July’s housing bill was received with a round of applause by politicians and analysts alike. A bill for “regular folk” some suggested, bringing together a creative mix of measures to salvage home ownership and the American Dream.Sure enough, the bill seemed to have something for everyone:
– A rescue plan for Fannie and Freddie and, by extension, the mortgage market as we know it and, ultimately, house prices.
– Up to $300-billion worth of government guarantees to help ill-fated borrowers negotiate their way out of foreclosure.
– $4 billion of grants to local governments to buy and rehabilitate foreclosed properties.
– Additional tax deductions for homeowners who (poor guys) are being traumatized by the decline in their home equity… etc etc.
“What about me?!” rants Joe Schmoe. That’s my neighbor from the skyscraper next door, and a fellow “regular” at our local Greek deli. A middle-of-the-road working professional in his mid-thirties, Schmoe seems to share my fondness for fried calamari on a Sunday night. Importantly, Schmoe is a renter (and aspiring homeowner) and, as such, represents one-third of America’s households.
For the Schmoes of this world the housing bill is anathema, and I quickly get the message as my neighbor’s fiery gestures end up overturning our shared Athenian tzatziki.
“Poor homeowners??” It is by now consensus that house prices overshot in recent years to levels way above what is justified by “fundamentals.” Indeed, a recent study by the IMF (see Chapter I here) reaffirms the point using two different methodologies: The first compares current house prices with what prices would have been, had they been driven solely by fundamental factors such as disposable income, mortgage rates, unemployment, construction costs or household size. The second method estimates a long-run relation between house prices, rents and interest rates and uses that to infer a “fair” price for house prices today, given today’s rents and interest rates. Both approaches conclude that, despite the recent price declines, American homes remain overvalued by more than 10 percent.
So those poor homeowners can’t be that poor after all. Apart from those who bought a home after mid-2006 (i.e. near or at the market peak), the rest are simply seeing a reduction in wealth that, arguably, came unduly fast. Any measures to arrest the decline in house prices would just prolong this overvaluation, benefiting homeowners who are sitting on (and some splurging with) an artificial wealth and hurting the Schmoes who have been waiting for the (free?) market to correct its own excesses.
Savers’ plight: Then we’ve had the credit crunch, distress in the financial system, the collapse of Bear Stearns, runs on anything—from hedge-funds to regional banks. So Ben rushes to cut interest rates by 3.25 percentage points to save America from slipping into a fat tail.
Schmoe is not happy! He had been prudently saving money to buy a home once his income stabilized and house prices returned to more sane levels. But with Fed policy rates down 325 basis points, savings rates are also down—Schmoe now earns 1.50 percentage points lower interest on his one-year CDs than a year ago.
This is bad enough… with inflation this year turning our higher than expected, his savings have been eroded in “real” (purchasing power) terms. But it gets worse. The Fed’s cuts have actually failed to translate into lower borrowing rates for aspiring home-buyers, as stress in the financial sector persists and banks are tightening their lending standards. For example, rates on a 30-year fixed mortgage have increased by more than 50 basis points since a year ago. So the Schmoes, savers in general, and even potential “refinancers” are being “treated” with a double whammy when it comes to protecting (or investing) their savings.
Paying the bill: Then there is the bill… I mean, the bill of the housing bill, which we will all be invited to pay, homeowners or not. Only that, unlike homeowners, who at least benefit from tax breaks in the form of mortgage-interest and real-estate-tax deductions, for Schmoe-the-renter the check will be especially sore. True, the housing bill contains “tax credits” for first-time buyers, so he could rush to claim his share of the pie? Well yes, although the “credit” is really an (interest-free) loan to be paid back over 15 years. In addition, it’s phased out for those earning above $75,000 and, capped at $7,500, is just a fraction of the median home price ($214,000), let alone the insane sums Schmoe needs these days to buy a hole-of-an-apartment in New York.
The bill could be large. The Joint Tax Committee estimated the cost of the bill’s tax provisions for multi-family and low-income housing at almost $16 billion over 2008-09, with (only partial) “payback” period after than. On top of that there are contingent payments associated with the government’s guarantees on up to $300 billion worth of mortgage loans. Some might sigh with relief reading the Congressional Budget Office’s (CBO) estimates that “only” around $68 billion of these guarantees may end up being extended due to the strict eligibility requirements and conditions. But Schmoe is losing faith…
Taking out the bazooka: …Especially as he watched Fannie and Freddie plunge deeper into crisis-territory last week. You see, Schmoe had trusted Hank Paulson and his “bazooka” rationale for rushing the bill through Congress: “If you’ve got a bazooka in your pocket, you may not have to take it out,” Hank eloquently argued. In other words, the bill was (hoped) to act as a “sell-off deterrent”—dissuade investors from taking their money out of the GSEs by offering the possibility of a government bailout. A botched hope, it turns out, as Fannie and Freddie’s stocks continued to dive, raising the chances of an actual Treasury bailout.
How big a bailout? Even the CBO shrank from revealing the ugly truth. In its letter to Congres, the CBO said the expected value of government intervention was $25 billion, reflecting a range of possible outcomes (from zero up to an unreported amount), each with different probabilities. The unreported amount would likely exceed $100 billion, which the CBO’s worst-case-scenario for credit losses by the GSEs. In that scenario, the government would need to cover not only the $100 billion, but whatever more it took to restore investors’ confidence in Fannie and Freddie’s capital adequacy.
Back to the American dream: By now, Schmoe sounds like he’s craving for desert: “Whatever happened to America’s mom, free-market and apple pie?”
“This housing bill is a reward for the reckless, the greedy, the uninformed—all those who indulged themselves ‘to debt’, blowing up house prices, inflating our trade deficit and crushing the dollar to its feet. All in the name of home-ownership! If you want to promote home-ownership, allow house prices to return to “sensible” levels… let the market find its bottom, correct its excesses, and learn better in the process.”
Schmoe is fuming… tzatziki all-over, fingers greasy, table in a mess. A moment where the invisible hand would indeed come in handy!
Originally published at Models & Agents and reproduced here with the author’s permission.