The Goverment's Influence

What role does the government play in the mortgage market? All levels of government impact the mortgage market each through a different avenue.

The local level, county or city, influences the inventory of housing and job creation. Utilizing zoning laws, local municipalities can increase or decrease the rate at which additional housing units come on the market. By creating tax incentives they can attract or hold onto businesses, with the result of increasing the desirability of the community. Local government directly influences the supply/demand equation for housing inventory. This has a direct impact on house values.

Home resale values determine the amount of equity one has in his home and therefore the security of a lender. Mortgage defaults tend to increase in regions with flat or declining real estate value and tend to reduce during times of appreciation. We’re seeing this occurring right now. The areas with the greater defaults are also the areas with the greater depreciation in sale prices.

The State level and to a lesser degree, the local level, sees the housing and mortgage markets as a source of revenue. Government on all levels need funds in order to supply services to the communities. Generally speaking our elected officials prefer to collect the most amount of money from the smallest set of voters. For example, an increase in a sales tax impacts everyone. Those in office run the risk of not being re-elected if too many voters blame them for taking their hard earned money away from them. Collecting money through a real estate transfer tax or a mortgage tax only effects the voters who are conducting a real estate transaction. The set of voters in this category is only a small percentage of the voter population. An elected official stands exposed to lose a lot less votes in this case.

By increasing the cost of executing a real estate transaction the State, government effectively discourages sales. At this level the mortgage market is influenced through a reduction in transactions that results in a lower rate of appreciation or worse, acceleration in the rate of depreciation in a declining market.

For example, let’s look at a property being sold in New York City. The seller will pay a transfer tax to the State of approximately 0.4% of the sales price as well as an additional tax to the City of 1.0 to 2.625% (depending on the type of property) of the sales price. The buyer will be giving the State a mortgage tax of 0.8% of the mortgage amount and an additional 1.0 to 1.8% to the City. If the purchase price is $1 million or greater the buyer will be paying an additional 1.0% of the sales price to the State. These taxes provide a windfall of revenue during a rapidly appreciating market but can discourage sales in a down market. It’s easy to see how large an influence State and local governments can have on a local housing market.

The Federal Government has the largest direct impact on the mortgage market. Washington is constantly searching for the proper balance of taking as many people from being renters to being owners, maintain the integrity of the banking industry, keeping the cost of financing as low as possible for every American and at the same time allow the free market to do its job.

Until The late seventies, the Federal Government set mortgage rates nationwide. This provided a consistency that everyone looking to purchase a home would be facing a 30 year fixed rate mortgage at 8.75% (or whatever the rate at the time was) with 0 points. The downside to this approach was that a lender would only allocate capital to mortgages if they couldn’t get a better return than 8.75% on their money elsewhere. The availability of mortgages would vary over time, reflecting market conditions. It was decided that this was not a healthy situation, especially during a period of high inflation, which was the case at that time. The government decided it was better that mortgage money consistently be available to everyone and allowed mortgage rates to vary, based on market conditions. This created a situation where there would always be mortgage money available but the cost of the money would now reflect market conditions. This decision opened up various options to the borrower. He could now elect to pay points upfront in order to get a lower rate for the duration of the mortgage term. He could borrower money on an adjustable rate to lower the initial payments, etc. This free market of mortgage rates gave the consumer a multitude of choices and gave the industry the opportunity to create products to accommodate the different needs of the borrower giving him even more options. The downside here is that the borrower needed to develop the skill set necessary to make a proper & informed decision.

The bigger problem this created for the mortgage market was that this freedom of pricing combinations and types of mortgage products, could be used by criminals. The same tools that an applicant used to get the best mortgage for his needs could be used by the crimminal to confuse the applicant and take advantge of that confusion. White-collar crime comes in all shapes and sizes, from the lender looking to steal homes out from under an innocent borrower to the thief looking to rip off a lender. The industry, law enforcement and all levels of government are in a constant battle to minimize the criminal activities.

The conclusion here is that the positive effects of a free market mortgage rate environment gives the consumer greater access to mortgages and the ability to capitalize on a low mortgage rate when the time is right. The negative effect is that obtaining a mortgage has become more complicated for the consumer and both the consumer as well as the industry, needs to be diligent in protecting themselves from the criminal element.

The Federal government has had an ongoing goal to increase the number of homeowners in the country. The basis of this focus on homeownership, is the wealth of most American families found in the equity that is built up in their home. The thinking goes that as more people own homes, there will be more families building up equity and therefore, personal wealth. Various government departments and agencies are constantly looking to design programs to aid the first time homebuyer. It’s because of this effort the FHA program was developed. A government insured program that helps people purchase homes with little or no money down, less than perfect credit and/or need more generous qualifying ratios. The government has also encouraged the GSEs as well as the rest of private industry, to create programs to accommodate the needs of first time homebuyers.

It doesn’t matter what industry we talk about, you won’t know that you pushed a standard too far until problems arise. An engineer can’t tell you how much weight a piece of steel can hold without first taking a sample and placing increasing weights on it until it finally breaks. We have pushed the underwriting standards of the mortgage industry to its limits. We know this because we are currently suffering the consequences, increasing number of defaults, foreclosures and depreciation of home values.

The best example of the negative impact of government pressure is what’s currently going on with the GSEs (Fannie Mae and Freddie Mac). They had record profits a year ago. The government reminded them that they have certain obligations, one of which is to keep the cost of mortgages down for as many consumers as possible. The GSEs responded by cautiously loosening their credit standards to permit the better quality Alt-A and subprime borrowers to be eligible for their loan products. This had the positive effect of lowering the cost of financing for these individuals. It also has the negative effect that the GSEs are currently suffering huge loses. In hindsight we can see that the standards shouldn’t have been made as liberal as they were. There was no way of knowing how far they could go without suffering the consequences of going too far.

The current market conditions are leading many to conclude that we should go back to the old ways of lending. Banks holding all mortgages in their portfolio, only lend to individuals with the best of credit, require substantial down payments and don’t let a borrower spend too much of his income on housing expenses. It’s believed that these standards need to be written into law by the government. This would be the worst possible path for the government to take. It would be an over-reaction to the current situation and by putting the standard into law, make it extremely difficult to correct the new problems that this would cause.

The government needs to concentrate on keeping the criminal out of the industry. This is done though mandating accountability of all individuals and entities in the mortgage process and creating monitoring systems that are capable of identifying every company and person that was involved in a particular mortgage. This way when problems arise, patterns will be found and the people and entities responsible for the damage become exposed. Any other government intervention needs to be kept to a minimum.