Does anyone else think that Ed DeMarco is the lone voice of reason in Washington when it comes to housing? In the last couple of months, he’s taken two important, very smart, but politically dangerous stands on housing policy. Recently, the FHFA announced that it would take action against municipalities that used eminent domain to seize underwater mortgages. In addition, the FHFA announced that it would not allow permanent principal reductions on loans backed by Freddie or Fannie.
Both positions are undeniably in the best long-term interest of the housing market. The argument against eminent domain is obvious. One of the biggest, current problems with the housing market is the almost total absence of the private market in loan securitization. One of the primary reasons for this is uncertainty regarding the impact of current and future regulations and legislation.
Adding the risk of eminent domain to an already chaotic regulatory environment would almost surely further delay the reemergence of private securities and would almost as certainly reduce the availability of lending to the housing market. Why would any sane lender continue making new loans with the risk that a municipality could seize the loan if property values decline?
The argument for principal reductions is just as weak. Yes, reducing principal for borrowers who are underwater might increase the probability that some delinquent borrowers would start to pay their mortgages again. However, the percentage of underwater mortgages that are current is vastly larger than those that are delinquent. For whatever reason, most borrowers with underwater loans have decided that they want to keep their properties and have continued to make their house payments. What about borrowers who still have positive equity, but lost value in the housing decline? If there is free money available, aren’t both of these groups as deserving of it as the first? How do these groups compare with borrowers who bought their homes with no down-payments and are now upside-down and delinquent?
In recent months, we have started to see some indications that the housing market is getting healthier. In some markets, we’ve seen better resale activity and stabilizing prices. We are still in a very precarious situation, however. The problem is that we are also in the midst of an election cycle and pandering to voters who are concerned about housing values is an easy way to garner votes. Recently, the current administration floated another proposal for refinancing borrowers who are even further underwater than those targeted by previous programs.
In my first economics class, I was exposed to the concept of risk and reward. Higher risks should generate higher rewards (or interest). My personal belief is that there was never anything wrong with subprime lending. The problem was that somewhere along the way, the GSEs, the rating agencies, Wall Street and lenders forgot the relationship between risk and interest rate. High-risk loans were priced at essentially the same price as vanilla, conforming product. We’re living through the results of that mistake and now politicians are proposing the same formula.
Anyway, my hat is off to Mr. DeMarco. He is a rare commodity these days! I only hope that principles and intelligence win in Washington.