You Will Pay for Subsidizing Homes Whether You Purchase a Home or Not
The government shouldn’t be subsidizing home purchases of $1.2 million but that is exactly what they plan on doing. Through Fannie Mae and Freddie Mac, the government will make this possible.. The Federal Housing Finance Agency (FHFA) recently increased the size of mortgage loans that Fannie Mae and Freddie Mac can purchase (the “conforming loan limit“) to $970,080 in “high-cost areas.” Loans for the purchase of houses of up to $1,212,600 are available with a 20% down payment.
Similarly, the Federal Housing Administration (FHA) will subsidize homes up to $1,011,250. That is the cost of a home with an FHA mortgage at the increased “high cost” limit of $970,800 and a 4% down payment.
The regular Fannie and Freddie loan limit will rise to $647,200, implying that a house will cost $809,000 with a 20% down payment. In June 2021, the median price for a home sold in the United States was $310,000. An $809,000 home is in the top 7% of all homes sold in the country. One selling for $1,212,600 is among the top 3%. In North Carolina, where house prices are less exaggerated, an $809,000 house ranks in the top 2%. For FHA loans, the regular limit will increase to $420,680, or a home costing more than $438,000 with a 4% down payment—41% more than the national median sales price.
Subsidizing on Steroids
Ordinary citizens may believe it makes no sense for the government to support people who buy, lenders who lend on, and builders who build such high-priced houses, not to mention Wall Street firms that deal in the resulting government-backed mortgage securities. They are correct.
The increase may make homeownership more accessible and affordable for some borrowers, particularly in more expensive areas of the country. However, the increased limits are likely to exacerbate debate over how large a mortgage is too large for government backing.
By law, loan limits are updated annually using a formula that takes into account national average housing price increases. Mortgage companies can currently back single-family mortgages with balances up to $548,250 in the majority of the country and up to $822,375 in expensive housing markets such as California and New York.
These ceilings are expected to rise to $650,000 in the majority of the country and slightly less than $1 million in the most expensive markets. […]
Fannie Mae and Freddie Mac, which continue to receive an effective guarantee from the US Treasury, will now be putting taxpayers on the hook for the risks associated with financing these homes. It’s not legally a guarantee because of clever financial lawyering, but everyone involved knows it is, and taxpayers are on the hook for Fannie and Freddie, whose massive $7 trillion in assets have only 1% capital to back them up. FHA, which is fully guaranteed by the Treasury, has also insured loans totaling well over a trillion dollars.
Pushing The Price of Homes Over $1 Million
Fannie, Freddie, its government conservator, the FHFA, and sister agency, the FHA, are feeding the already out-of-control house price inflation by pushing for more government-sponsored loans. House prices have now risen by 48% since the peak of the Housing Bubble in 2006. They were up 15.8 percent year on year in October. As the government assists in pushing up house prices, houses become less and less affordable for new families, particularly low-income families, attempting to climb the rungs of the homeownership ladder.
The FHFA is raising the Fannie and Freddie loan-size limits by 18% because the FHFA’s House Price Index has risen by 18% in the last year. The FHA limit increases in lockstep with these changes. These increases are cyclical in nature. They amplify house price increases rather than dampening them, as a countercyclical policy would. Procyclical government policies, by definition, exacerbate financial cycles and harm low-income families, who were the intended beneficiaries.
The contrasting countercyclical goal was eloquently expressed by William McChesney Martin, the Federal Reserve Board’s longest-serving chairman. Martin gave us the most famous of all central banking metaphors while in office from 1951 to 1970, under five U.S. presidents. “The Federal Reserve is in the position of having the chaperone who ordered the punch bowl removed just as the party was really warming up,” he said in 1955.
- Subsidies are generally some form of payment made to the receiving individual or business entity, either directly or indirectly. Subsidies are generally regarded as a more privileged form of financial assistance, as they alleviate an associated burden previously imposed on the recipient or promote a particular action through financial support.
- Subsidies have an opportunity cost associated with them. Consider the Depression-era agricultural subsidy once more: it had very visible effects, with farmers reporting increased profits and hiring additional workers. The hidden costs included what would have happened to those dollars in the absence of the subsidy. Subsidies had to be deducted from individual income, and consumers were hit again when grocery store prices increased.
Long after the current housing price party has become not only warmed up, but positively tipsy, the Federal Reserve of 2021 has been spiking the punch instead of removing the punch bowl. It has accomplished this by, in addition to maintaining historically low short-term interest rates, purchasing hundreds of billions of dollars in mortgage securities, thereby maintaining abnormally low mortgage rates and continuing to heat up the party.
In general, a strong housing finance system requires less government subsidy and distortion rather than more.
In fact, the government has upped the ante on the housing party in three ways. The first is the Federal Reserve’s purchases of mortgage securities, which have ballooned its mortgage portfolio to $2.6 trillion, or roughly 24 percent of all outstanding residential mortgages in the United States.
Second, the government increases the leverage in the housing finance system through Fannie and Freddie, making it riskier. This is true for both income leverage and asset price leverage. This is also true for FHA loans.
In addition, Fannie and Freddie make a higher proportion of large loans with low down payments or high loan-to-value (LTV) ratios than corresponding private markets.
The government’s massive payments and subsidies in response to the pandemic are the third spike in the house price punch bowl. A portion of this ill-advised deficit spending has found its way into housing markets, driving up prices.
The differential impact of house price inflation on lower-income households is a critical housing finance issue. In general, a strong housing finance system requires less government subsidy and distortion rather than more. The issue of increasing the size of Fannie and Freddie loans, and thus those of the FHA, is part of a larger picture of what their overall policy should be.
Who Will Pay for Subsidizing?
Should we support expanding their subsidized, market-distorting, taxpayer-funded activities beyond the $8 trillion they already are? Should they become even more powerful than they already are? Or should the government’s hegemony over the sector and its risk be gradually eroded? That would be a shift toward a mortgage industry that functions more like a market and less like a political machine.
In a nutshell, what is the future of the government mortgage complex, particularly Fannie and Freddie? Should they be larger or smaller? We prefer smaller.
How might this be accomplished? Senator Patrick Toomey, the Ranking Member of the Senate Banking Committee, has introduced legislation that would eliminate Fannie Mae and Freddie Mac’s ability to subsidize loans on investment properties, which is a very appropriate proposal. It will not move forward with the current Congress, but it is the right idea. Similarly, it would make sense to prohibit Fannie Mae and Freddie Mac from subsidized cash-out refis, which increases a home’s debt. Another basic idea, often proposed but never implemented in the past, would be to reduce, not increase, the maximum size of loans that Fannie and Freddie can buy and, by extension, FHA can insure.
Meanwhile, the house price party continues. After all of the spiked punch, how will it end? Almost certainly with a hangover.