and becomes the new rule of the game.  The incentives will not be there for the private sector to take a role because the expectation will be that the government will continue to prop up the market.  Private capital will flow into areas other than mortgages and the taxpayer will end up with the flaming crap bag on their steps.  Temporary government intervention typically turns into permanent government intervention because it distorts market signals and diverts investment to alternative sectors.


I don't know about you but if I hear the phrase, "Mortgage Rates are at historic lows," one more time I am going to exercise my second amendment rights and blow up my television.  Mortgage rates have been too low for too long, another part of the problem.  The Treasury officials are arguing that without a government guarantee on mortgages, mortgage rates will soar.  Fantastic!  Let them soar, they have been distorting the real cost of lending and altering borrowers decision making calculus for too long.  Interest rates are prices and as such, they should reflect the risk associated with lending and the cost of doing business.  Let interest rates rise and more private investors will enter the mortgage markets.  Keep interest rates below the actual market rate and the government will be the only entity dumb enough to jump in.

I am so tired of government stimulus that I think I need a Valium to cope with my over-stimulation.  

Fannie Mae is a Bitch

If you haven't heard of Fannie Mae or her crazy ass cousin, Freddie Mac, then I am assuming the aliens have just returned you to earth.  Congratulations on your safe return from abduction.

Although Fannie Mae sounds like someone who could whip up some mean homemade potato salad and serve it to you in a kitschy Pyrex bowl, she really is a bitch.  Her cousin, Freddie Mac, probably beats his wife.  The whole family of Ginnie, Freddie and Fannie share more than just hillbilly names, they share government sponsorship.  Here is an oxymoron for you:  Fannie and Freddie were set up as private firms with government sponsorship.  Now obviously they functioned with the private sector motive of profit (How's that working out for you?) but they also were intended to lube the capital markets to foster the public good of homeownership, particularly for the middle class. Unlike Fannie and Freddie, who operated with the inherent assumption that they were government backed although they were private, Ginnie Mae actually was government backed.

I'm not going to wax indignant here about the inanity of this but I must get on my soap box briefly to point out a few things that are not getting enough attention.

1. If the perception is that you are government backed then people will behave as though you are government backed.  If I hand you $100 and send you into a casino with the instructions that you can keep all of your winnings and not be responsible for your losses, you will behave more recklessly than if you were responsible for paying me back if you lost.  This in a nutshell is why Fannie and Freddie took on so much risk.  Also, they were explicitly encouraged by the government to do so.
2. I have a problem with the "homeownership is a public good" mentality.  I had a problem with it before I got into the mortgage industry and now it really makes me seethe.  Homeownership is not a fundamental human right.  Oh and turns out, homeownership isn't proving to be that great for people.  
3. What we know now is that the perception of government backing=government backing.  Go figure.

The point of this post isn't to pontificate about the unintended consequences of government intervention, no, I will save that for happy hour.  Really I just want to begin to describe the types of loans Fannie and Freddie allowed me to do that were considered prime, meaning low risk.  It will make you feel sorry for sub-prime loans, they took all of the heat in the beginning and were the tiniest part of the crisis.  Poor little scapegoats.

Fannie Mae and Freddie Mac had a monopoly over the secondary mortgage market.  If you have ever had a mortgage the odds are Fannie or Freddie had something to do with it.  For those of us on the front lines, the goal was to make every loan a prime loan which was a loan that Fannie or Freddie would approve.  The reasons for this were numerous but fundamentally, loan officers want to earn commission.  The more easy loans you can do, like those Fannie and Freddie approve, the more money you can make.  The folks at Fannie and Freddie understood that and they gave loan officers the tools to be lazy while making tons of money. 

Both Fannie and Freddie had proprietary automated underwriting systems, desktop underwriter(DU) and desktop originator(DO), that made being a loan officer less painful.  Anywhere I went with a laptop and an internet connection, I could run a customer's loan application through these underwriting systems and receive a loan approval in five minutes.  A. Hole and I have gotten loans approved at happy hour which is the ultimate in utility maximization.  Making money while drinking with friends, brilliant.

The loan approval from Fannie or Freddie would list the conditions for final loan approval, including the types of documentation the customer would need to provide so that they could close on their mortgage.  If a loan didn't receive approval through these systems it might qualify for a manual underwrite as an Alt-A (more on this later) or sub prime loan.

These automated underwriting systems were designed to approve loans based on the layers of risk.  The layers of risk in the industry included debt to income ratios, appraised value, cash reserves and assets, employment stability, property type, and credit profile.  All of this sounds sensible, right? 

In practice, this automated underwriting system was inconsistent and sometimes left you scratching your head.  My theory on this is that the underwriting system was tweaked on a regular basis as a method of controlling risk and liquidity.  I don't know this for a fact, but it makes sense given the fact that you could run the same loan through the system a week apart and get two different results.

At the peak of the housing boom these automated underwriting systems were spitting out approvals the way the Duggar Family spits out kids.  Nothing was finer than to be a loan officer with a whole stack of loan files with neat little Fannie Mae approvals in them.  As I said before, sub-prime loans have really been thrown under the bus by Fannie and Freddie.

During this glorious peak I was getting prime loans approved on a regular basis through Fannie for customers with debt to income ratios of 65%.  YES, I said 65%.  The debt to income ratio was calculated by adding up the mortgage payment, debts listed on the credit report, taxes, and homeowners insurance as monthly expenses and comparing them to the customer's GROSS monthly income.  Not only did we not include monthly expenses like utilities we calculated the ratios on pre-tax income.  Wow.

When I returned to the lovely world of economics I finally grasped what this meant.  For the average person, a 65% debt ratio to gross income would result in a monthly shortage.  Fannie was basically approving loans with the implicit assumption that the borrower would have to deplete their savings for luxury items, like groceries and child care.

I am not an idiot but when I say I was in true believer mode when I was in the industry, I mean it.  I really thought I was making people wealthier.  Now I know that a great majority of these loans depleted wealth by giving somebody a declining asset (their home) and encouraging them to drain their 401-K and savings just to pay their bills.  This tandem punch resulted in the largest ever decline in household wealth between 2007 and 2008.

Like I said, Fannie Mae is a bitch.