The Future of the US Mortgage Market

“The trigger for the most recent crisis remains the part of the global financial system that has been least reformed”. The Economist, August 20, 2016.

There is a thorough and thought-provoking diagnosis of contemporary US mortgage markets in the USA in the new edition of the Economist. You may ask why this is a significant issue worth attention. First, the proximity of US mortgage securitisation to the global financial crisis and the extent to which earlier structural and other challenges have been repaired is important for the world financial system not least because the rest of the world owns trillions of dollars of US mortgage debt. Second, the US market has had a lengthy and difficult period which has had all manner of knock-on effects for housing, communities and the economy. Third, there is the key question of the future – how stable, resilient and sustainable is the current system and also proposals for reform. Finally, how relevant is any of this to the UK’s mortgage market?

The article argues that despite the rebalancing of Wall Street banks since 2008, alongside the banks sits the mortgage sector, which creates almost as much credit as the banks but unlike them the housing credit sector is much less capitalised and only just in profit. US mortgage debt is of the order of $11 trillion. The Economist argues that the taxpayer subsidies the system to the tune of $150 billion a year (tax breaks but also the indirect effect on interest rates of the Fed purchasing mortgage bonds). This is in part because of the conservatorship of Fannie Mae and Freddie Mac, or de facto nationalisation of the great majority of the US mortgage sector (at least 2/3 of new mortgages originate from agencies of government). The economist concludes that it is not the market but ‘administrative fiat’ which determines mortgage volumes, the structure of loans and attitudes to risk.

The collapse after 2008 led to major changes in the regulation, ownership and practice operating in the mortgage lending sector. The Economist stresses the withdrawal of traditional lenders from mainstream new home loans to be replaced by specialist orginators. Second, the Government’s rescue of the system between 2008-2012 left them in control of large parts of that system and in particular of securitization of mortgages. Third, although the old derivatives market has been largely removed, it is still the case that the ownership of mortgage assets is still widely distributed across the banks and internationally.

This is where the Economist’s argument gets a bit schizophrenic – they argue that on the one hand there is too little regulation of the new originators of mortgage loans is too loose but at the same time the rest of the mortgage market is far too regulated – with 10,000 pages of law and rules that tighten up who gets loan, what kinds of property and loan types are eligible. Yet loan to value ratios are weakly controlled and 95% LTV loans are increasing (25% of new loans in 2012) and down payment regulations have been loosened.

The upshot for the authors is that the US mortgage system seems to be playing two roles – providing liquidity in the mortgage bond market but also using implicit and explicit subsidy to boost home ownership. What is to be done –the Economist is not keen on just leaving it alone (which itself is a common response after the shocks of 2008 and thereafter). Instead, they want a market solution but also note that with the status quo remaining because of the dominant role of the state, a future default crisis in the mortgage market will need to be bailed out by the taxpayer and this might be huge.

What is the market alternative? Force mortgage lenders to recapitalise like the banks on Wall Street and at the same time raise fees to create profit signals and incentives to take risks (and bear their costs). Administrative control and subsidy would be reduced and mortgage rates would probably go up a bit too. The Economist reckons this would require about $400 billion of new capital.

There are however difficult political economy barriers to such reform: the Government currently receives income from its conservatorships (but does not have their debts on its books) and of course the twin reduction of subsidy and higher interest rates (plus potentially sounder market criteria and regulation for lending) does not win support from the middle classes.

This all sounds like the policy reform problems we have discussed many times before – important coalitions and stakeholders who thwart reform even when it is in society’s long term interests. Figuring out ways to build consensus or use opportunities to act while sorting out the design and implementation of system wide reform, and indeed to compensate or mitigate the impacts on losers from reform – is a challenging mix. Default to inaction is made all the more likely by the need to get new enacting legislation through a partisan Congress.

While one may not necessarily agree with the precise policy thrust in the article, the problems are real enough. While not accepting the prognosis we still have to confront how to make policy well in a complex and uncertain setting. For those thinking about wishing to tilt the UK mortgage market to or from further regulation, it is worth considering the experience of the different and distinctive US setting.

Freedom

Today was a milestone day in our household. We finally paid off our mortgage. Our journey is probably not too different to many of our vintage and trajectory but certainly it now looks like a housing career much less likely to be possible or typical for many folk starting out now wanting to buy a home.

As many did in the high water mark of mortgage deregulation, we started in the late 1980s with a 100% endowment mortgage. This was for a two bedroom interwar four in a block or cottage flat purchased a couple of months after I started my first full time job as a research fellow. Mortgage rates were 15%. It needed a lot of work, much of which family and friends assisted with and we stayed there, in hindsight, too long. There was a dodgy roof and a comparatively large garden, which were both in their different ways time-consuming and stressful.

I really wanted out of that house by the time we moved- I still occasionally have a recurring dream that we have to move back there (and to be clear I wake thinking I have had a nightmare). We moved about half a mile into a new home and watched it being built, which was an exciting time. This was a semi-detached three bedroom house, our larger mortgage was in two parts (a legacy of that earlier endowment). The new house was an incredible contrast to its predecessor and we had a little more than five years there. We would probably have stayed longer but an attractive, detached house around the corner came on the market and we managed to get it (the vendors also moved to another house in the immediate vicinity).

We have been in the present house more than 11 years now and we were able to use the redemption of the endowment (at nothing like its original supposed value) to pay off one bit of the mortgage and then overpay the other part till we could clear it today. A combination of very low interest rates and two jobs made this possible.

We know we have been fortunate working in comparatively secure jobs while escaping the vicissitudes of economic turmoil both in the early 1990s and late 2000s. We were able to secure a 100% loan in 1989 and make incremental progress thereafter. This is now a much more challenging problem for would-be buyers because of the binds of higher entry level house prices, weaker earnings growth, greater job insecurity and the much more significant down payment constraint.

If people cannot access funds, build savings or inter-vivo transfers or other financial support from family or friends, and do so when it is required or opportune, the average age of first time buyers will remain high except for the lucky few. As an aside I think there would be much merit in detailed and extensive independent research in the binding nature of these down-payment constraints and the effectiveness of policies that try to relax them. While there is much to be said for not returning to 100% mortgage loans the industry may have gone too far in the other direction but it is a complex multidimensional problem and simple pat answers about how to safely increase mortgage lending should be viewed with suspicion.

So, it is no more ‘I owe, I owe, so it is off to work I go’. However, to be honest I never really felt like that about work. Still, it is a rite of passage to close the mortgage account, and, as so many aspects of life increasingly do these days, it does make one feel old. The future will be about maintenance rather than a mortgage. We will just have to plan it ourselves.