Ok, so Mitch McConnell, of all people, is talking about a new Federal program
to offer 4% mortgages to anyone "credit-worthy." (If anything like this
happens while Barney Frank is in power, "credit-worthy" will be defined
as "has a pulse.")
What will happen if we do this? It's basically the opposite of the things being discussed to fix the banking system. Wouldn't you assume that everyone in America will dash to refinance at 4%? This obviously wouldn't do anything for housing values per se, because of the overcapacity that still exists. But it would certainly make every mortgage more affordable.
I'm not entirely sure yet, but my gut is that it wouldn't necessarily slaughter the banks and other holders of toxic MBS.
Those securities are toxic for a long chain of reasons, but the head of the chain is default risk. If every mortgage in America becomes issued and guaranteed by the government (well, more likely issued through the nationalized banking system, so we can feed some of the profits back to the bank share and debtholders), then the default risk becomes replaced by market (interest rate) risk.
But hasn't mortgage securitization always contained features to hedge against market risk (which in the case of mortgages takes the form of prepayments)? You basically expect that anyone who lends money for mortgages is holding a large slug of 10-year T-notes, or swaps, or some other derivatives, which would show offsetting capital gains in case of prepayments.
Bottom line, this move might not be too destabilizing in the near term. Plus, there's historical precedent, because the New Deal in essence socialized all mortgages.
The real risk here is that to fully socialize US housing finance (worth more than $10 trillion in all), you MUST MUST MUST never allow the 10-year T rate to rise above some historically-appropriate spread to the 4% mortgage target rate. (Today's spread is anomalously high, well over 200 basis points, which is why mortgages "feel" unaffordable now, even though the prevailing market rate, about 5.1%, is far below typical rates during the bubble.)
So if we pin long rates where they are now, you're creating a classic economic imbalance, just like the Chinese undervaluing their currency. The stress will come out somewhere, somehow, unless we get really lucky. The stress will show if we have to keep deficit-spending at extraordinary levels for years to come. It will either show as high inflation, or a collapse of the dollar.
What will happen if we do this? It's basically the opposite of the things being discussed to fix the banking system. Wouldn't you assume that everyone in America will dash to refinance at 4%? This obviously wouldn't do anything for housing values per se, because of the overcapacity that still exists. But it would certainly make every mortgage more affordable.
I'm not entirely sure yet, but my gut is that it wouldn't necessarily slaughter the banks and other holders of toxic MBS.
Those securities are toxic for a long chain of reasons, but the head of the chain is default risk. If every mortgage in America becomes issued and guaranteed by the government (well, more likely issued through the nationalized banking system, so we can feed some of the profits back to the bank share and debtholders), then the default risk becomes replaced by market (interest rate) risk.
But hasn't mortgage securitization always contained features to hedge against market risk (which in the case of mortgages takes the form of prepayments)? You basically expect that anyone who lends money for mortgages is holding a large slug of 10-year T-notes, or swaps, or some other derivatives, which would show offsetting capital gains in case of prepayments.
Bottom line, this move might not be too destabilizing in the near term. Plus, there's historical precedent, because the New Deal in essence socialized all mortgages.
The real risk here is that to fully socialize US housing finance (worth more than $10 trillion in all), you MUST MUST MUST never allow the 10-year T rate to rise above some historically-appropriate spread to the 4% mortgage target rate. (Today's spread is anomalously high, well over 200 basis points, which is why mortgages "feel" unaffordable now, even though the prevailing market rate, about 5.1%, is far below typical rates during the bubble.)
So if we pin long rates where they are now, you're creating a classic economic imbalance, just like the Chinese undervaluing their currency. The stress will come out somewhere, somehow, unless we get really lucky. The stress will show if we have to keep deficit-spending at extraordinary levels for years to come. It will either show as high inflation, or a collapse of the dollar.
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