Presidential elections historically turn on the condition of the economy, and economic recovery has historically relied on a housing market recovery.
With the 30 year mortgage rate at historic lows — currently below 4%, the Fed balance sheet tapped out — reflecting $1.25 trillion QE2 mortgage related purchases and the federal debt at historic highs — over 100% of GDP, politicians must resort to other off-budget gimmicks this election year.
The Federal Housing Administration is already technically insolvent and by the
Former Fed Vice Chairman
Then during a Christmas Eve showdown, the president signed a two-month extension of the Social Security tax holiday to spur the economy financed with a ten year tax on Fannie and Freddie. As they are currently receiving indirect subsidies of about $50 billion annually (based on the Congressional Budget Office calculation of the interest saving on their debt and my calculation of their taxes saved by using tax-deductable debt in place of equity
Some readers may question why, if subsidizing mortgage borrowers stimulates the economy, taxing them doesn’t have the opposite effect. It seems everything the government does in a down economy produces "jobs" in an election year, such is the magic of economic models of social engineering. But macro-magic aside, these are both bad policies on their merits.
The right to pre-pay — technically "call" — non-portable long term mortgages is necessary to facilitate household mobility. Corporate borrowers pay a substantial interest rate penalty for this right, and as a consequence most corporate debt is not callable. Refinancing fixed rate mortgages when rates fell was never meant to be an automatic "right" for all borrowers to exploit, but became standard practice with the development of secondary mortgage markets in the 1970s when the interests of mortgage originators were aligned with the borrower against those of the ultimate saver/investor.
Most states prohibit charging the borrower a direct pre-payment fee, so the mortgage rate on thirty year fixed rate mortgages is now generally somewhat higher than it otherwise would be. The interest rate risk premium provides the lender modest compensation but refinancing represents an un-hedgable risk. The lender is stuck with low yield mortgages with high cost funding if funded long when rates fall, or if funded short when rates rise. Deposit rate ceilings historically passed the cost to savers, but when interest rates rose sharply in the 1970s, money market funds bypassed deposit rate ceilings, savings and loan shareholders were largely wiped out and taxpayers were stuck with a bill of hundreds of billions of dollars.
Refinancing also played a role in fueling the most recent housing bubble, allowing borrowers with little or nothing down to refinance teaser rate mortgages at the time of reset, often taking cash out to capitalize on the house price bubble. Politicians again played savers and investors for suckers, as savers are once again paying the price for the cost of the sub-prime lending debacle and bailout, with taxpayers once again picking up most of the tab.
It is hard to see how current 4% thirty year fixed rate mortgages are a good investment. Even if inflation remained steady at zero for the next thirty years, the real return to savers after loan servicing, credit default and deposit administration or other funding costs would be well below historical levels. And if it merely averaged zero, with historical volatility, then the "refinancing" option would result in a steeply negative average real return to savers. But even that is unlikely. Deflation would reflect a failure of the economy to recover, and would likely be followed by high inflation to monetize the resulting unaffordable fiscal deficits, so investors will be hurt in any event. Following past form, taxpayers will bear most of the pain.
The argument that refinancing prevents foreclosures is fraught with moral hazard. The potential merit from the reduced likelihood of default due to reduced monthly payments is extremely small, and swamped by the cost of foregone interest on non-defaulting current loans.
During the Great Depression the Home Owners Loan Corporation required lenders to write down the loan to 80% of current house value before acquiring loans. But in spite of turning down more applications than it accepted and forbearance averaging two years, the subsequent foreclosure rate still exceeded 20%. HOLC was "costless" to the government in the same way that Fannie Mae and Freddie Mac were, with misleading accounting and hidden subsidies.
Besides being counter-productive macro-policy, the Social Security tax holiday funded with Fannie and Freddie fees to finance the Social Security Trust Fund is triply disingenuous. First, it compounds the current problem of "funding" the trust fund with purely illusionary Treasury bill assets (recorded as assets by the trust, but not as liabilities by the Treasury) by funding current Social Security payments with illusory fees (as Treasury currently pays additional Fannie and Freddie expenses) or with taxes on mortgage borrowers that could abort the housing recovery.
Second, funding current tax cuts with promises of future tax increases, labeled a "positive precedent" toward balancing the federal budget by the Committee for a Responsible Federal Budget, is a charade.
Third, as with Harp refinancing, the tax extends the Fannie and Freddie lifespan of off-budget subsidies and systemic risk for another decade.
With a jolly Christmas spirit, these Santa Claus policies deliver election year presents. If the new Dodd-Frank created Consumer Financial Protection Bureau really wants to educate consumers about finance, it should require disclosure that the policy is sheer folly without a warranty, and billing is merely deferred until November 15, 2012 at a usurious rate of interest.
Kevin Villani was senior vice president and chief economist at Freddie Mac from 1982 to 1985.
