The government finally weighed in on three proposals to try to end government support of the mortgage industry. The big question is: Can the U.S. housing market manage to get healthy without government support?
It might be interesting to look back at the 70-year history of the government’s support of the housing industry through easier financing. Back in the 1930s during the Great Depression, banks would only lend on short-term mortgage loans, and of course that made foreclosures more likely when the loans became due.
The government stepped in and created the Federal Housing Agency, now a part of U.S. Department of Housing and Urban Development. In later years the Government Sponsored Entities, GSEs, Fannie Mae and Freddie Mac were created. The rationale for the creation of all these entities was to assure the availability of 30-year fixed rate mortgage loans.
I believe that the time has come to end this government subsidy of the 30-year fixed rate mortgage. To support this contention, let me lay out the damage that reliance on this loan has caused.
The Other Side of the Coin
While long-term fixed rate mortgages are attractive to homeowners, it has also led to the collapse of the Savings & Loan industry. In the early 1980s, the S&Ls had billions of dollars of low-interest rate loans on their books. Loans that yielded, say, 6%. However, we had an unanticipated wild swing in rates starting in the Carter years. This graph shows how high the rates got. In order to attract deposits, the S&Ls had to pay much higher rates, like 15% to their depositors. You can’t receive 6% from your loans and pay your depositors 15% for very long before you go out of business. The industry basically vanished.
Note that this wasn’t the fault of the S&L management. They were suddenly faced with unanticipated volatility in rates that were due in part to the impact on the economy that resulted from an increase in the price of oil. Here’s what that graph looks like.
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In the early 1990s after rates fell back to single-digit rates in 1991, the S&Ls were gone and we witnessed a significant expansion in the market of Fannie Mae and Freddie Mac (F&F). The story was that the S&Ls failed because they couldn’t handle the volatility. So F&F were instrumental in providing money for loans.
Mortgage originators dealing with borrowers could create loans in the “Primary Market” and sell them to F&F. The money from this sale would go back into the originating banks where it could be lent again. F&F would pool these mortgages and sell them in the “Secondary Market” to the ultimate investors who wanted fixed income securities with a higher yield.