Policymakers will likely keep mortgage rates low for the next several years because it's the best and cheapest way to heal the housing market, a senior Obama administration official hinted on Wednesday.
In a nearly hour-long, wide-ranging interview with a small group of reporters from various publications, the senior official, who spoke frankly on the condition of anonymity:
- Defended the administration's lackluster foreclosure-prevention initiatives, arguing that a million struggling homeowners benefited from a temporary period of lower monthly payments even though they may ultimately lose their homes;
Critics Target Housing Policy
Experts inside and outside of government have:
- Criticized the administration's housing policy, accusing policymakers of engaging in an "extend and pretend" strategy which calls for extending the time period to achieve success while pretending all's well until that final day of reckoning arrives;
In short, the administration hasn't been aggressive enough, critics say. The senior official said the administration has taken the most effective and prudent steps possible to heal the economy.
The official touted the ever-growing pipeline of homes likely to enter foreclosure as a success in the administration's fight to stem the rising tide of home foreclosures. It's taking longer for homes to enter foreclosure, and it's taking longer to evict homeowners once they enter foreclosure. The so-called "shadow inventory" of homes -- those with severely delinquent mortgages, in foreclosure or already repossessed that have not yet been put on the market -- has significantly grown since the administration took office and is estimated to range from 5 to 7 million homes. Through June, borrowers in foreclosure have been delinquent for an average of 461 days before being evicted from their homes, according to Jacksonville, Fla.-based data provider Lender Processing Services.
That's a good thing, the official said, because it gives the market time to absorb these homes gradually -- without leading to a dramatic drop in home prices. While analysts disagree -- prices will decline when those homes flood the market, which many, like Mark Hanson, a housing industry analyst based in California, believe to be a virtual certainty -- the official pointed to the futures market where traders are betting that home prices will remain stable through the fall of 2014.
But there have been just 40 trades all year through Wednesday, said Mary Haffenberg, a spokesperson for the CME Group, which runs the S&P/Case-Shiller Home Price Index Futures market, the market the administration uses as its benchmark. Last year there were just 720 trades, Haffenberg said. By comparison, about 12 million contracts trade daily across the various CME Group markets. One of its markets sees an average of 2.7 million trades a day, Haffenberg added.
Also, traders are betting that home prices will remain at current levels until November 2014, CME Group data show. In other words, traders believe that homeowners won't see their most important asset appreciate in value for at least the next four years.
The senior administration official said that the only effective way the White House can ensure that prices remain stable is by maintaining low interest rates. To that end, in 2008 and 2009 the Treasury Department purchased about $221 billion in Fannie Mae and Freddie Mac mortgage-backed securities. The twin mortgage giants have also gobbled up nearly $150 billion in taxpayer funds to cover their losses. In addition, the Federal Reserve purchased more than $1.2 trillion in taxpayer-supported mortgage-backed securities, and more than $170 billion of Fannie, Freddie and the Federal Home Loan Banks' debt to keep their borrowing costs low in a cumulative effort to keep mortgage rates down.
However, it's unclear what more Treasury can do to keep rates low. Some Fed officials have advocated that the central bank resume purchases of mortgage securities to support the slow economic recovery.
Low Interest Rates
The Fed will keep the main interest rate near zero for an "extended period" to support the recovery. Some Fed officials, most notably Thomas Hoenig, the president of the Kansas City Fed, believe that maintaining a zero interest-rate policy for an extended period will inevitably lead to asset bubbles: cheap money encourages speculation, and speculation can drive prices to an artificially high level (like housing during the boom years).
Christopher Whalen, a noted bank analyst at Institutional Risk Analytics, said this month that big banks "are busily creating the next investment bubble on Wall Street -- this time focused on structured assets based upon corporate debt, Treasury bonds or nothing at all -- that is, pure derivatives." Whalen said low rates are to blame for this burgeoning bubble.
But the administration official couldn't disagree more. The purpose of low rates is to encourage investment, and that's what the economy needs right now to increase output and help get the nearly 15 million unemployed back to work. Hoenig, the official noted, represents a part of the country with low unemployment. But the national economy needs this further stimulus.
Taxpayer Support For Banks
One of the top priorities for the administration is to pass legislation authorizing the Treasury to lend up to $30 billion to small and medium-sized banks in hopes that they'll lend it out to small businesses. The official said that policymakers should consider similar initiatives for a long period to come because of the exposure many smaller banks have to real estate. Smaller banks over-invested in commercial real estate and housing construction, and many are now paying the price as borrowers are unable to pay back the loans they took out to finance inflated assets. So it would be good policy to support smaller banks as they digest these toxic assets, the official argued.
With about 15 million American workers unemployed -- nearly half of them for at least six months -- the nation risks turning what is now largely a cyclical problem into a long-term structural one, the official said. The longer a worker is unemployed, the more likely they are to lose critical skills. As industries evolve, new skills will be needed. Those out of work for extended periods may not develop the skills needed to compete. That's one of the big risks in today's economy, the official noted. Boosting demand to get the jobless back to work and initiating programs to re-train them will be key to prevent a European-style unemployment situation in which a permanent segment of the population is constantly out of work, said the official.
In February 2009, President Obama vowed in front of an audience gathered at Dobson High School in Mesa, Ariz., that the administration's signature effort, the Home Affordable Modification Program, would "enable as many as three to four million homeowners to modify the terms of their mortgages to avoid foreclosure." The $75 billion initiative -- $50 billion from the bank bailout, $25 billion from government-owned Fannie and Freddie -- was designed to induce lenders, servicers and investors to modify distressed mortgages through a series of cash incentives.
More than 529,000 homeowners have been kicked out of HAMP through June, Treasury figures show. About 1.2 million entered the program with a promise and expectation of permanent relief. Roughly 389,000 are benefiting from the "permanent" modifications guaranteed to keep their payments down for five years. They're saving on average more than $500 a month.
Lenders have repossessed more than three times as many homes during this time, according to data provider RealtyTrac.
The program has been nearly universally panned by housing consultants, Wall Street analysts, economists, and homeowner advocates. But the official was adamant that it was the best option available.
The administration knew they'd only reach a fraction of those needing help, the official claimed, and that millions of homeowners would ultimately lose their homes to foreclosures the administration chose not to prevent. Taxpayer money was on the line, and the administration couldn't justify spending the amount of money it thought would be necessary to save those homes, the official said.
Nevertheless, HAMP remains the best option -- even though it's reaching fewer borrowers than forecast. Other programs, the official noted, would have been either too expensive or unfair. Homeowners who consciously bought more homes than they could afford shouldn't be bailed out.
One of the reasons why HAMP has been effective ties back to the foreclosure pipeline. The official said that because some 1.2 million homeowners entered the program and immediately benefited from a trial period of lower monthly payments, not only were their foreclosures delayed but they also received what was essentially a tax cut of more than $500 a month -- all without cost to the taxpayer, the official boasted. Even though nearly half of those borrowers have been booted from the program, they still benefitted from lower monthly payments courtesy of the Treasury Department with the cost borne by lenders and investors of those mortgages. Plus, at the very least, those homeowners got a chance at a permanent modification, the official said.
Other options, like lowering the overall amount owed on the mortgage (the mortgage principal) or rewriting bankruptcy laws to allow judges to modify the terms of first-lien mortgages on owner-occupied homes, just weren't feasible, the official said. They were either too expensive or Congress wouldn't have supported it.
Reforming The Global Banking System
The official said U.S. and European bank regulators remain very far apart on the basic issue of how much cash banks should hold to guard against losses. U.S. regulators want banks to hold substantially more -- particularly given the fact that the lack of capital held prior to the crisis led in part to the massive taxpayer-financed bailout -- while Europeans believe that's too drastic a step. Though negotiations continue, one bright spot can be found in the fact that the various national bank regulators have agreed on what will define capital. Stronger forms of capital will be better able to support banks during times of crisis.
Critics, like Hoenig, are already dismayed by the fact that global banking giants have been able to dilute the rules on the heels of the worst financial crisis since the Great Depression.