The Government Wants You to Buy a House

This bit of folk wisdom was shared with just about every young adult who came of age and got a steady job between 1945 and 2006.  Yesterday, we discussed the antecedents of this policy.

It was based largely on the fact that mortgage interest expense can be deducted from AGI in federal income tax filings.

It made a certain sense.  During much of that period, the American economy was growing and new households were forming.  Home prices generally followed suit, increasing as well.

But during the 1990s, the government doubled down on promoting home ownership for everyone.  This may have been a reaction to the despicable practice of redlining -- withholding credit from low-income and/or minority people, refusing to offer home loans in poor neighborhoods -- but once it got going, the effort took on a life of its own.

First Fannie Mae and Freddie Mac, the national mortgage insurance providers, were incentivized with credits to offer more loans to poor people. Then the agencies reduced down payment requirements for loans.  Then they reduced the personal credit history requirements for borrowers.  Then they blessed increasingly strange adjustable-rate mortgages (ARMs).  Early in the aughts, some government programs even gave people cash toward down payments on home purchases.

And it wasn't just the government.  Mortgage origination offices were eager to write up the contracts and collect origination fees. Wall Street bankers were happy to bundle the loans and sell them as bonds, also collecting fees.  Ratings agencies rode along, issuing indefensible opinions that the new loans were secure and would be repaid, again for fees.  Real estate agents loved the increased volume of business and the new transaction fees they collected.  Everybody was in on the game.

By 2005, according to the National Association of Realtors, almost half of new homebuyers made no  down payment at all when buying houses.  Another 20 percent made down payments of less than 5 percent.  Houses were effectively being given away on the promises of increasing incomes and increasing home values.

The census chart below shows the effect on national home ownership.

As might be expected, this had other effects.  With many more people able to buy houses, price competition raised home prices.  The higher demand for houses led builders to construct many new subdivisions, especially in areas where land was cheap.

Many people, unsophisticated in real estate, began buying homes and flipping them every year or so.  They assumed the prices would just keep rising, even though the economy and people's incomes were not increasing at a similar pace.  Others bought homes in fear that prices would go so high that they would be unable to buy ever again.

The strategy worked -- until it didn't.

By 2006, the frothy real estate market had hit a wall.  Housing prices had become too expensive for just about everybody.   The people who had been planning to flip their houses and collect nice gains found themselves stuck.

In addition, people who had taken out some of the nutty ARM loans were unable to pay their mortgages when the early years' teaser rates expired and interest expense was adjusted to the market rate.

By the time the economy went into recession in 2007, house prices had begun to collapse.  People who could not afford their homes began to default.  Mortgage bond payouts declined rapidly, taking financial institutions with them.  Many people discovered that their homes were worth less, sometimes much less, than the mortgage notes they had signed, and that there were no buyers willing to pay enough to get them out from under their debt.

Here are a couple charts that demonstrate the macro effects.  The second one demonstrates that home ownership still remains relatively more expensive than renting.  Both suggest that, even with the dip that followed the housing collapse, the price of homes didn't adjust downward as much as should have been expected and that another bubble might be developing.

The fallout of the housing crash echoed through the economy.  A savings and loan I knew a bit (but whose stock I did not buy) served as an illustration to me.

The S&L was founded in California in the middle of the last century.  It was careful, conservative and profitable until the founders retired and the son-in-law of one took over.  It was seized in 2008 and sold to a bigger bank.  At the time, $6.9 billion of its assets were in "option ARM" loans that allowed borrowers to choose how much to pay each month; most payments were not covering even the interest expense on their mortgages, with the result that mortgages were growing as home values were declining.  The S&L also had gone big on "reduced documentation" loans, known as liars' loans because borrowers' credit and asset claims were not checked before loans were approved.  By the end of 2005 more than 90 percent of the S&L's mortgage originations were of the "reduced documentation" variety.

The fate of such lenders was bad, but the worst pain was for the people who lost their homes.

In May of last year, the Federal Reserve Bank of St. Louis issued a report concluding that Americans had built back only 45 percent of the assets they lost in the 2007-2008 recession.

"While many Americans lost wealth during the Great Recession," CBS quoted the bank president as saying, "younger, less-educated and nonwhite families lost the greatest percentage of their wealth."

According to CBS, "Those families tended to have low savings and high debt."

Today:  The government still wants people buy houses.

Current FHA requirements for loan guarantees require only 3.5 percent down payments, even if the entire down payment consists of gifted money, usually from families.  In addition, the FHA will insure loans for borrowers with credits scores as low as 500 (the scale is 300 to 850) "so long as there's a reasonable explanation for the low FICO (credit score.)"

The "Welcome Home Illinois" program provides $7,500 toward a down payment for those with incomes up to $88,320.  Buyers are required to ante in 1 percent of the purchase price or $1,000, whichever is greater.  First-time buyers and people who have not owned a home in the last three years, with incomes up to $88,320, are eligible.

In New York, the Smart Move program requires a 1 percent down down payment and offers a second mortgage at a low interest rate for a total of 99 percent financing to homebuyers with incomes of $83,400 or less.

There has been discussion lately suggesting that, post recession, lenders have tightened mortgage requirements too much.  That may be.  I hope these government-assisted homebuyers are able to keep their houses and that the homes they buy increase in value.  After the experience of the last 10 years, though, I worry.