US mortgages: US mortgage finance needs a new foundation. Sure, fixing up Fannie Mae, Freddie Mac and the private home loan market is crucial – and remains a work in progress. But the crisis had a third leg: borrowers got ahead of themselves.
In the decade of easy money before the crash homeownership rates shot up to 69 per cent by 2004 from an historical and fairly steady average since the 1960s of roughly 64 per cent. With around 110 million homes in the United States, simplistically this means the lending boom handed some 5 million properties to people who perhaps should never have owned them. As of June, the rate had dropped back to about 67 per cent, implying at least part of the excess has been painfully worked out.
Some of the ways future bubbles could be limited aren’t new. First, borrowers should have to make a decent down payment. Back in 2000, only five per cent of subprime borrowers had no equity in their homes, yet by 2006 – in a market that had more than tripled in volume – some 70 per cent had mortgages worth at least as much as their real estate.
Second, lenders should concentrate on the borrower’s ability to repay the loan rather than on the potential increase in value of the property.
Sure, the crash has already imposed some of this discipline on the market. But credit standards will loosen again – and regulators must be prepared and willing to rein in any recklessness.
One idea is not so obvious: Give lenders recourse to the borrower when a home loan goes sour, not just to the property. That’s how Canada does it, for example, and America’s neighbor had a much less severe downturn. It’s not a panacea, but being on the hook ought to discourage home buyers from borrowing more than they can really afford.
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A fourth idea would be to curtail borrowers’ ability to refinance. The US market is almost unique in offering 30-year, fixed-rate mortgages that can be refinanced at lower rates at very little cost thanks to the involvement of government agencies like Fannie Mae and Freddie Mac. But the uncertainty and built-in expense discourage private sector mortgage lending.
The last in a handful of possibilities would be to reduce or eliminate the deductibility of mortgage interest for tax purposes. Of course, all these measures would make mortgages harder to get, more expensive, or both. But considering the recent damage caused by blind belief in the dream of home ownership, that might be no bad thing.