Today’s subject is housing, and as part of my research I’ve been going through the U.S. Constitution, looking for the exact words that guarantee Americans access to a 30-year, fixed-rate home mortgage.
I haven’t found the provision yet, but it must be in there somewhere: As everyone knows from listening to the debate over fixing our damaged housing finance system, the long-term fixed, or FRM for short, is as essential to America as free speech or the right to a jury trial.
President Obama, leading Republicans and Democrats on the Senate Banking Committee, the top Republican on the House Financial Services Committee, the mortgage bankers’ lobby and affordable-housing advocatesall have pledged that, whatever else happens in housing reform, we must protect the FRM.
“Across the world, homeownership is too often reserved for the well-off,” Sen. Elizabeth Warren (D-Mass.) declared last October. “But in America, thanks to lower down-payment requirements and the prevalence of the 30-year fixed mortgage, homeownership is widely accessible.”
Moistens my patriot’s eyes. Still, I admit that my difficulty, thus far, in locating the FRM clause has started me thinking: What if the FRM is not actually in the Constitution — or even a very sound idea? What if this country has actually paid dearly, financially and socially, to perpetuate it?
Every home loan carries credit risk — the risk of borrower default — and interest-rate risk — the risk that rates will go up during the life of the loan.
Lenders manage credit risk by reviewing customers’ finances and requiring down payments. They can manage interest-rate risk through such devices as adjustable-rate loans, whose rates can go up at predetermined intervals, and prepayment penalties, which discourage borrowers from refinancing when rates fall.
Such provisions were common in U.S. mortgages until the Great Depression more or less destroyed the single-family housing market — and paved the way for federal interventions, from the Federal Housing Administration to Fannie Mae and Freddie Mac, the consistent feature of which was support for the long-term, fixed-rate loan. Today, more than 90 percent of all U.S. mortgages take that form.
Unlike prewar mortgages, the FRM offered a simple-to-understand loan whose monthly payment and other terms never varied, unless it was to the borrower’s advantage — that is, unless rates went down and the borrower refinanced, which he or she could usually do without a penalty.
No wonder people liked it. Rates go up and down a lot over 30 years, but the FRM left all the interest-rate risk with lenders. In theory, that would have driven them out of business, but in practice the government enabled mortgage lenders to package home loans into securities and sell them to agencies such as Fannie and Freddie, which were “government-sponsored” and thus implicitly taxpayer-guaranteed.
Fannie and Freddie raised funds by selling their debt to investors, who considered it safe since home prices always rise (or so it was believed) and because the government implicitly stood behind Fannie and Freddie.
All was well — except that the system was steadily, but not transparently, shifting credit and interest-rate risk associated with millions of FRMs to government, i.e., taxpayers. The bailout of Fan and Fred cost $187 billion.
We don’t have much to show for all this drama. The U.S. homeownership rate peaked at 68.9 percent in 2006; now it’s 64.8 percent, a mere 0.9 percent higher than it was in 1965, according to the Census Bureau. And it’s still dropping.
Contrary to advocates’ descriptions of the 30-year FRM as a “plain vanilla” loan, it is actually quite “exotic” in comparative terms: With the partial exception of tiny Denmark, no other developed nation bases its housing finance system on a long-term FRM.
In Canada and Europe, the typical instrument is a medium-term adjustable-rate mortgage with a prepayment penalty. Banks, not investors in securities, provide funding. (In Australia, 92 percent of all home loans are ARMs.) Notably, these are not “subprime” loans, as many ARMs were during the U.S. housing bubble; lenders, watched by regulators, enforce strict down-payment requirements and other credit risk-reduction measures.
Credit risk and interest-rate risk are more transparent and, crucially, shared by lenders and borrowers, not taxpayers. Contrary to Warren’s claim, such systems have produced homeownership rates comparable to those in the United States. Britain, Canada and Australia hit nearly 70 percent homeownership in recent years, according to economist Michael Lea of San Diego State University.
In other countries, apparently, homeownership isn’t seen as a middle-class entitlement program, nor do government planners dictate a one-size-fits-all home loan. The business is left up to mature adults, one with money to lend and another with the intention and capability to use the funds sustainably.
But that would never work in America. This is a free country!