Insights & Advice

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Treasury Floats a Trial Balloon –4.5% Thirty Year, Fixed Rate Mortgage

Last night the U.S. Treasury Department leaked the rough details of a plan designed to boost home sales. The scheme would use the weight of government-owned mortgage giants Fannie Mae and Freddie Mac to ‘encourage’ banks to lend money a full point below existing 30 year, fixed rate mortgages. Okay, I admit, that got my attention.

No, it isn’t a total solution to the housing mess since it does nothing to solve the foreclosure problem, which continues to worsen. Nor does it allow homeowners struggling with high adjustable rate payments to refinance at the lower rate. What it could do however is allow as many as 2.5 million Americans to make a hefty dent in the growing inventory of unsold homes.

To me, the plan would make more sense if they permit re-financings. Otherwise, we would end up with a two-tier interest rate scheme: one rate for new buyers and a higher rate for everyone else. If history is any guide, it would take less than a nano- second before some enterprising mortgage company figures a way to arbitrage the two rates while circumventing the intent of the plan.
Some critics rightfully argue that it would help those least in need of a bail-out. It would allow the wealthy or those with jobs with financial assets to buy up real estate at bargain basement prices with the lowest interest rate in fifty years. True enough but riddle me this, dear reader: how else are we going to get those buyers sitting on the fence to actually plunk money down on a home? Prices have already dropped 20-30% and still the inventory of houses for sale continues to rise. Without an incentive will housing prices have to fall by 20%, 40% or even more?

There will also be a salutatory ripple effect on overall mortgage rates as well as home equity loans. As more and more houses are sold at the lower rate, I believe it will pressure other lenders to lower their rates in order to attract some of that new business. That would benefit those most in need.

Take my situation for example. Fortunately, I’m one of those writers who follow my own advice. Over the last few years I’ve managed to pay down debt. At the same time my wife lost her job this summer and prospects for employment seem dismal. I vacillate between wanting to buy a home closer to work and enjoying my debt-free security. I’ve been looking and waiting for home prices to decline further. If this 4.5% fixed rate plan actually happens, I would be sorely tempted to take the plunge.

Detractors of the plan argue that the last thing the country needs right now is for another couple million of us to go into debt. Since hundreds of thousands of workers are projected to lose their jobs next year saddling oneself with a thirty year mortgage could be financial suicide. Others say that lowering interest rates is what created the housing bubble in the first place and this plan is simply an attempt to revive that process.

Clearly, it would do nothing for those who are unemployed or shortly will be losing their jobs. Banks lend or re-finance on the customer’s ability to re-pay not on what collateral the borrower can put up. Recent forecasts point to a doubling of this year’s 2.25 million foreclosures by the end of 2009 because of job losses and the recession. The government has already begun to address those issues through a variety or programs.

However, Federal Reserve Chairman Ben Bernanke told Congress Thursday that “more needed to be done” to stem foreclosures in the country. He outlined several new avenues lawmakers should consider. No doubt, the new administration will do just that. And yes, it would be nice if someone could come up with one simple solution for the myriad of problems that seem to pop on a daily basis in this economic maelstrom. But wishing gets us no where. This plan actually addresses part of the demand side of this housing problem and because it does it deserves our attention.

Posted in A Few Dollars More, Macroeconomics