Government Intervention in Housing Market May End Soon

Based on all measures, the government’s role in the housing/mortgage markets has expanded rapidly since the onset of the credit crisis in 2008. “In fact, more than 80% of the new residential mortgage loans made this year benefited from some form of government support, according to the trade publication Inside Mortgage Finance.” Experts reckon that if the government were to exit, the nascent recovery would collapse immediately. Unfortunately, due to budgetary problems, this is becoming increasingly likely.

Let’s begin by examining the government “intervention” in greater detail. First, there is the government tax credit, which provides up to $8,000 towards the purchase of a new home, by first-time homebuyers. Originally designed as a tax credit, the cash can now be “monetized” and put towards a down-payment. It is impossible to understate the success of this program: “Deutsche Bank estimates the credit has helped generate 350,000 sales, about half the increase in single-family home sales in the past six months.”

Unfortunately, many analysts are skeptical that these sales were facilitated by the tax credit. Rather, the assumption is that buyers who would have entered the market in the next couple years anyway, simply moved their plans forward to take advantage of both the credit and weak prices. It stands to reason, then, that if the program expires in November (as scheduled), that demand could plummet, and home prices could once again sink.

Then, there is the government takeover of Fannie Mae and Freddie Mac. Both companies are basically insolvent, and if not for the injection of $200 Billion funded with taxpayer money, it’s safe to say that the market for mortgage securities wouldn’t be functioning. At some point, the government will have to come up with a viable long-term alternative to the current situation, the implications of which are still unknown. [See related post: "Could Fannie and Freddie Disappear?"].

The Federal Reserve Bank has also played an important role in keeping the market for mortgage-backed securities functioning smoothly. The Fed has purchased at least $800 Billion in such securities as part of its quantitative easing mission, with total purchases to reach as much as $1.45 Trillion next March, when the program is slated to come to an end. Again, it’s impossible to understate the impact on mortgage rates. Since intervention began, the spread between mortgage rates and Treasury rates has narrowed by .7%, implying that rates would not be toying with record lows if not for the hand of the Fed. As the Fed slows down and eventually stops its purchases, mortgage rates are expected to rise dramatically. [Chart courtesy of WSJ].

Last but not least, there is the Federal Housing Administration (FHA), which has become the major player in the mortgage market. While the housing bubble was inflating, less than 10% of all loans were backed by the FHA. Nowadays, that figure is closer to 40%, and for some lenders, as high as 90%. When you consider that the FHA recently raised its limits, it’s fair to say that obtaining a mortgage would be much more difficult otherwise.

The FHA has also been among extremely aggressive in executing loan modifications, in contrast to private lenders, which continue to drag their feet. Under the terms of the FHA program, borrowers are only required to pay interest on 2/3 of the outstanding principal balance. The remaining portion of debt is not forgiven, but must be repaid only in the event of a sale or refinancing.

Regardless of whether this saves the organization money – as it alleges – it still results in a net loss on every mortgage that it insures. Given also that a higher proportion of FHA loans are delinquent (when compared to uninsured loans), it’s inevitable that its role in the housing/mortgage market will soon decline. Its reserves have already fallen to the lowest level in 75 years, and the government has announced that drastic measures will be required if a bailout is to be averted.

Regardless of what happens, you can be sure that obtaining a mortgage and buying a house are both due to become more difficult.