Thursday, July 31, 2008

The Housing Recovery Act: Who's Zoomin' Who?

The Housing and Economic Recovery Act that President Bush signed into law yesterday is a good example of how politics drive the government response to the financial and economic crisis. For many months, the Republicans have blocked Democratic legislative efforts to provide assistance to homeowners. Then, the stock prices of Fannie Mae and Freddie Mac nosedived, and the Bush administration was forced to cobble together a bailout for them. A crucial part of the bailout was legislation giving the Treasury Department the authority to provide capital to Fannie or Freddie under whatever terms and in whatever amounts it considered appropriate. When the Republicans tried to get the Democrats to sign off, the Democrats said that homeowner assistance had to be a part of the package. The Republicans wanted the Fannie/Freddie bailout so badly that they swallowed hard and agreed to homeowners assistance.

But the question remains, who really benefits from this legislation? The Republicans--and Fannie and Freddie--got what they wanted: a blank check for Treasury, good until the end of 2009, to make loans to Fannie and Freddie or invest in their stock in order to prop them up. This provision was a clear victory for the Republicans and Wall Street.

What about homeowners? The law authorizes the FHA to help distressed homeowners by insuring up to $300 billion of new 30-year fixed rate mortgages if the lender agrees to write down the mortgage debt to 90% of the home's current appraised value. While $300 billion is a pretty big number, the Congressional Budget Office estimates that only about $68 billion of this authority will be used and that about 325,000 people will be assisted. When you consider that there are several million homeowners who have defaulted or are expected to default on their mortgages, assistance for 325,000 isn't likely to have a big impact on the housing market.

The law also provides for a tax credit of up to $7,500 for first time home buyers. But calling this a "credit" is politics at its most political. The provision is really an interest-free loan, which you have to pay back over 15 years. If you can take the maximum $7,500 credit, you're really getting a loan with an average balance of about $3,750 over its duration. Assuming an implied interest subsidy of 6% (around the interest rate for 15-year mortgages), you're getting about $225 a year on average. Whoop-de-doo. There won't be a surge of new buyers into the market on account of this provision.

The law increases the loan limits for Fannie, Freddie and FHA guarantees to as much as $625,000. However, Fannie and Freddie have already been working with temporarily increased loan limits (to higher levels than $625,000), so this provision doesn't add much except to make higher limits permanent. But Fannie and Freddie's weakened financial condition means they don't have enough capital to underwrite that many new loans. So increasing the limit permanently isn't likely to have a rapid impact on the real estate markets.

The law provides $4 billion to the states to buy and rehabilitate distressed properties. That's an average of $200 million per state. Given that our real estate market runs in the trillions, does anyone think $4 billion will make a big difference?

The law also includes provisions that may actually impede the recovery of the real estate markets. Downpayments for FHA guaranteed mortgages have been increased to a minimum of 3.5%, from 3%. Given the American allergy toward saving, this provision may reduce the number of qualifying borrowers. The law also prohibits seller assistance for downpayments in FHA guaranteed loans. It increases federal regulation of Fannie and Freddie (which also surely will require them to raise more capital). These provisions should strengthen the financial system and discourage some of the stupid lending that has taken place in recent years. But the cost will be less mortgage credit available to home buyers and a longer recovery time for the current real estate market.

When you get down to it, the Republicans and Wall Street got the better part of the deal for the Housing and Economic Recovery Act. They wanted a blank check to support Fannie and Freddie, and got it. Their nightmare, that Fannie or Freddie might land in bankruptcy court before the Presidential elections this fall, is much less likely now than before the new law. The Democrats might claim victory, but coming up with tangible proof of it (especially before the election) could be difficult. Who was zoomin' who when this deal was struck? Almost all the crucial factors in the upcoming election favor the Democrats: the economy is stagnant, unemployment is increasing, inflation is rising sharply, U.S. military adventures overseas haven't produced lasting successes, and no rebound in the real estate market is in sight. But the Republicans displayed a bit of the agility that has kept them in power during most of the last 40 years. This fall's election remains up for grabs.

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