The Multi-Pronged Mortgage Debacle Next Year (So Long, “Housing Recovery”)

The feverishly awaited taper announcement, after months of deafening Fed cacophony, is in the can. The Fed, unless it backtracks again, will cut its purchases of Treasuries and Mortgage Backed Securities by $10 billion in January, and possible every month until it’s done with its money-printing and paper buying binge. The program repressed mortgage rates and inflated the value of MBAs.

But mere talk of ending it has sent mortgage rates soaring – and mortgage applications plunging to the “lowest level in more than a dozen years,” lamented the Mortgage Bankers Association. The Refinance Index has crashed. The all-important Purchase Index is now 12% lower than last year.

People who need mortgages to buy homes – hence, not hedge funds, private equity firms, oligarchs, and other sundry investors – have been throttling back. Sales of existing homes slumped for the third month in a row in November, down 4.3%, to a seasonally adjusted annual rate of 4.9 million, 1.2% below last year – the first annual decline in over two years. It’s just getting too darn expensive. Home prices have soared over the last two years. And mortgage rates have soared since May. A toxic concoction.

The average contract rate for 30-year mortgages with conforming loan balances ($417,000 or less) rose to 4.62%, up from 3.59% in early May. Over a full percentage point. Just on taper talk – though the Fed has continued its bond-buying binge with relentless determination. Where will mortgage rates go when the Fed actually stops trying to repress them?

Interesting times.

Now comes part three of the debacle, after soaring home prices and mortgage rates. It was drowned out by the hullaballoo over the Fed’s taper announcement. It came from our favorite bailed-out, taxpayer-owned Fannie Mae and Freddie Mac that purchase mortgages from banks and then either keep them on their books or stuff them into MBAs that they sell with some guarantees. Biggest buyer? The Fed. It has been plowing $40 billion a month into them – to be reduced to $35 billion in January.

The banks love this system because they get the fat fees from originating the mortgage without having to absorb the risks. The GSEs and the Fed run the show. Banks are involved just enough to cream profits off the transaction. It’s not exactly the paragon of a free market.

But there are some efforts underway to encourage private capital to play a larger role. So last week, the Federal Housing Finance Agency announced that it would impose a 10 basis-point increase (1/10th of 1 percentage point) in guaranty fees that Fannie Mae and Freddie Mac charge banks. And now Fannie Mae and Freddie Mac have announced that they would revamp their risk-based matrix of fees that they charge lenders.

Lenders roll these fees into the mortgage, which drives up monthly payments. The change will hit borrowers with a so-so credit score who cannot come up with a down payment of at least 20% – hence the majority of all borrowers – the hardest.

“What had been an exercise by regulators to systematically attract private capital into the mortgage market has now turned into an attempt to shock private capital back into the system,” explained Mortgage Bankers Association CEO David Stevens. “The timing of this could not be worse, especially with the Qualified Mortgage Rule, which is already tightening credit, going into effect in January.”

And with mortgage rates already jumping.

Based on the Mortgage Bankers Association’s analysis, guarantee fees – Loan Level Price Adjustments, they’re called – could increase by 0.75 to 1.5 percentage points for borrowers stuck in so-so credit-score purgatory.

“As a result, a borrower with a 730 FICO score making a 10% down payment will pay an LLPA of 2.25% for a 30-year fixed-rate loan, up from today’s fee of 0.75%,” the Mortgage Bankers Association pointed out. “These increases are in addition to the 10 basis point ongoing guarantee fee increase. The estimated net impact on this borrower would be a 50 basis point increase in the interest rate costing borrowers thousands over the life of the loan.”

Half a percentage point! On top of the full percentage point that mortgage rates have already increased, on top of any increase in mortgage rates that might occur as a result of the Fed’s withdrawal from binging on MBAs. That’s the first hint of what might happen when a subsidized industry as housing is being encouraged to try to stand on its own wobbly feet.

The Mortgage Bankers Association, which represents banks that have gotten fat by creaming off profits from this subsidized process, is now aggressively lobbying against the change. They want neither the Fed nor the taxpayer to abandon them.

It was a “dangerous and misguided” approach, Stevens said. “These fee increases could have a negative effect on the fragile housing recovery and could harm the very potential home buyers and borrowers that the housing market needs to sustain that recovery.”

Of course, home buyers only have to pay the fees if they want to get the lower mortgage rates that these government guarantees make possible. If they don’t want to pay the fees, they can always pay an even higher rate for a mortgage that is not guaranteed by the GSEs. In either case, owning a home is in the process of getting much more expensive.

Hard-pressed consumers are hitting a wall. So, something will have to give: either mortgage rates (if the Fed were to backtrack) or home sales and eventually prices. And that would be the end of the “housing recovery.”

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