Here’s the newest twist on how to stabilize the housing market: price fix the retail mortgage rate at 4.5%, with the government (i.e. you and me) subsidizing the rates for folks who wouldn’t otherwise be able to afford the mortgage payments. My suggestion for stabilizing housing prices is below.
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Excerpted from WSJ, “Low-Interest Mortgages Are the Answer”, Hubbard & Mayer, December 17, 2008
The Treasury Department is considering a plan to offer a 4.5% mortgage for home buyers for a period of time. Let’s hope it does. It would help arrest the decline in house prices that is at the base of the ongoing financial crisis and recession.
In most markets house values are today lower than what is consistent with the average level of affordability in the past 20 years. Current futures markets suggest that house prices will decline by 12%-18% in the next 18 months.
Nonetheless, without policy action house prices are likely to continue falling. Conversely, we see little risk that increasing the demand for housing will touch off another housing bubble. While the economy is contracting, low interest rates would spur housing activity.
A 4.5% mortgage rate is not too low. The 10-year U.S. Treasury yield closed at 2.3% on Dec. 12, 2008. Hence a 4.5% mortgage rate is 2.2% above the Treasury yield, above the 1.6% spread that would prevail in a normally functioning mortgage market.
Recall that a mortgage can be thought of as a risk-free bond plus two possibilities that increase risk to lenders: default and/or prepayment. Historically, the risk of default adds about 0.25% to the interest rate. The remaining spread of the mortgage rate over the Treasury yield represents the risk of prepayment and underwriting costs. With falling house prices, the risk of default could indeed add 0.75% or more for a newly underwritten and fully documented loan.
Moreover, a 4.5% mortgage rate will raise housing demand significantly. A simple forecast can be obtained by applying the 2003-2004 homeownership rates to 2007 households. We use the 2003-2004 home ownership rates because those were the years of the lowest previous mortgage rates (the average mortgage rate was 5.8%).
An increase in the homeownership rate from 67.9 (third quarter, 2008) to 68.6 (the average rate from 2003-2004) would increase homeownership by about 800,000 new homeowners. A simple statistical analysis examining the impact of lower mortgage rates and higher unemployment rates yields an even higher, and firmer, estimate of 2.4 million additional owner occupied homes in 2009.
4.5% mortgage rate that the Treasury is considering also should be available for present homeowners who want to refinance, because of the benefits for the economy as a whole. We calculate that up to 34 million households would be able to do so, at an average monthly savings of $428 — or a total reduction in mortgage payments of $174 billion.
Research article:
http://www4.gsb.columbia.edu/realestate/research/housingcrisis/mortgagemarket
WSJ article:
http://online.wsj.com/article/SB122948162452913103.html
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Ken’s Way:
Eliminate capital gains taxes on all residential property that is acquired during 2009 and 2010, provided that the property is held at least 24 months. (Note: that the tax exclusion would depend on both the purchase date and the holding period)
The goal: get private investors — large and small — to buy residential property (i.e. houses) and rent them to folks who neither really can’t afford to buy a house on their own. To sweeten the deal, let landlords depreciate the property on a highly accelerated basis for income tax purposes, and allow all current tax losses to offset ordinary income when calculating taxes.
It would be a win-win. Investors would have a place to park their money; more rental housing would be available for non-owners; tax payers wouldn’t have to subsidize anything.
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