The mortgage market has begun the long and arduous process of crawling from the wreckage of the last two years. While the government has been involved in mortgage lending since the 1930s, recent recovery efforts have resulted in a massive intervention in the mortgage sector to both support the financial system and keep mortgage money flowing to the housing markets. However, the government's involvement in mortgage lending will be difficult to end without renewed disruptions to the financial and housing markets. Whether they know it or not, they are in for the long haul. With a long-term recovery in housing as the ultimate goal, they need to examine some of the distortions stemming from the government's traditional role in mortgage and MBS markets.
The Treasury Department and the Federal Reserve are actively working to push mortgage rates lower using a variety of tools, from "qualitative easing" (i.e., the Fed purchasing Treasury notes and bonds) to directly buying agency MBS. While their activities have succeeded in keeping conforming mortgage rates relatively low, the non-conforming mortgage market remains in a state of severe distress. The lack of a capital market outlet for mortgage loans ineligible for federally backed guarantees, combined with the risk aversion of many large lenders, has virtually paralyzed jumbo lending. (For example, JPMorgan Chase and Harris Bank now require a 70% LTV on jumbo-balance loans, irrespective of credit score.)
While the government's intervention in mortgage lending is expressly short-term in nature, there will be upward pressure on rates once its activities are scaled back. Large agency MBS buyers of the past will be unreliable sources of future demand. This includes the big overseas investors, the hedge funds (with both fewer players and reduced buying power) and the GSEs. Given the uncertainties surrounding capital market demand for MBS, the withdrawal of government support for mortgage lending will likely precipitate a spike in lending rates. This would risk disrupting what at best will be a slow and unsteady housing recovery. Therefore, I expect the government to be deeply involved in the mortgage sector for the foreseeable future.
This has profound implications for housing and home prices. Since the founding of Fannie Mae as part of the New Deal, the government's role in mortgage lending has been to support and subsidize the lower and middle tiers of the housing markets. This is reflected in the statutory balance limits that have traditionally precluded the GSEs from buying or backing "large" loans.
However, real estate markets do not necessarily differentiate by price. Many markets have a wide dispersion of prices; in addition, trade-up buying is a time-honored staple of real estate activity. The tiering of mortgage lending resulting from the collapse of the market for new-issue private-label MBS means that the recovery of home prices in many areas will continue to be stunted by the lack of available and affordable financing for higher-priced homes. This is already reflected in high-cost states such as California, which has been disproportionately impacted by the lack of jumbo financing. (A "middle-class home" in many areas of California easily runs into the high six figures and beyond.)
As mortgage lending rates will be controlled and subsidized by the government for the foreseeable future, the government needs to reconsider the historical limits on its activities. As it does with the tax code, the government should actively support lending for the entire housing market. For starters, the limit for jumbo-conforming should be increased to 250% of the statutory conforming limit from 175% of the limit, which would put it slightly more than a million dollars in high-cost areas.
Bill Berliner is a mortgage- and capital-markets consultant based in Southern California. His web site is www.berlinerconsulting.net.
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