New Bubble May Be Building in 30-Year Mortgages
By Edward Pinto Dec 22, 2011 7:00 PM ET
Bloomberg.com
The 30-year fixed-rate mortgage, the most common way U.S. buyers finance a home purchase, isn’t the ideal instrument its supporters claim it to be.
First, its dominance requires permanent government subsidies. Second, it amortizes slowly, exposing homebuyers to years of unnecessary default risk. Third, it was responsible for two taxpayer bailouts in the last 20 years.
Most important, these mortgages may be behind a new bubble.
The combination of a federal funds rate of almost 0 percent since late 2008 and injections of money into the economy through quantitative easing by the Federal Reserve has kept borrowing rates artificially low. Federally insured banks, thrifts and credit unions hold $1.7 trillion in Fannie Mae-, Freddie Mac- and Ginnie Mae-guaranteed securities, while an additional $2.2 trillion are held by local, state and federal governments and agencies. Both categories have increased by about 30 percent since 2007. As a result the government, banks and other financial institutions backed by the Federal Deposit Insurance Corp. now hold 52 percent of outstanding agency securities. Most are backed by 30-year fixed-rate mortgages.
Federal policy has, in effect, created a closed system whereby the government subsidizes the rate on 30-year mortgages, guarantees the credit risk and then puts itself on the hook for most of the interest-rate risk. Although government protects holders from credit or default risk, these investors are exposed to potentially sizable losses due to changes in the price of the security if interest rates go up.
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If mortgage-loan rates went up only by a moderate amount, say from 4 percent to 5.5 percent, the value of the securities held by banks and other financial institutions would go down by about 6 percent, or $100 billion based on the size of their holdings. A larger increase in mortgage rates -- to say 9 percent -- may put us on the verge of another financial meltdown.
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More: http://www.bloomberg.com/news/2011-12-23/new-bubble-may-be-growing-in-30-year-mortgages-commentary-by-edward-pinto.html
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