The Government Will Probably Make a Fortune with This Nationalization of Housing Finance
We are drifting toward nationalizing housing finance. And as long as the government can borrow at the Treasury rate it can buy up and refinance the country's stock of mortgages without paying a dime in the long run. The largest risk-arb operation in history--and since the government can mobilize the entire risk-bearing capacity of America, a very low-risk one
James Kwak:
We Have a Winner? « The Baseline Scenario: After seeing dozens of mortgage proposals emerge over the past several months, there are news stories that Larry Summers and the Obama economic team are converging on an unlikely candidate: the proposal by Glenn Hubbard and Christopher Mayer first launched on the op-ed page of the Wall Street Journal on October 2. Hubbard and Mayer published a summary of the plan in the WSJ last week; a longer version of the op-ed is available from their web site; and you can also download the full paper, with all the models.
I say “unlikely” not only because Hubbard was the chairman of President Bush’s Council of Economic Advisors, but because it doesn’t look like a Democratic plan; then again, it doesn’t look much like a Republican plan, either. Most plans I have seen have focused on minimizing foreclosures through some form of guaranteed loan modification for delinquent homeowners. Before getting to the policy specifics, though, I want to outline two of the premises.... First, Hubbard and Mayer, like many others, have the goal of preventing an overcorrection on the downside (housing prices falling further than where they need to go to be reasonable). But unlike many others, they have calculated where prices need to go, and one of their central arguments is that we are already there.... The authors divide cities into three markets - cyclical (San Francisco), steady (Chicago), and recent boomer (Miami), and conclude that (Figure 10): cyclical city prices are 10-20% above their average level of affordability over the last twenty years, but that is consistent with 2% expected annual real appreciation for these highly desirable cities; steady city prices are at their average level of affordability already; and recent boomers still have some way to fall. Looking at the imputed rent-to-income ratio (Figures 6-8), they find that housing prices are already where they should be in most markets.
Second, Hubbard and Mayer argue that housing prices are mainly a function of real mortgage rates. While they acknowledge that other factors took over at the peak of the boom, their model shows that most housing price appreciation through 2005 was due to fundamentals.... Right now, they argue, mortgage rates are historically high relative to Treasury bond yields, and those high mortgage rates are pushing housing prices below their long-term levels....
Given those premises, the policy proposal is simple: force mortgage rates down to 4.5% (by reducing the cost of Fannie/Freddie debt relative to Treasuries), thereby propping up housing prices at a level that Hubbard and Mayer think is sustainable....
This isn’t a program for reducing mortgage foreclosures; this is a program for boosting housing sales and refinancings across the board. This does have the nice property of eliminating all those worries about how to prevent solvent homeowners from turning insolvent in order to profit from a bailout....
The goals of the program are to stop the slide in housing prices, stimulate the economy by unfreezing home sales and through the wealth effect of increased housing prices, and stabilize the value of mortgage-backed securities, thereby aiding the financial sector.... One question is whether the loans will be sustainable. Hubbard and Mayer say that 1.9% is more than enough because the ordinary spread is 1.6%. But these are not ordinary times, and even if the plan does help turn around the economy, we are probably looking at 1-2 more years of rising unemployment and resulting defaults. Furthermore, conforming mortgages rates are already down to 5.2% (thanks in part to the Fed talking rates down), so Fannie and Freddie could face the problem of getting stuck with riskier mortgages while the private sector keeps the better ones. But in any case there are signs that some version of this plan will be brought to the floor.
