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Housing in the New Millennium: A Home Without Equity is Just a Rental with Debt
This report assesses the prospects of the U.S. housing/mortgage sector over the next several years. Based on our analysis, we believe there are elements in place for the housing sector to continue to experience growth well above GDP. However, we believe there are risks that can materially distort the growth prospects of the sector. Specifically, it appears that a large portion of the housing sector's growth in the 1990's came from the easing of the credit underwriting process. Such easing includes:

* The drastic reduction of minimum down payment levels from 20% to 0%
* A focused effort to target the "low income" borrower
* The reduction in private mortgage insurance requirements on high loan to value mortgages
* The increasing use of software to streamline the origination process and modify/recast delinquent loans in order to keep them classified as "current"
* Changes in the appraisal process which has led to widespread overappraisal/over-valuation problems

If these trends remain in place, it is likely that the home purchase boom of the past decade will continue unabated. Despite the increasingly more difficult economic environment, it may be possible for lenders to further ease credit standards and more fully exploit less penetrated markets. Recently targeted populations that have historically been denied homeownership opportunities have offered the mortgage industry novel hurdles to overcome. Industry participants in combination with eased regulatory standards and the support of the GSEs (Government Sponsored Enterprises) have overcome many of them.

If there is an economic disruption that causes a marked rise in unemployment, the negative impact on the housing market could be quite large. These impacts come in several forms. They include a reduction in the demand for homeownership, a decline in real estate prices and increased foreclosure expenses....

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A Perfect Storm of Ignorance
You are familiar by now with the role of the Federal Reserve in stimulating the housing boom; the role of Fannie Mae and Freddie Mac in encouraging low-equity mortgages; and the role of the Community Reinvestment Act in mandating loans to "subprime" borrowers, meaning those who were poor credit risks. So you may think that the government caused the financial crisis. But you don't know the half of it. And neither does the government.

A full understanding of the crisis has to explain not just the housing and subprime bubbles, but why, when they popped, it should have had such disastrous worldwide effects on the financial system. The problem was that commercial banks had made a huge overinvestment in mortgage-backed bonds sold by investment banks such as Lehman Brothers.

Commercial banks are familiar to everyone with a checking or savings account. They accept our deposits, against which they issue commercial loans and mortgages. In 1933, the United States created the FDIC to insure commercial banks' depositors. The aim was to discourage bank runs by depositors who worried that if their bank had made too many risky loans, their accounts, too, might be at risk.

The question of whether deposit insurance was necessary is worth asking, and I will ask it later on. But for now, the key fact is that once deposit insurance took effect, the FDIC feared that it had created what economists call a "moral hazard": bankers, now insulated from bank runs, might be encouraged to make riskier loans than before. The moral-hazard theory took hold not only in the United States but in all of the countries in which deposit insurance was instituted. And both here and abroad, the regulators' solution to this (real or imagined) problem was to institute bank-capital regulations. According to an array of scholars from around the world — Viral Acharya, Juliusz Jablecki, Wladimir Kraus, Mateusz Machaj, and Matthew Richardson — these regulations helped turn an American housing crisis into the world's worst recession in 70 years....

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Five Decades of Failure Are Enough
With trillion-dollar deficits as far as the eye can see, policymakers need to scour the federal budget for departments to cut and eliminate. They should start with ones that are not just wasteful, but actively damaging to the economy. Top of the list would be the $60 billion Department of Housing and Urban Development.

HUD's negative impact on the economy is far larger than its multibillion-dollar budget.

HUD's policies played a key role in causing the housing boom and bust and then the recession in its wake. Weak lending standards on HUD-insured mortgage loans helped fuel risky non-prime lending. HUD also put pressure on banks and the failed housing giants Fannie Mae and Freddie Mac to make risky loans to underqualified borrowers. Thanks to those policies, Fannie and Freddie went bankrupt and already have received $112 billion in taxpayer bailouts.

Steady increases in home-buying subsidies in recent decades were motivated by political attempts to curry favor with special interests such as the Realtor and homebuilder lobbies. Politicians justify the subsidies on their claimed civic virtues. But, as we've seen in the wake of the housing bubble's bursting, there's nothing virtuous about putting people into homes they can't afford.

Since the financial crash, the politics of housing subsidies seem to have become even worse. The housing lobby groups continue pushing to expand federal intervention in housing markets, and politicians keep increasing subsides through the Federal Housing Administration and the Government National Mortgage Association, which insure and guarantee more than $700 billion in mortgages and mortgage-backed securities.

HUD's FHA has expanded so much that it is facing the possibility of an expensive taxpayer bailout because of rising defaults on mortgages it insures. As for Ginnie Mae, its portfolio has exploded, and there are growing concerns it could be the next Fannie or Freddie....