We should revamp the mortgage market

As the Occupy Wall Street protests continue and the first one is even planned tomorrow right here in Boulder, I’d like to briefly talk about how “Wall Street” screws the average person through the bond and mortgage security markets.

The bond market as it exists today is a “private / public partnership” which, like all such fiascos, means the government joins with big money in designing institutions furthering profit extraction from the public.  It’s done in a number of ways, the most glaring being the institutionalized extraction of “risk-free returns” on government debt.  This is an extraordinary welfare transfer to the rich in which income is received without taking risk.  Notice how this bit of welfare is widely accepted whereas the twin version for labor where perhaps a tiny bit of income may be collected by the poor without working is widely condemned.  By historical standards, current risk-free rates are low but they still represent a transfer to capital of $22,228 per year per million dollars of wealth based on today’s 10 year yield.  As we know from the insights of Modern Monetary Theory, there’s no basis at all for this transfer given that the government can generate its own supply of dollars without cost and always has it within its power to keep interest rates at zero.  If this is surprising, I urge you to review the posts under the monetary tab and to research Modern Monetary Theory on the web.

The subject of this post is the scam called the mortgage market, specifically mortgage backed securities.  As everyone knows, many homeowners in the US are underwater on their homes and cannot refinance for various assorted technical reasons.  The vast percentage of mortgage loans in this country are guaranteed by the government through the entities Fannie Mae, Freddie Mac, and FHA.  While the legal documents on all these loans give borrowers the option of pre-paying or refinancing at any time, millions are unable to do so.  The inability to refinance into lower rates is hugely profitable to holders of these securities as they’re able to collect each month risk-free incomes even higher than the $22,228 they can obtain on the riskless 10 year securities.

For example, an FHA backed GNMA 4.50% security consists of large pools of 5.00% note rates (the difference being government fees and servicing charges) that provide the holder with $45,000 per year per million of riskless income.  These are above market interest rates that are extremely valuable to the holders.  How valuable?  They’re trading today at more than an 8% premium above par or $80,000 per million, an amount representing the hard cold monetary value placed on the inability or unawareness of the borrower to refinance to market rates.  It’s a scam.

Today’s Financial Times has an article on this problem entitled “Move to refinance home loans hits wall”.   It cites a number of very technical reasons borrowers are having difficulty refinancing to lower rates, things like charges for low credit scores and various loan warranties.  We shouldn’t accept the ascertains that the problem is technical, however, since there’s tremendously powerful interests which will be severely hurt if the loans were refinanced to lower rates.  All premiums, like the 8% per above, would disappear into thin air if homeowners had the liberty to obtain market rates.

Here’s what I think we should do.  For starters, the government through the housing agencies should immediately lower all rates on the loans it guarantees to market.  There are many ways it could do this.  I think the agencies should 1) immediately send letters to all borrowers stating it will immediately modify their loan and 2) sign into law a provision that holds all banks and mortgage companies liable for past fraudulent behavior, regardless of the modification.

This would yield tremendous benefits to homeowners stuck at above market interest rates.  But we need to go much further.  The average mortgage rate for new loans today is still at 4.36%, outrageously high considering they’re eligible for inclusion into riskless securities.  The average life of a mortgage today is roughly five years and the five year government yield is just 1.19%, a whopping 3.17% spread!  If we accept that the government can maintain whatever interest rate it desires, and we should, then any positive riskless interest rate is a gift to capital.  One of the goals in a truly democratic society should be to eliminate riskless returns and the government should therefore maintain a zero interest rate on all risk free debt.  There’s absolutely no reason homeowners should have to pay interest just to live in their home and public policy should assure they don’t.  The government should therefore offer zero rate loans to all residents living in the country.  One could expand on this even further, and say that the loans would require principal repayment based solely on one’s income.  There would then never be a need for foreclosure.  One can certainly think of objections to this proposal but they’re not at all insurmountable with just a bit of creativity.  One obvious issue would be the probable need to put in place some cap on housing prices to keep a zero rate policy from leading to housing inflation.

Capitalism has dug society into such a deep hole it’s hard to figure out where to even start.  Money and debt seem to be logical first choices though.