US housing: Sunset Boulevard
By Suzanne Kapner
Published: August 16 2010 22:38 | Last updated: August 16 2010 22:38
With one child at home and another on the way, Elise and Morgan Richardson of Idaho Falls began looking last spring to buy a home. “You get married, you have kids and you buy a house,” says Mrs Richardson, 26. “That is just the order of things.”
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Buying a home has been a rite of passage for nearly two-thirds of the American population since the 1960s. But as the dream of ownership turned into a nightmare for borrowers who, thanks to easy credit during the recent boom, wound up in homes they could not afford when the market began to collapse four years ago, government officials are for the first time in decades seriously rethinking policies that promoted home ownership as a national birthright.
“The goals of housing policy should be that people are well housed, not necessarily that they are homeowners,” says Raphael Bostic, a senior official at the Department of Housing and Urban Development. Mr Bostic’s views differ from the administrations of Presidents George W. Bush and Bill Clinton, which tried to expand ownership. “We want sustainable home ownership, not just home ownership for ownership’s sake,” Mr Bostic says.
Ownership rates have already fallen from their pre-crisis peak and any further decline could be damaging for Democrats as they head into the November midterm elections. Nearly 10 per cent of borrowers are at least 90 days behind on their mortgages in the average Congressional district, more than two-and-a-half times the rate on election day 2008, according to a Deutsche Bank study. Democratic districts tend to have more troubled borrowers than Republican districts, suggesting Democrats might face greater voter anger over housing.
At the same time, the Obama administration is under growing pressure to tackle the housing problem as taxpayer losses continue to balloon at Fannie Mae and Freddie Mac, the government-sponsored entities that are propping up the mortgage market by buying or guaranteeing almost all new loans being issued today. The debate is expected to heat up today at a Treasury conference that will bring together experts from the private and public sectors – including bank executives, scholars and directors of urban planning groups – and continue to accelerate into the autumn, when several Congressional leaders have promised to make housing reform a legislative priority.
Australia, Ireland, Spain and the UK all have higher home ownership rates than America, and although those countries have suffered from the housing bubble’s collapse, none has suffered quite as much as the US. One reason is that American home buyers had greater access to cheap credit, created by a Wall Street securitisation machine that bundled mortgages, many of which were high-risk subprime debt, into bonds and sold them to investors around the world.
THE GOLDEN AGE
A sector that survived a world war buckles post-bubble
The notion that every American should own their own property dates at least to the Great Depression, when economic upheaval led to a proliferation of drifters and shanty towns. “We want to see a nation built of homeowners,” said Herbert Hoover, at his 1929 presidential inauguration.
It would be five years before legislation was passed to bring that about. The 1934 National Housing act, part of President Franklin Roosevelt’s New Deal, attempted to make ownership more affordable. It established the Federal Housing Administration, which insured mortgages; and the Federal National Mortgage Association, or Fannie Mae, which buys mortgages from banks, freeing them to make further loans. A sibling agency, the Federal Home Loan Mortgage Corporation, or Freddie Mac, followed in 1970.
Back in the 1930s, the average home loan was of short duration, typically three to five years; required a large deposit; and carried high interest rates, putting it out of reach of most. At around that time, government agencies developed long-term loans, later followed by fixed rates, lending stability to the market and making mortgages more widely available.
But it was after the second world war that the age of home ownership came into its own. In addition to programmes guaranteeing loans to returning troops, a great migration to the suburbs fuelled the idea of ownership as an integral part of the American dream. By 1968, ownership rates had soared from 45 per cent to 64 per cent, where they stayed for the next three decades.
Then the game changed. Presidents Bill Clinton and George W. Bush introduced policies that helped create a housing bubble by promoting low deposits and relaxed lending standards.
“One of the great successes of the United States in this century has been the partnership forged by the national government and the private sector to steadily expand the dream of home ownership to all Americans,” Mr Clinton said in 1995.
A decade later, with ownership rates peaking at 69 per cent, the market was poised for a nose dive. By 2006, prices were starting to slide; they have since crashed almost to pre-bubble levels. Borrowers who had taken out subprime loans beyond their means with high interest rates, and those who had paid no deposit, soon wound up owing more than their homes were worth.
The ripple effect on the economy triggered today’s high unemployment levels, making it hard even for prime borrowers to stay up to date with payments and creating an ever widening circle of defaults.
Ownership rates have already fallen to about 67 per cent, and most experts say they are likely to sink further.
They “are trending downward”, says Bill Gross, founder of Pimco, which runs the world’s largest bond fund. “The big question is what the correct percentage should be.”
But analysts also point to US public policy, which pushed ownership at the expense of rentals. The UK flirted with its own policy-induced bubble during the Thatcher era, when discounts made it affordable for lower-income tenants to buy council housing. But the Labour government that ruled from 1997 until earlier this year did not make the programme a priority and in 1999 Gordon Brown, then chancellor of the exchequer, did away with mortgage tax deductions. Other European countries such as Germany have also scaled back ownership subsidies, according to Hans-Joachim Dübel, founder of Finpolconsult, a Berlin-based consultant, but US buyers are still eligible for a lucrative mortgage interest tax credit. And because European mortgages tend to be financed by banks, they often require higher downpayments than government-backed US loans.
“Europeans have abandoned the idea that you can artificially push up ownership rates,” says Mr Dübel. “It’s a lesson the US still has to learn.”
US policymakers have long upheld the benefits of home ownership, including the creation of safer, more stable communities. Studies have even shown that children of homeowners perform better in school than children of tenants. But now some researchers are starting to rethink those assumptions, arguing that a community of renters can be just as stable, so long as those renters are encouraged to stay in their properties for a long time. New York City, which has a large number of renters and also communities that are civically minded, is a prime example. “The benefits of home ownership are largely a myth,” says Dean Baker, co-director of the Center for Economic and Policy Research, a left-leaning think-tank.
The other argument for home ownership has been as a pure investment. Why throw away money on rent, when you can build equity in your home, often for similar monthly payments? While US house prices soared in the past decade, over the longer term they have generally increased about 1 per cent to 3 per cent a year, or no more than inflation. In that respect, stocks would have generated a far higher return. A $100 investment in housing in 1933 is now worth $178, adjusted for inflation. A similar investment in stocks would be worth $932 in today’s dollars, according to Robert Shiller, the Yale economist. The comparison does not account for dividends or the use of debt.
Buying a home also includes legal fees and other costs. For such costs to be recoverable, owners must usually stay in their homes at least five years – and that is in a normal market, not one where prices have declined 30 per cent since 2006, estimates Mr Baker.
Some government officials have started to play down the benefits of home ownership. Speaking in January at a meeting of the American Economic Association, Karen Pence, the Federal Reserve’s chief researcher for household and real estate, argued that homes were a terrible investment. Emphasising that she was speaking for herself and not on behalf of the Fed, Ms Pence said that unlike stocks and bonds, homes were an indivisible asset. “You can’t just slice off your bathroom and sell it,” she said. And because home prices are closely tied to the job market, what amounts to the largest financial asset for most people would decline in value just when they needed it most.
There is another downside to generous subsidies funnelled to homeowners, namely that the US is potentially investing too little in other important areas such as education, infrastructure and technology. At the height of the housing bubble in 2006, for instance, mortgages accounted for nearly half of all US debt issued that year, about double the historical norm, according to Haver Analytics. “We’ve over-emphasised our investment in housing and neglected to invest in education and infrastructure,” says Bill Gross, who, as the founder of Pimco, is the manager of the largest bond fund in the world. “We need to refocus on the production of ‘things’ rather than the production of financial products and houses.”
Administration officials have hinted that they plan to do just that by scaling back some support for government-backed home loans in a broad overhaul of housing finance.
But analysts caution that switching gears will be difficult. Any further decline in house prices could destabilise an economic recovery that has already begun to falter. They add that the government needs to do more to encourage affordable rentals, such as provide tax credits and other incentives to secure financing for these types of developments. “We are looking at ways to make that work better,” says Mr Bostic, the HUD official.
In spite of the best intentions, some experts warn, the US economy has become addicted to artificially high levels of home ownership and any attempt to wean itself could result in a painful withdrawal.
Mr and Mrs Richardson of Idaho Falls finally found the house of their dreams this summer, a five bedroom, two-bathroom colonial-syle property, which had gone into foreclosure and was on the market for $106,000. The couple only had $3,500 saved for a down payment, which normally would have put the home out of their price range. But a new programme offered by the Idaho state housing agency allowed the Richardsons to buy the home with only $1,000 deposit. If the Richardsons default on the loan, taxpayers will foot the bill, through an arrangement with Fannie Mae, which has agreed to repurchase loans from the programme, as long as they do not go bad within six months of issuance.
Susan Semba, the lending director for the Idaho Housing and Finance Association, which administers the programme, said she expects the new initiative to have default rates of about 7.5 per cent. That rate is lower than on loans insured by the Federal Housing Authority, which helps low-income borrowers by requiring down payments of only 3 per cent, but higher than the national average for conventional loans with down payments of 10 per cent or more.
Experts say that this programme is similar to policies that led to the housing mess in the first place. “Unless the economy comes back like gangbusters, homes in many of these areas will continue to fall and people who put little money down will quickly end up with no equity,” says Danilo Pelletiere, the research director for the National Low Income Housing Coalition. “As policies go, it’s more of the same.”
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