The great bad news of housing reform

February 15, 2011

The reform of U.S. housing finance proposed by President Obama will drive the price of mortgages higher and be a disaster for house prices, construction and the real estate industry.

In other words, in helping to kill the illusion that a whole nation can grow rich by living in ever more expensive houses, it will be a very good thing.

The U.S. released a range of proposals for scaling back government involvement in housing last week, all of which are aimed at transforming a mortgage market in which 92 percent of new loans currently carry a government guarantee.

In addition a budget proposal from the Obama administration on Monday included a call to cut across the board by 30 percent a range of tax exclusions for better off Americans, including the mortgage interest deduction so long considered sacrosanct.

The proposal for housing finance reform from the U.S. Treasury Department includes three scenarios for debate, all of which include the gradual winding down over a period of years of Fannie Mae and Freddie Mae, the government sponsored mortgage companies which had to be taken into public conservator ship as losses mounted.

Option one is an almost full privatization of the mortgage market, with small involvement from some agencies which will provide mortgages to narrowly targeted groups such as the less well off.

Option two is similar to option one but with a pre-planned government guarantee of mortgage securities which would come into play only in times of financial stress when the mortgage market might otherwise freeze or suffer a drought.

Option three adds to the mix a government reinsurance plan which would pay off if private market insurers failed, thus increasing liquidity.

So far, the betting is on something close to option two, though to be clear, the very fact that house prices and the housing industries will be so badly hit by this means there is a very good chance it is watered down or never come about at all.

Don’t get me wrong, Fannie and Freddie weren’t principally responsible for the housing bubble and all the ills of an overly financialized and debt-dependent economy.

That being said, the death of the mortgage giants will lead pretty clearly to the following outcomes:
First, mortgage rates will rise, pushing the shakiest borrowers out of the ownership pool and into rental or shared housing.

Second, more expensive mortgages, not to mention diminishing tax breaks, will lead to less expensive housing. People will be able to afford less, will pay less, and will make different, and to my mind better, decisions about what risks to take, how to save and what to consume.

Construction, real estate brokerage and other industries allied to the proposition that we can all grow rich by living in bigger, shinier and more elaborate houses will see less capital flow their way and will, all things being equal, shrink relative to the size of the economy.

The capital that has for generations been diverted from the rest of the economy into housing will trickle back towards where actual productive returns are higher.

Theoretically, that’s great. The U.S. can address its export problem by putting more of its money to work developing things and services that the rest of the world wants to pay for, rather than covering all available counter space with granite.

The problem of course is that it is very possible that a goodly bit of that capital which previously kept the nation’s construction crews and real estate agents busy might not flow to U.S. investment but might very well see better opportunities abroad.

That’s probably simply a risk the U.S. will have to face, but it is going to produce even more pressure to improve education and training. While manufacturing jobs in the U.S. have shrunk from 25 percent of private employment to just over 10 percent since 1980, construction fell by far less, from 6.0 percent to 5.0.

That probably understates the extent to which housing has absorbed lower skilled labor over the past 30 years. Think about industries such as “staging,” the tarting up of houses for sale, which simply did not exist 15 years ago.

That, like the fallacy that housing is more investment than consumption, will slowly be squeezed in coming years as house prices suffer.

Take for example the rise and rise of the size of an average new house, from 1660 square feet in 1973 to a peak of 2521 in 2007.  That was partly a reflection of higher living standards, but also partly the result of a government subsidized speculative bubble in which people believed they were being paid to live in nicer, larger houses. This is especially true given the stagnation of real wages in much of the same period.

The end of the housing illusion, and of the subsidies which fed it, will be difficult, but must be counted as a good thing.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email:


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With mortgage rates already going through the %5, government announcement on a future of Fannie Mae and Freddie Mac, call for higher down payments, debates on a mortgage deductions and with such an inventory of properties being repossessed, – real estate could be buried completely. Can someone imagine couple years ago anything under $150,000 in the Bay Area? I don’t think so. But today’s reality looks completely different. Here are a filtered out properties from MLS for San Francisco and cities around going south up to San Jose. 29 of them as of Feb 15, 2011, primarily in San Jose but there is also San Bruno, Milpitas, Los Gatos, Santa Clara, Fremont etc. See what is going on in an usually recession proof San Francisco and around: click here. Seems like we could charge them on our credit cards very soon. Ha? There are a lot of properties for sale in San Francisco and aroung being much more affordable then ever. You can look on your own at With free MLS access, foreclosures search, short sales links and bank owned REO’s along with current and always updated blog on real estate this site is perfect for those looking to buy something for themselves or as an investment

Posted by ValBayArea | Report as abusive

The housing market is so hyped up on govt intervention, it could not stand on its own to save its own life. Tax breaks, deductions, subsidized mortgages, artificially low rates. The market is in a slow decline thanks to Uncle Sam that will last a long time.


Posted by precisiontrade | Report as abusive