More Doubts About 30-Year Fixed Rate Mortgages

Here is some further heretical thinking on 30-year fixed rate mortgages from, believe it or not, an economist who works for the federal government’s housing cabal. His name is Patrick Lawler and he works for the Federal Housing Finance Agency.

James R. Hagerty wrote of Mr. Lawler’s comments in the WSJ Developments blog. Here is the gist of what he had to say from Mr. Hagerty:

Now, Americans are very attached to their 30-year fixed-rate freely prepayable mortgages. They like not having to fuss about the possibility of 28% interest rates in 2032, even though most of us will move or die long before then. They love to refinance every time rates drop and then brag to their neighbors about how much they are saving per month.

What they don’t stop to realize often enough is that they are paying a very large price for that privilege– twice.

In the first place, mortgage rates are higher than they otherwise would be. That’s because lenders and mortgage investors must build in protection for the risk that we will prepay and stick them with a lower yield than they were anticipating. Mr. Lawler estimates that Americans pay at least an extra 0.25 to 0.50 percentage point in rates because of this option to prepay without penalty. They also pay another premium-–sometimes a percentage point or two–for having a long-term fixed rate. Over 30 years, that translates into some real money, but no one ever mentions that when bragging to the neighbor.

In the second place, our nation has created the likes of Fannie, Freddie and the FHA to facilitate these oddball 30-year fixed-rate loans, which aren’t normally provided by the private market. For a long while, that seemed like a free lunch. Fannie and Freddie, we were told, were far better able to handle those complex risks than we dumb consumers ever could. But since the government had to rescue Fannie and Freddie in 2008, the taxpayers’ tab for this indigestible lunch has swollen to $145 billion, and it’s still rising. So that’s the second time we’ll pay for our irrational love of American-style mortgages – only this time, we all pay, not just mortgage borrowers.

Meanwhile, other wealthy nations–notably Canada–do without our kind of mortgages and yet somehow manage to have homeownership rates similar to ours. They do not pretend that there are risk-free ways to buy houses on credit.

Apparently Mr. Lawler wasn’t content to stop with a criticism of our infatuation with the 30-year mortgage. He went further and suggested that we could do quite well without Fannie and Freddie at all:

Mr. Lawler then skewered one of the favorite arguments of those who assert that we need Fannie and Freddie–their ability to borrow money all over the world, drawing in foreigners’ savings to finance ever-larger McMansions (which then need to be filled with Asian gadgets and European gewgaws). But why exactly do we need all of that foreign investment in our mortgages? Mr. Lawler asked: “A good case can be made that we massively over-invest in housing.” Indeed, we might be better off investing any money foreigners lend us in something that would help us sell more of our goods and services to those foreigners so we can hope to pay them back one day.

You might want to click through to a post I put up a couple of weeks ago that reviewed the thoughts of Arnold Kling on the 30-year fixed rate mortgage. I said at that time, with little hope that it would happen, it would be refreshing to see more discussion along these lines as we figure out what to do with the GSEs.

Given the amount of propaganda which surrounds the 30-year fixed rate mortgage, I doubt seriously that you can convince the home buying public that there are better alternatives. For that reason alone, I’m pretty sure that it’s likely to be the mainstay of mortgage finance. But at least there are some willing to step up and question its usefulness and if that sparks a broader, open discussion about what to do with housing finance than so much the better.

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