Sunday, June 29, 2008

Housing Bailout Close to Fruition

The $300 billion housing bailout bill, currently stalled in Congress, promises to rescue homeowners and save the economy. Comprising the core of the bill is a $300 billion increase in FHA lending permitting banks to offload their riskiest mortgages onto American taxpayers in exchange for realizing losses that would be all but a certainty. In order to ensure there are sufficient special interests handouts to appease everyone, a new policy has been included that enables homeowners to deduct up to $1,000 in property taxes even if the homeowner does not itemize. Additionally, the bill provides money to local governments to buy foreclosed properties in an attempt to reduce “blight” and prop up the values of houses in depressed areas. All of these proposals may have noble intentions, but they are misguided pork-laden attempts at preventing further pain in the housing market.

Politicians, always quick with the handouts and forgetful of past mistakes, prefer to ignore the ineffectiveness of prior intervention, both by Congress and the Federal Reserve. The Federal Reserve lowered interest rates to 2% in order to support the housing market and ease the pains of the credit crunch. Aside from propelling inflation to lofty new heights, this policy has been relatively ineffective in stalling the free fall of the housing market. As a result, Congress sprung into action and authorized Freddie Mac and Fannie Mae to buy jumbo loans and increased their portfolio limits despite growing quarterly losses on their insured loans and low capital levels. The GSEs have seized upon this opportunity, not to expand their loan portfolio through new lending, but instead to repurchase loans that they insured but previously sold to investors. Therefore, this policy had little simulative effect on lending and failed to relieve the credit crunch facing homeowners. Instead of utilizing their congressional authority to buy jumbo loans, Fannie and Freddie have spent $32.4 billion to buy back their own securities compared to $244 million in jumbo loans.

The Federal Housing Authority (FHA), Congress’s new savior of the housing market, is backed by the government and should cover mortgage losses with the insurance premiums it collects. Unfortunately for taxpayers, the FHA has experienced mounting losses of its own, including a $4.6 billion loss last year. An attempt by the Clinton administration to expand FHA market share in 2000 by lowering insurance premiums to 1.5% from 2.25% has left the agency facing substantial shortfalls and delinquencies of 12-13% compared to 5-6% on all mortgages nationwide. A further expansion of FHA lending, especially precipitated by banks’ desire to offload their most risky loans, is a recipe for disaster and major taxpayer financed bailout. Congress’s proposed housing bill benefits builders and lenders more than homeowners by temporarily supporting housing prices and enabling banks to jettison their most risky loans. Banks and investors with significant exposure to mortgages and housing realize the potential bonanza this bill represents and have lobbied extensively. Lehman Brothers alone spent $190,000 in the first quarter of 2008 lobbying on behalf of this bill eagerly anticipating a bailout of billions of dollars of subprime securities that the investment bank owns.

Congress’ housing bailout bill is misguided and will ultimately prolong the housing crisis. It will prevent necessary market adjustments and postpone the realization of losses that must occur before housing can rebound. The FHA is one of the only intuitions offering 3% down payment loans and allowing seller financed down payment assistance effectively creating no money down loans. As can be expected, governmental institutions do not accurately appraise the consequences of their policies but instead focus on the short term political benefits of a decision. The housing market will rebound naturally once the homeowners that can’t afford their homes exit the market and banks realize all losses from the excesses of the housing boom. By offering new low down payment loans to homeowners that got in over their heads, Congress only prolongs the housing downturn by preventing necessary adjustments that will facilitate a return to normalcy in the housing and credit markets.