Wednesday, August 31, 2011

Where are America’s Housing Market and Unemployment Rate Heading?

Keywords or Terms: Housing Market; Fannie Mae; Freddie Mac; Unemployment Rate; Housing subsidies; Nominal Interest Rate; Home Equity Loans; Government Revenue; Loan-to-value ration threshold; Employment Data; Public Employment; Private Employment; Economic Performance Indicators; Veteran Benefits; Social Security Benefits, Medicaid and Medicare Benefits. 

The challenging housing market and high unemployment rate in America inspire a review of past policies and some possible recommendation on the best options available to government to avert Economic Armageddon due to the slumping housing market and painful unemployment problem. Given that no true solution for the depressing housing market and unemployment rate can be complete without addressing government subsidies in the housing, banking and finance sectors, it will be premature to make recommendations that are short-term in unraveling current challenges. Further, it will be superficial to expect long term changes in the housing glut without addressing the underlying issue of subsidized home ownership strategy of the past decades, through subsidies to the US Mortgage Market, via Fannie Mae and Freddie Mac. As Banks refine their lending practices, making home owner’s credit tighter and the mortgage market a little more stable, with huge inventory of foreclosed homes, it may be time for the Federal Government to consider policy strategies that lessen its involvement in both banking and house ownership subsidies to avert the continued slump in the housing market. The blog today undertakes a discussion of strategies to counter the slump in the housing market and the unyielding unemployment problem in America.

Just as it seems infinitesimal at this time for the Federal Reserve to keep nominal interest rate at zero during high unemployment, the expectation that employment will grow without clearing of the housing glut in the market is probably over simplistic and whimsical. The disproportional distribution of the housing glut across many states in the union, complicates the tax revenue base for some bigger cities and markets with huge inventory of foreclosed homes. As the housing glut continues to grow partly due to high unemployment, it maybe necessary to pull out the mortgage interest deduction at 50% rate and initiate the taxing of rental property income to a threshold of 80%. Such policies are likely to increase government revenue, pull back government subsidy to the housing market and assist in the clearing of foreclosed homes in various markets; hence affording for increased activities in the building industry and some form of revenue base for many cities that are hurting due to poor tax base and over inventory of foreclosed homes.

The owner-occupier housing strategy buttressed by full mortgage interest deduction at the end of the year has created a high ratio of property ownership in the recent past. While very helpful to assist in increased home ownership, the challenges of the time demand that we look over most responsive public policies to effect immediate changes in the housing market. It is probably safe to assume that at the peak of the heated housing market, home ownership in the United States reached up to 70% of households. In hindsight, it is probably not the best policy to follow, even though; it places the country at the highest rate of home ownership in the world. The reality of a public policy that deregulated lending practices in mortgage financing and allowed banks to get into dubious derivatives without necessary oversight, is probably part of the reasons why the economy is in a slump and unemployment, out of whack. 

The competitive landscape that fuels cautious consumer behavior was absent just before the collapse of the housing market. Banks and finance houses manipulated screening, administrative and maintenance costs of mortgage loans. The net effective cost of underwriting loans became so small for banks as most  maintenance and administrative costs of mortgage underwriting were defrayed to Fannie Mae and Freddie Mac, who in turn seeded the risk involved in most of these underwriting to government bonds. The less than stellar practice that allowed home-owners to borrow against equity in their homes may work well for high income and rich folks, but it has been a disaster for the low and middle income earners, majority of whom became first time home owner under a vastly deregulated finance and mortgage market. The challenge now is how to restore confidence in the mortgage and housing market.

The insolvency of many banks and insurance companies in the beginning of the recession may partly be blamed for government subsidies of home ownership. The fact that Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Association) under-wrote the lending risks involved in home loans carried by commercial banks and other mortgage finance houses, created an impression that government guarantees aggregate credit risks that is undertaken by the financial institutions. Further, the fact that the bond market financed to some extent, Fannie Mae and Freddie Mac, allowed some banks and a few finance houses to avoid due diligence, which in turn encouraged frivolous mortgage products, which some banks and finance houses probably knew were dubious and criminally culpable, since the end costs of the risk were eventually shifted to taxpayers, but which those banks and finance houses could hardly pass over in the heat of the mortgage debacle.

The implicit federal guarantee of Freddie Mac and Fannie Mae, made effective rate of borrowing for home-ownership artificially low, as these pseudo-governmental institutions, were able to borrow at marginal cost over the treasury bills rate. Although they may want to deny it, mangers at Freddie Mac and Fannie Mae understood that an insolvency of their operations may cause disruptions in the whole financial system; however, they hardly felt any responsibility to adequately inspect all the devious derivatives or bundling from commercial banks and mortgage finance companies doing volume business in real estate lending. With unusual increases in aggregate mortgage delinquency from rising unemployment and sluggish economy, it was just obvious that foreclosure rates were going to go on the increase. With many banks and mortgage finance companies undertaking huge risks, with products like 'zero down, zero payment' for the first 12 months, 'roll into mortgage principal, interest costs of the first six months of a loan', and no one bating an eye-lid at Fannie Mae and Freddie Mac, because these pseudo government institutions considered their securities as substitutes or close to substitutes, for treasury bonds, no wonder the economy went into a spiral when the housing market bottomed out in the middle or at the end of the recession.

Many Americans are still trying to understand what was going on in the mortgage market and what exactly was the contribution of devious financial institutions, whether there were duplicities or omissions of any sort that may be considered criminal; however, as of to date, no one has gone to jail for the size of collateral deviousness involved in the mortgage risks taken by many banks and financial institutions. The tricky thing is, no one has been able to explain truthfully, how these duplicity and criminally culpable negligence have contributed to many Americans loosing their jobs during the recession. Many households have defaulted on their mortgage loans and a few have actually stayed put or walked away, deciding not to pay any more mortgage because their houses had lost too much value and probably are now worth less than half of what they paid for them at the height of the mortgage bonanza or boom. It is probably necessary to see that a few in the financial and mortgage industries went to jail for their complicity, and contribution to the recession; it is probably doubly necessary to investigate the extent to which executives at Fannie Mae and Freddie Mac knew of the devious derivatives sold to them, and which they in turn refinanced in the bond market. Without some form of accountability, it is probably unlikely that this or similar events in the mortgage industry will not repeat themselves.

Fannie Mae and Freddie Mac seem to have been a success story in helping Americans own their first homes, prior to the deregulation of the finance and housing markets. The fact that precipitous deregulation of the financial sector of the economy under President Bush afforded all types of devious marketing and transaction inadequacies, make it imperative that the fault of the tanking  America’s economy be laid squarely at the door step of the last Republican President. Dubious financial instruments or portfolios and renegotiated repurchase agreements littered the banking and mortgage industries, yet no one is paying for these. Imagine the absence of implicit guarantee of Fannie Mae and Freddie Mac for underwritten mortgage portfolios; wouldn't banks have been less frivolous and cautious as they underwrote many of the mortgages that are now in foreclosures? The fact that Fannie Mae and Freddie Mac, pseudo government entities, considered their debts just as safe as treasury bonds, probably led to the debacle in the housing market. It is time to undo the subsidies to the housing market in terms of direct interest rate write-offs for home ownership, to help correct for part of the problems associated with the housing glut and repercussions of high unemployment.

To get away from the housing slump, it may be necessary for government to tax the banks, insurance and mortgage finance companies and use revenue from these financial institutions’ to buy private mortgage loans that were dubious in writing. Use aggregate house values in each market as basis for valuing each delinquent private mortgage loans bought over and insist that newly purchased mortgages involve compulsory mortgage loan insurance to 100% value, plus 50% additional insurance coverage to be carried by banks and insurance companies underwriting mortgage loan for the first ten years. The additional insurance to be carried by banks must be sourced from private insurance companies not Fannie Mae or Freddie Mac. This arrangement will discourage lousy mortgage products marketed by banks and mortgage finance institutions. speculation in the housing markets by short-term investors, seeking to make a buck during the heated housing market.

To deal with the current foreclosure crisis, it is time to evaluate the trend in the liquidation sales revenue of foreclosed homes in various market regions and compare them with market prices of repeat sales index across regional markets. This will allow the government, banks and financial institutions appreciate the average losses in various market and use this as an index for underwriting future loans on mortgage products. It is apparent that the realistic values of homes sold at the peak of the housing boom or mortgage debacle was hardly based on the realistic value of each home sold. It is known that many home owners avoid foreclosures by either selling their homes, refinancing them or paying off the arrears on the mortgage. This edging behavior is likely not to stop except there are incentives for home owners provided by the lenders. The volatility of the housing foreclosures depends on the speediness of either of the latter three actions in the various market regions. Areas with high unemployment has suffered tremendously from the speediness with which either of the three actions were undertaken by home owners. The removal of government subsidies of mortgage interest is to make carrying mortgages at higher loan to income threshold less attractive. Effective interest rates has the tendency to weed out those home-owners likely to default from entering into mortgage contracts that are excessive for their income threshold.

New data on employment has not been very promising. Though companies are recruiting and hiring, the employment rate is not keeping pace with the number of people seeking work.There is going to be a need to re-energize employment by investing in programs to encourage increased and stable employment in virtually all sectors of the American economy, including expansion of public employment. The argument that the private sector creates jobs is well taken; however, cities, counties and state governments have been shedding jobs in recent years at unprecedented rate. Employment programs must not only address increased private employment, there is need to create jobs for teachers, fire-fighters, police and other public employees, if we are to revert the trend of the vehement unemployment rate. Unfortunately, it is fiscally unlikely that the country can afford this choice; however, if Republicans are willing to play ball it is very possible to accomplish this end in the coming twelve months and more.  The United States Congress must get on board now, if the unemployment problem is not going to end up being a political fiasco in the coming general elections.

The job creation strategies anticipated to be released by President Obama must include the following, if a dent is going to be made in the unemployment problem in the country: 1) Subsidies for increased private employment, including investments in schools and college buildings, waterways, airports and highways redevelopments and expansions; 2) ample public employment to be financed with increased government revenue base, including jobs at state, county, towns, cities, parishes, burroughs and similar local governments; 3) investments in social support programs for Afghanistan, Iraq and Libya veterans; 4) private and public reinvestment initiative in health support programs for infants, adults and vulnerable groups; and, 5) encourage the Federal Reserve Bank to increase the nominal interest rate to at least one percent to see what difference this will make in the market place. One thing to definitely avoid and to campaign against, if he so chooses, is an obligatory balanced budget initiative as advanced by the Republicans, as this will only stifle government's ability to react to emergencies as the recent floods, hurricanes and storms in the North East, funding of social safety net as the Social Security Benefits, Veteran's Benefits, Medicare and Medicaid. The aggregate welfare effect of obligatory balanced budget initiative is close to negative, no matter what Republicans may continue to espouse.

Finally, there is the question of whether government subsidies contribute to federal deficit?  A very credible answer to this question is simply this: If the private sector continues to sit on tons of cash in the bank without investing in the economy, the federal government has the obligation to invest in the economy to prevent further deterioration of the economy. The essence of government spending is to force increased economic activities that can help expand the economy and create jobs. One way for the nation to succeed at this time is to ensure that economic growth and jobs creation are fore-front in the list of things to be done to help expand national income. For instance, Federal Government needs to be innovative in its approach to resolving the unemployment problem; and, in its effort at measuring economic performance variables or indicators, including how stimulus spending are invested in various sectors of the economy; else, we end up with similar result from previous effort.
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