If you want to reduce unemployment in the United States then action, not double-talk, is needed in Washington. And the best way to start taking action to stimulate our economy is through immediate legislation that abolishes Fannie Mae and Freddie Mac and replaces the GSEs with a new entity called the Federal Mortgage Security Guaranty Corporation. And this means that Congress, the Treasury, and the Fed need to get their acts in order now. There is no reason to wait any longer.
Mortgage debt in the United States is $10 Trillion of which about half is currently being managed by the Government (through the GSEs, FHA, VA, Ginnie Mae) and half by private sector banks. Despite the horrific manner in which mortgage debt has been handled in the past, it is time to recognise that we have already paid most of the bill for our past mistakes. And now it is time to move on.
Mortgage debt does not have to be bad debt. In fact, most of the mortgage debt in the United States is good debt. Over the past three years, including the period encompassing the entire period of the Greatest Recession Since the Great Depression, 90 per cent of those who had mortgage debt continued to make their principal and interest payments month after month, keeping their loans current. In other words, more than 90 per cent of Americans continued to honour their debt obligations throughout our Great Recession. Currently, after removing a lot of the bad debt, that percentage has increased to represent nearly 90-five per cent of our remaining mortgage debt obligations.
Like mortgage debt, a U.S. guaranteed mortgage-backed security also does not have to be a bad security. I know because a good portion of my professional career in finance dealt with mortgage-backed securities. For a twelve-year period (1988-2000), including the period covering the S&L crisis, I lead the PricewaterhoueCoopers’ team that was responsible for monitoring the risk of $600 billion of mortgage-backed securities at Ginnie Mae.
How does a mortgage-backed security work? Here is a two sentence primer that fundamentally explains it all. When a mortgagor originally gets, for example, a 5.5% mortgage, it is quickly packaged and bundled with other 5.5% mortgages and put into a security that is then sold to an investor who will collect interest on that security at a 5.0% rate. The remaining 0.5% that the mortgagor pays is used to cover the costs of servicing the loan, foreclosures, and to make a reasonable profit for the entity that issues the security.
A U.S. guaranteed mortgage-backed security means that an investor is assured to receive proper principal and interest payments as the loan is paid down. If the loan defaults or is put into foreclosure, the investor is still guaranteed to recover the remaining principal associated with that loan.
The Great Recession did not come about because we “eased credit in terms of rates” like many economists like to claim, but because we “eased credit to people that did not deserve credit.” And there is a big, big difference between those two different ways of easing.
Every risk manager of mortgage debt worth a grain of salt knows that certain fundamental financial principals should be followed before issuing mortgage credit. A couple of the more standard principals are: (1) the ratio of annual mortgage principal and interest payments should not exceed 31% of a mortgagor’s income; and (2) the ratio of total overall annual debt payments, including that of mortgage debt, should not exceed 38% of a mortgagor’s income. A large part of what happened in the 2000s is that both the GSEs and the banks ignored these principals, and believe it or not, mortgage debt was issued without asking what kind of income the borrower was making.
Every risk manager of mortgage debt worth a grain of salt also knows that ARM loans and other such type of “funny” loans, used to qualify borrowers that could not get the same loan under a fixed rate, are also high risk loans. In fact, history has shown that ARM loans prove to be more risky than fixed rate loans even before ARM loans even get readjusted after their low-rate grace period. Unlike the GSEs and the private banks, the FHA and the VA learned of ARM loan risk a long time ago and essentially shutdown their ARM programs long before the Great Recession.
Who are the investors that currently own the $10 Trillion of U.S. mortgage debt? A number of people own that debt, including the U.S. taxpayer, China, Japan, pension programs, banks, private individuals—the list goes on and on. And do you know what? Not a single one of those debt “investors” lost a single dime these past few years while collecting an annual average return of more than 5.0% on their mortgage security investments. That is a 5.0% return on a guaranteed risk-free investment when inflation has been less than 2.0% if not nil.
Now here is what needs to be done to stimulate the economy and reduce unemployment. For every one of those 90 to 90-five per cent of mortgagors that are current on their debt, who have a mortgage on their primary home under $500,000, the Government should immediately offer to refinance the “existing” loan amount on that primary home at 4.0% fixed rate (without allowing any cashouts). This guarantee should flow through the solid checks using a new underwriting system developed especially for the new Federal Mortgage Security Guaranty Corporation. Believe it or not, with technology, this could be done fairly quickly, and we have already waited longer than we should have to put this action in motion.
As part of this refinancing effort, pay off the investors who own the securities associated with the current mortgage and issue new securities at 3.5%. This is a common refinancing practice that has been going on for more than 20 years and investors are fully aware of the practice.
Now if China, Japan, the individual investor does not want to renew their debt investments by buying these new U.S. guaranteed securities, which most of them will, then OK, let the U.S. Government purchase them. Remember, this is risk free debt backed with substantiation (i.e., debt to individuals that have already proven that they pay their debts throughout a very serious recession). Long term inflation in the U.S. for a number of various reasons is very likely to remain low and a 3.5% risk free interest rate on a U.S. guaranteed security is more than justified and still represents a credit-worthy hedge against inflation.
Refinancing $9.0 Trillion of mortgage debt down to 4.0% from what is now on average 5.5% will reduce American mortgagor annual housing payments by $100 billion. And this $100 billion will provide an immediate and ongoing stimulus to our economy, and unlike Government spending or tax reductions, it will not adversely affect the Federal Budget.
Some of my critics say, mortgage rates are already being offered at 4.0%, so what is so new about what you are professing? My response is this: (1) no cash outs; (2) “every primary” home with a mortgage under $500,000 that has a proven track record of current payments “without questioning currently assessed values”; (3) continued Government guarantees for those loans; and (4) offer only fixed rate refinancing.
Now Washington, if you want to find consensus for my approach, don’t bother talking to three different economists (you’ll get four different responses). And that has been half of your problem. Instead start listening to those 90-five per cent of homeowners out there with a mortgage that still want to believe in their country and who have proven so by honouring their debt responsibilities. As I have said many times before, those are the people that are the true heroes of our recovery, and it is long past time that we reward them.
So my question for you, Washington, is this: How much longer is going to take for you to get your act in order?
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