As long as the federal government continues to indicate they are willing to redraw the promises contained in mortgage loans, investors will be wary of buying more mortgage bonds. Hence the interest rates on mortgages will stay higher than normal. That’s how the Real Estate Center’s Chief Economist Dr. Mark Dotzour sees the recent government takeover of Fannie Mae and Freddie Mac.
“Fannie and Freddie were doing a great job of providing low cost mortgages to a large majority of American families for three decades of the 20th Centrury. Somewhere in recent years, they lost track of their mission and morphed into the largest mortgage bond speculators on the planet,” said Dotzour. “They did this by veering away from their mission of ‘packaging mortgages’ into the risky waters of keeping mortgages and hoping they hold their value. That bet has completely failed, and now they become a part of the problem and not a part of the solution to the housing market.”

Dotzour outlines what he thinks should be done.

“First, they (Fannie and Freddie) should be re-chartered to their original purpose of serving as a conduit for mortgages. They shouldn’t be in the business of holding mortgages as investments.
“Second, the government should monitor the spread between FRANNIE mortgage rates and the ten-year treasury rate. Mortgage rates should be about 1.6 percent higher than the current ten-year Treasury. This means that 30-year mortgages should be about 5.1 percent today.”

Dotzour says there are several reasons why mortgage rates are not down to around 5 to 5.25 percent already.
“First, mortgage bond investors have been very skeptical about the truthfulness of the quarterly earnings reports of FRANNIE for years. Now that they have been temporarily nationalized, this global skepticism should be greatly reduced.”
“Second, members of Congress have been suggesting this year that the interest rates on troubled mortgages should be ‘frozen’ so that the homeowners are not hit with interest rate ‘resets’ that make their payments higher.”
“This sounds great for homeowners that bought more house than they could afford, but it sounds terrible if you are a bond investor. When the federal government suggests interest rate freezes, this is like the government just took away part of your private property. You were expecting to get 2 percent interest for two years and then 6 percent interest on your bond and then the federal government threatens to freeze the rate at 2 percent indefinitely. Consequently, you won’t buy any more of those bonds when there is a threat that the contractual promise in the underlying mortgage could be abrogated.”

Dotzour says the new housing law signed by the President recently allows certain existing mortgages to be “crammed down” to 90 percent of the current value of the home.
“This sounds great for homeowners as well. Say you bought a $500,000 house with a $500,000 mortgage. Today it’s worth $400,000 and the Federal Reserve and Congress both encourage banks to lower the principal amount to 90 percent of the current value. So the loan is reduced from $500,000 to $360,000.
“Who will want to buy any more U.S. mortgage securities when the government is willing to wipe away value of your investments with a stroke of the pen?” asks Dotzour.

Source: Real Estate Center