DECLINING HOME PRICES - WE CAN TURN THEM AROUND
by Mike CotterThere are many reasons for the extreme weakness in U.S. and World economies, but the main reason is the unparalleled deflation that is happening with U.S. home values.
This decline of 20 to 25% in some markets is causing extreme weakness in banks, savings and loan, credit unions and in the large number of institutions that have purchased collateralized mortgage obligations. (And all the other names for these CDO’s) As home values deflate, the banks are taking an increasing number of loan losses that are impairing their capital. The weakness in banks has led to a restriction in lending that has led to a crash in auto sales that has led to more unemployment which has led to more bank weakness. It is a cycle that must be broken.
The U.S. economy is not going to recover until we can stop the decline in house values.
The only way to stabilize house prices is through demand stimulation. The best way to stimulate demand is with CHEAP mortgage rates. If we can provide cheap mortgage money, then buyers will realize that they can own for about the same cost as renting. When buyers then calculate the tax and interest deductibility of owing rather than renting, it becomes a win/win situation.
There are still plenty of employed individuals that can qualify and are willing to buy with the proper incentive. Mortgage funds should be available for first time home buyers only. Otherwise it will disrupt the market and require far too large a quantity of funds. With previous programs, first time home buyers are those who have not owned a residence for at least three years. This would cover younger purchasers as well as older purchasers who have sold their primary residence and for one reason or another, have not purchased a new primary residence.
This is how the program would raise the money to fund a low cost home finance program.
The U.S. government would create a special Treasury bill / bond (A Mortgage Liberty Bond) with a maturity of 20 or 25 years. Legislation can make this bond exempt from both state and federal income taxes. The present rate environment for 10 year T-bills is 3.80% and 4.10% for 30 year T-bills. These are for taxable T- bills. If they carried a tax exempt status from state and federal levies, their rates would certainly be in the 3.5% or lower range. The government could then fund mortgages thought FHA underwriting programs. These loans could be available at a low interest rate of 4.75% which would then allow the government to make a spread over its approximate cost of 3.5%. This spread would cover the cost of administration.
The loans would be insured by FHA and that insurance would accrue to the government in order to provide a loss reserve as would the spread between the bond rate and the borrower’s rate. The mortgages would absolutely require a minimum down payment of 3.5% per FHA rules. No need to provide down payment assistance on a below market mortgage. Every borrower will scramble to find a way to make the down payment for a 4.75% interest rate. The mortgage could easily allow for the standard 3.0% seller contributions. Most standard FHA rules would apply with one major exception; the loan would not be assumable. If these loans are assumable, the mortgages would remain outstanding for too many years and would tie up governmental funds unnecessarily.
In today’s market, and every market I have witnessed in the past 25 years, any rate under 5.0% spurs substantial demand.
The beauty of this plan is that if we can stimulate the demand for first time home purchases, then the sellers of these starter homes can move up to more expensive homes and those sellers to more expensive homes and so on. This increased velocity of home sales will stimulate the economy and will halt the decline in home prices.
When implemented this program would create excitement among first time home buyers.
New home builders would be eligible for this program and as home construction ramps up to meet demand, new jobs will be created.
The best and least expensive way to stop the vicious cycle of deflation and then reduced demand is to lower interest rates. As long as banks are experiencing loan losses from residential mortgages, investors will be unwilling to purchase mortgages, thereby keeping mortgage interest rates high. If the government uses its credit rating to raise inexpensive bond money, that money can be used to fund first time home buyers who will create demand. This plan will work.