An intensified effort to exploit government control of Fannie Mae and Freddie Mac to drive down US mortgage costs and cushion a decline in house prices could start soon.
This might begin in the final weeks of the Bush presidency and is likely to continue under Barack Obama’sadministration.
By the time it is over, the US taxpayer could own a large chunk of the US residential mortgage-backed securities market.
The Federal Reserve has already stated its intention to buy $600bn (€449bn, £401bn) of Fannie and Freddie securities and is interested in doing more. Meanwhile, support is building for a plan to offer government-funded 4.5 per cent mortgages for new home purchases that would be sold by banks, securitised by the mortgage giants and sold on to the government.
This proposal – based on an idea by Glenn Hubbard and Christopher Mayer, professors at Columbia University – is being considered by Hank Paulson’s Treasury. Tim Geithner and Lawrence Summers, the president-elect’s economic chiefs, also appear interested.
Mr Paulson may launch a version of the plan, offering 4.5 per cent mortgages for new purchases as a final hurrah before leaving office.
A more ambitious effort to offer 4.5 per cent loans for refinancing – opening the door to a giant government-sponsored refinancing boom that would put cash in the hands of homeowners to support consumption – could follow. The initiatives reflect a recognition that the US authorities have failed to exploit control of Fannie and Freddie and ultra-low government borrowing costs to drive down mortgage rates.
Prof Hubbard told the Financial Times that offering 4.5 per cent loans for new house purchases “would raise house prices by 10 to 12 per cent compared to the baseline” – which he thinks is a further decline of about that magnitude. The plan could be self-financing. If the government borrows at, for example, 2.7 per cent, there would be a risk premium of 180 basis points to cover defaults. That could mean the Treasury would launch the plan without funds from Congress, as long as it remained under the overall statutory debt ceiling.
Critics attack the plan for not addressing the supply of homes from foreclosures and say the impact of lower rates on prices could be muted in current economic conditions.
If large-scale borrowing pushed up government borrowing costs and house prices continued to plummet regardless, raising defaults, the plan could prove costly. Nonetheless, advocates argue that this is a risk worth taking.
The Fed is already targeting mortgage rates. The central bank believes it can buy Fannie and Freddie securities without any credit risk because the government now stands behind them. Senior Fed officials are enthused by the impact of their announcement about buying Fannie and Freddie paper and see scope for more large-scale intervention.
The central bank has a limitless capacity to buy Fannie and Freddie securities, providing it is willing to expand the money supply – something that helps guard against deflation. Alternatively it could issue debt to fund purchases, although this would require approval from Congress.
The Fed effort and any new Treasury efforts to hammer down loan rates could operate in parallel. But the two initiatives might come together, with the Fed buying the 4.5 per cent loan securities.
Interest is also growing in a much more ambitious version of the low-cost loan plan that would involve offering 4.5 per cent loans to refinance existing mortgages as well.
This would have some extra effect on house prices but its main importance would be as a macroeconomic stimulus: a de facto tax cut for homeowners.
James Lockhart, Fannie and Freddie’s regulator, said last week they were considering waiving the requirement to get new home price appraisals before refinancing loans they hold – a move that could greatly increase the scope for refinancing.