Another Ignorant and Misguided Attack on the 30-Year Fixed-Rate Mortgage

The 30-year fixed rate mortgage provides a reasonable balance between affordability and buying power. Historically, it has been associated with stable housing markets. Despite these facts, some foolishly want to see it replaced with adjustable-rate mortgages.

Irvine Home Address … 14 IRON Spgs Irvine, CA 92602

Resale Home Price …… $839,000

I was born with the wrong sign

In the wrong house

With the wrong ascendancy

I took the wrong road

That led to the wrong tendencies

I was in the wrong place

At the wrong time

For the wrong reason

And the wrong rhyme

On the wrong day

Of the wrong week

I used the wrong method

With the wrong technique

Wrong

Wrong

Depeche Mode — Wrong

I recently wrote the post Government Bureaucrat Recommends Against 30-Year Fixed-Rate Mortgages. The author of that article wrote a scathing and dismissive rant against the 30-year fixed rate mortgage, and he provided no rational arguments for his opposition to its widespread use. I thought it was a one-off written by a crank who had too much coffee that day. Apparently he has company.

I am prone to write stinging rebukes to poorly written garbage on the web, but when I call someone out, I will devote the post to building a factual argument as to why they are wrong. I never ask anyone to just take my word for it because I am some kind of expert. Authority comes from the presentation of data in a compelling argument. Mindless rants don't make authors an authority, it makes them lunatics.

The source article for today's post is horrible. I don't know if the writer is a lunatic, but she certainly is very wrong about her reasons for opposing the 30-year fixed rate mortgage.

The Government's Role in the Housing Bubble

Megan McArdle — Jul 23 2010

I never would have guessed that years in, we'd still be debating the role of the government in the housing bubble. Conservatives are still pinning most of the blame on the Community Reinvestment Act, while liberals are saying that there's no evidence that government played any significant role–unless, perhaps, it was all the fault of Alan Greenspan.

As it happens, I think that the government did play a role. A big role. But I think it's rather subtler, and thus, rather more problematic, than most people on either side are discussing.

To me, the unsung villain of the mortgage crisis is the 30-year fixed rate self-amortizing mortgage with no prepayment penalty. This hothouse creature is beloved of liberals, who like any product that gives the consumer the power to shaft banks whenever it is to their advantage. And it is beloved of conservatives because it smacks of sober citizens taking on modest, stable obligations they can meet.

The 30-year fixed-rate mortgage has been popular among progressives and conservatives alike because it is a good loan product. (Note she used the old term liberals demagogueed by the Right rather than the more fashionable progressives.) She makes a ridiculous straw-man argument that the Left is out to screw the banks. Perhaps some die-hard conservatives who are willing to believe anything bad about progressives will believe that, but the reason the Left likes the 30-year loan is because it provides a means for average wage earners to acquire wealth. Paying down a mortgage through the forced savings of an amortizing mortgage used to be the primary wealth generating mechanism of the middle class — that is until we allowed everyone to rob the piggy bank with HELOCs.

Did you notice the writer setting the emotional groundwork with the phrases "unsung villain" and "hothouse creature" and "the power to shaft banks?" This dismissive language is not presenting a sound argument based on facts, it is setting the stage for an emotional argument based on hyperbole.

But this product is about as stable as a nitroglycerine shot with a TNT chaser.

That statement is complete and utter bullshit. Actually, bullshit is a statement with a casual disregard for the truth — realtorspeak is a good example. The statement above is an intentional lie. A lie cloaked with emotional baggage to disguise its intent.

The 30 year fixed rate mortgage was ultimately at the heart of the Savings and Loan crisis.

That statement is a half-truth used to support a weak argument. The heart of the S&L fiasco was an asset-liability mismatch. Banks often borrow with short-term funds and lend on a long-term basis. The 30-year fixed rate mortgage contributes to this problem, but ultimately this is a financial management problem at banks. Nobody forces banks to underwrite these loans, and nobody forces them to match those loans with short-term deposits. This is a choice banks make that sometimes blows up in their face. Banks could float long-term bonds to match their loans, and they can also offload them to the secondary market; in fact, that is one of the primary arguments for keeping a secondary market in place.

Yes, yes, deregulation set the stage for the ultimate denouement–but the Savings and Loans were deregulated in such a haphazard fashion in part because they were being slowly driven into bankruptcy by their huge collection of low-interest, long-term real estate loans, in an environment where Paul Volcker had briefly driven short-term interest rates up to 20%. While fraud and abuse were certainly rampant, the enormous scope of the problem was not due to S&L officers suddenly becoming more thievish, or regulators more tolerant of thievery, but because everyone in the industry was flopping as wildly a a beached sturgeon in an attempt to keep their banks solvent atop large portfolios of low-interest loans. Meanwhile, whenever interest rates dropped, people would refinance, meaning that even the high-interest loans they did make didn't help much.

The answer to this, as you may recall, was . . . the creation of the massive private market in mortgage bonds. In an environment with a floating currency and considerable worries about inflation, the only thing that can neutralize the risks of the 30-year mortgage is laying them off to as large a pool as possible.

Selling low-interest loans in the secondary market is still the answer. There is no problem here. Banks are currently under no obligation to keep any loans they originate on their balance sheets. During the debates on financial reform, there was a proposal for banks to keep 5% of the loans they originated on their balance sheets, and it was defeated by intense opposition from the banking lobby. Their primary argument was that it created asset-liability mismatch. They were right.

MIchael Lewis chronicles what happened next in the still-terrifyingly-relevant Liar's Poker.

Give me a break. She has now associated all the evils of Wall Street with a 30-year fixed rate loan? Did she really think nobody on the web would call her on that nonsense?

Moreover, this product exists, as far as I can tell, only because of massive government intervention into the markets, a point that Reihan Salam and Chris Papagianis made in their recent, excellent piece.

"As far as I can tell?" I respect that she has the courage to flaunt her ignorance so publicly. The product exists because people demand it. People demand it because it is a good and stable loan product that builds wealth for ordinary Americans. The government supports it because it provides stability in housing markets.

Until the Great Depression, the mortgage was a very, very different product. There was no amortization, and down-payments were often massive–half or more of a home's value. They lasted perhaps 3 or 5 years, and were rolled over if borrowers could not meet the balloon payment. The default crisis of the 1930s resulted from the inability to roll those loans, and so the government stepped in, causing the fifteen year self-amortizing loan to proliferate. This process was especially accelerated by the VA loans that were offered to returning veterans. Eventually, the payment terms stretched out to allow more and more people to buy homes.

This had some curious effects. As aforementioned, it was ultimately not good for banks that were restricted to the kind of boring business many commentators would like to see banks return to: loaning money to consumers and small businesses, and taking deposits.

Yes, that is exactly what banks are supposed to do. Is that boring? Are we supposed to have an exciting banking system? Did everyone enjoy the volatility in our economy over the last several years? It was certainly exciting. Financial innovation is a fallacy. Banks are supposed to be boring, stable institutions. What does she want?

The mismatch between their short-term obligations and their long-term assets too easily becomes catastrophic.

Nonsense. If banks do not properly utilize the tools available to them to prevent asset-liability mismatch, they can certainly go broke, but that is only a catastrophe for the poorly managed bank. It isn't a catastrophe for the economy. She is pointing to some bogeyman that doesn't exist.

It also–at least according to economists I've interviewed–contributed to the long, broad run-up in housing prices that took place in the latter half of the twentieth century.

She must have interviewed some real idiots. The transition from a 50% down interest-only loan market of the Great Depression to the 20% down conventionally amortizing loan market beginning after WWII did see a runup in prices. However, once prices stabilized in the early 1950s, the 30-year fixed rate mortgage provided a stable price-to-income structure with excellent affordability for the next 25 years (see graph below). Even then the system broke down in the late 1970s because allowable DTIs got out of control, not because of the mortgage product.

People price their homes by their monthly payment, and what the bank will lend them. As banks lent more, and longer terms lowered the monthly payment for a given loan amount, people bid up the price of housing. This created the expectation of steadily appreciating home values–something that had not been historically true.

This statement is inaccurate. Robert Shiller did detailed studies on this subject for the book Irrational Exuberance. His studies showed that expectation of appreciation was not present prior to the late 1970s. The 25 year period of stability from 1950-1975 — the heyday of the 30-year fixed rate mortgage — did not have expectation of appreciation. If you look carefully at the chart of inflation-adjusted home prices, you see that prices did not rise faster than the general rate of inflation during this period.

Over time, people began pricing expected appreciation into their purchase price as well, a phenomenon that again, tended to accelerate over time.

No, this was a phenomenon of the first bubble of the late 70s, and with each successive bubble and continued "innovations" which allowed people to access appreciation for spending money, the expectation of appreciation and the desire for free money has created an entire population of kool aid addicts.

Most subtly, and most perniciously of all, it created generations of buyers who thought of all mortgages as thirty-year fixed rate loans.

Perniciously? I wish everyone thought of mortgages as 30-year fixed-rate loans. If they did, we wouldn't have a demand for interest-only and Option ARMs — the real culprits of the housing bubble.

People in other countries understand that their mortgage rate resets when interest rates go up.

I think the author is revealing her hidden agenda here: she is pandering to banking interests that would rather issue adjustable rate mortgages at the bottom of the interest rate cycle. Banks would certainly rather have everyone on ARMs because it offloads the interest rate risk. When interest rates go up, the value of fixed-rate annuities goes down. The value of fixed-rate loans held on bank balance sheets will plummet. I wonder if she it receiving compensation from banking interests?

Even the people who theoretically understood that they were taking on an adjustable rate mortgage didn't have any cultural context for them–no unhappy childhood memories, no newspaper stories, no parents or friends to warn them about what would happen when the loan rate reset. And of course, many very naive people simply assumed that their floating-rate mortgage was fixed–and were rooked by unscrupulous mortgage brokers.

I am not sure what she is arguing for here, but the fact that we have had 25 years of steadily falling interest rates is exactly why some boneheads continue taking out adjustable-rate mortgages when it makes no sense to do so. The next bailout of the mortgage and housing industry will come from those idiots taking out ARMs today. The ARM reset issue hasn't gone away, it has only been temporarily deferred by even lower interest rates.

As I see it, this decades long intervention in the housing market took a terrible toll. And whenever this product went bad, rather than reconsidering its support, the government staged another intervention to keep this type of loan alive.

The first statement is true: government intervention has certainly ruined the housing market, but the connection to the 30-year mortgage is a figment of her imagination.

It gave an implicit guarantee to Fannie and Freddie, deregulated the savings and loans (and then bailed them out), had its regulators and lawmakers help create the market in mortgage securities, and so forth. All the while, it gave a giant tax subsidy to mortgage interest that convinced people they were fools not to buy.

No, the National Association of realtors is what worked to convince people there were fools not to buy. They are bullshit artists who will use any tool available. (Graphic below is from 2006.)

As of this writing, are we rethinking any of it? Will the new head of the CFPA crack down on mortgages that offer prepayment options?

I certainly hope not.

Will lawmakers finally break up Fannie and Freddie and cut off the flow of cheap capital they glean from the implicit government guarantee? Will it get the FHA out of the business of propping up the conventional loan market?

I certainly hope so.

Of course not. There is no constituency for such a thing except for a few crazy libertarians.

It is rare that I find an article that annoys me as much as that one. I don't mind that people promote their agendas. I do it. I just prefer it when people do so with rational arguments based on facts and data. The piece of crap this woman wrote reads like something from a tawdry political blog. Many of the best articles I have read on the web have come from the Atlantic. This isn't one of them.

Palladio Properties is at it again

These guys are very active in the Irvine market. Today we have yet another flip.

The previous owners did not buy at the peak, and they did not abuse their HELOC, but they still over borrowed and lost their home.

  • This property was purchased for $952,000 on 6/16/2004. The owners used a $714,000 Option ARM first mortgage with a 1.25% teaser rate and a $238,000 down payment.
  • They quit making payments in early 2008 and squatted for over two years before being kicked to the curb.

Foreclosure Record

Recording Date: 05/18/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 07/25/2008

Document Type: Notice of Default

http://www.irvinehousingblog.com/wp-content/uploads/images/uploads/01%20Post%20Images%202010-8/Fund%20Party%208-1-2010%20.jpg

If you would like to learn how you can get involved with trustee sales, please contact me at sales@idealhomebrokers.com.

Irvine Home Address … 14 IRON Spgs Irvine, CA 92602

Resale Home Price … $839,000

Home Purchase Price … $708,000

Home Purchase Date …. 6/10/2010

Net Gain (Loss) ………. $80,660

Percent Change ………. 11.4%

Annual Appreciation … 106.3%

Cost of Ownership

————————————————-

$839,000 ………. Asking Price

$167,800 ………. 20% Down Conventional

4.62% …………… Mortgage Interest Rate

$671,200 ………. 30-Year Mortgage

$166,286 ………. Income Requirement

$3,449 ………. Monthly Mortgage Payment

$727 ………. Property Tax

$225 ………. Special Taxes and Levies (Mello Roos)

$70 ………. Homeowners Insurance

$100 ………. Homeowners Association Fees

============================================

$4,571 ………. Monthly Cash Outlays

-$828 ………. Tax Savings (% of Interest and Property Tax)

-$865 ………. Equity Hidden in Payment

$291 ………. Lost Income to Down Payment (net of taxes)

$105 ………. Maintenance and Replacement Reserves

============================================

$3,274 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$8,390 ………. Furnishing and Move In @1%

$8,390 ………. Closing Costs @1%

$6,712 ………… Interest Points @1% of Loan

$167,800 ………. Down Payment

============================================

$191,292 ………. Total Cash Costs

$50,100 ………… Emergency Cash Reserves

============================================

$241,392 ………. Total Savings Needed

Property Details for 14 IRON Spgs Irvine, CA 92602

——————————————————————————

Beds: 4

Baths: 2 full 2 part baths

Home size: 2,600 sq ft

($323 / sq ft)

Lot Size: 3,755 sq ft

Year Built: 2002

Days on Market: 12

Listing Updated: 40370

MLS Number: S624557

Property Type: Single Family, Residential

Community: Northpark

Tract: Aldc

——————————————————————————

Beautiful home located in Northpark Square. 4 Bedrooms and 1 Den. Granite countertop. Hardwood flooring. New carpet & New paint. Built-in BBQ in backyard. Move-in ready.

77 thoughts on “Another Ignorant and Misguided Attack on the 30-Year Fixed-Rate Mortgage

  1. OrangeRenter

    Most Option Arm loans recast (at a fully amortizing market rate) @ year 5… OR when the balance (from making less-than-interest only payments) balloons to 115-125% of the original balance would could easily happen by year 4… Which is exactly when they defaulted.

    This alone counters her stupid argument against the 30-year fixed.

    Clearly these people simply could NEVER afford the true payment to begin with!

  2. lowrydr310

    scottinnj posted an article yesterday about how the governor of NJ vetoed a bill that would have allowed a $15K tax credit to buyers of new homes. I just got around to reading it, and realized that there are so many people who still don’t ‘get it’ when it comes to housing.

    Christie [Gov of NJ] has said that while he would support some economic development programs in other times, the state does not have the luxury of paying for them now.

    What a novel concept! You mean I can’t buy something if I don’t have the money for it? Too bad a majority of voters and lawmakers around the country couldn’t understand this logic.

    Christie argued in his veto the money would have been used by people already committed to buying homes and would “briefly and artificially inflate home values.”

    Bingo

    Assemblyman Louis Greenwald (D-Camden) said the governor has an “alarming misunderstanding of how the tax credit works,” saying it would be at least 18 months until new homebuyers began claiming the credit – meaning it would not affect this year’s budget.

    “If you want to stimulate the economy it’s as simple as building a house,” he said.

    So it’s that simple? Keep building houses, and the economy will be stimulated? If that’s the case, nationalize the homebuilders and just build millions of more homes, that way the realtors profit, banks profit, brokers profit, local governments get higher tax revenues, it’s a giant win, and everybody involved gets stimulated!
    /sarcasm

    Jeffrey Otteau, an East Brunswick-based appraiser who studies the state’s housing market, said the market took a big hit when the federal tax credit expired.

    “Absent a stimulus to the housing market, home prices will decline further, which will put additional downward pressure home prices,” he said.

    Without the stimulus, homes values will dip even further, in the second half of the year, which could push more people into foreclosure, Otteau said.

    So the response is to keep the ‘stimulus’ going indefinitely, or else home values will dip? Is this how free market capitalism works?

    Our nation must get over the obsession with supporting elevated home values. When you start to think of your home as an investment rather than a place to live, you must accept the fact that your ‘investment’ may lose value just like anything else. Expectations of double digit appreciation must be balanced by recognizing that the likelihood of double digit depreciation exists.

      1. Kirk

        Well, in the long term, the commentary is right on. In the near term, we may have to support house prices to keep the economy from collapsing.

        The question is: What do you think will happen if we let house prices rapidly fall to their intrinsic value?

        I think most people here know that we would have many big banks collapse. What does that do to the economy? I actually don’t know at this point. Maybe instead of propping up the banks by propping up house prices we should just have the government let the banks fail and instead put tax dollars to work on projects that make America better. Like nationwide high speed rail or something.

        Well, that’s not going to happen. So, instead we have to prop up house prices for a few more years.

        Not that I like it. This whole fiasco has screwed me over. I didn’t buy, but I’ve wanted a house for years now. Instead, I live in a crappy apartment. So I could save for a house. Imagine that… saving for a house. What an idiot liberal I was.

    1. scottinnj

      The other part of the article that was depressing to me was that the bill passed the NJ senate by a vote of 38-0. NJ’s State Senate is actually controlled 23-17 by the Democratic Party and partisanship in NJ is no less than elsewhere in the country. I doubt you would get a unanimous bipartisanship vote in the NJ Senate to give a lifetime achievement award to Bruce Springsteen.

      That something like this passed 38-0 shows you just how much the real estate industry controls this country.

      1. matt138

        This shows a lack of economic understanding among politicians and voters who elect them. The collectivists have taken over and I can only hope this coming economic tarpit is put on the shoulders of government and not capitalism. capitalism is our best friend. Let the market work sans govt subsidy/intervention. The fatal flaw of anti-capitalists is they assume the way to run a business successfully long term is to screw people and commit fraud. This is nonsense.
        Yes you can do it in the short term but long term market mechanisms weed out the unscrupulous through competition, price, value etc.

    2. different church lady

      Actually, you’re wrong about one thing: McArdle is the very definition of a bullshitter — she simply has no regard for the truth. I’m not sure something like “the truth” in an external sense even exists in her mind. To her the truth is whatever she is thinking at the moment.

  3. Stock Investor

    30-year FRM:
    – 3% – total interest paid = 51%
    – 4% – total interest paid = 71%
    – 5% – total interest paid = 93%
    – 6% – total interest paid = 115%
    – 7% – total interest paid = 139%
    – 8% – total interest paid = 164%

    IMHO, too expensive to be good. 30 years are too long for planning purposes. Almost no equity if house is sold after 5 years.

    1. winstongator

      Her issue is less with the length of the loan, but the fixed-interest rate terms. 15 yr as the main product probably makes more sense, and it would generate a much lower overall level of leverage.

      How to transition to 15yr mortgages? Use the GSE’s!

      1. AZDavidPhx

        Agreed. 15 year mortgages are the way to go as well as higher down payments. Prices on used houses will just have to fall to levels where the folks to can play on those terms. Let the premium go to the construction of new houses and stop pretending that a house’s intrinsic value goes up every year.

          1. IrvineRenter

            I would rather see the 15-year myself. Unfortunately, here in Orange County, that would put a median wage earning family in a 1/1 condo.

          2. winstongator

            What percentage of homes loans between 417k & 729k are GSE purchased in the OC now? What impact would eliminating the high-cost area increased cap have?

          3. Laura Louzader

            Were 15-year mortgages with substantial down -payments to become the industry standard, Orange County house prices would drop, or no one would be able to buy property, would they? Because no sensible buyer is going to pay such a premium over rent with conservative financing. Only ARM loans with low teaser rates and ridiculous DTI ratios made that possible.

            A universe of 15-year-mortgages would stabilize the housing market at much lower values everywhere.

            Given the transition to such a norm would be pretty rocky, especially for people who bought in the past 10 years and are still holding on to houses worth far less than they paid. But transitions are always rough. The sooner we start on the road to frugality and financial sobriety, the better.

          4. lowrydr310

            The only thing that means is that prices need to fall to make that a reality; I can wish all I want but it’ll probably never happen because of the attitudes of nearly everyone toward housing. Nobody wants lower houses, even though that certainly would fix a broken economy. $2000 less spent on interest to the bank is $2000 more spent on some consumer good that may actually help the overall economy.

            On the other hand, if this ‘black swan event’ I hear mentioned every so often actually occurs, things may be a different story. Banks may not want to or be able to lend so much, and there’s a limited supply of prospective buyers with enough for an all-cash or mostly-cash deal.

            Not likely, I know, but it is possible.

          5. Jon H

            ” $2000 less spent on interest to the bank is $2000 more spent on some consumer good that may actually help the overall economy.”

            Hell, in that case, do something about credit card interest. Cap rates, or make it deductible, or something.

  4. Anonymous

    Actually, I agree with the writer for The Atlantic. In Canada, there is no 30 year fixed rate. You can only finance for 5 years. Many years ago, buying a started condo in Canada, we asked the loan officer what would happen if rates were significantly higher in 5 years. He told us we’d have to sell or lose the house.

    Because the rates can fluctuate, the banks can hold them on their own books (matching a 5 year mortgage to 5 year deposits is much easier). Because the banks hold them on their own books, they are much more conservative underwriting because they are not passing the risk along to the govt or a pool of mortage investors.

    There was no financial crisis in Canada and no banking bailout.

    She’s right. It is better overall for the taxpayers that way.

    But since this 30 year loophole exists, someone buying a house today with record low rates is of course better off taking it. It’s just not going to be so good for future taxpayers that get stuck with some unintended consequence later to subsidize the people buying houses today.

    1. IrvineRenter

      The jury is still out on Canada. When interest rates go up and people start losing their homes, we will see if Canada was right or not.

      1. Anonymous

        No body in Canada cares if other people are losing their homes. When I lived there, there were no news stories about homeownership rate going up or down or why doesn’t the govt do something about it.

        If people lose there homes, well, then they lose them. And the banks try to resell them. If the banks make a profit or a loss on it, no one cares because the banks take the profit or loss themselves, there is no govt guarantee or subsidy.

    2. 5 years max

      I think the maximum loan term should be 5 years in order to pay off the house, and for the “owners” to really own it. We would be a much happier and less stressed society.

      1. r€nato

        and then only the wealthy or those who come across a windfall (inheritance, lottery winnings, etc) would be able to afford to own a home; everyone else would likely be renters for life.

        The 30 year FRM strikes a nice balance between affordability and paying off one’s home in a reasonable amount of time.

        Gee, it’s almost as if some folks would like to destroy the middle class… hmmm…

    3. irvine_home_owner

      Is the raw building materials, labor and land cost cheap enough to be able to mortgage a home for 5 years?

      In SoCal… that would be close to impossible for the median income earners. Although it would be nice to see $250k SFRs.

      1. 5 years max

        My statement was all wishful thinking, although many other countries do it in 5 years albeit with about 50% down payment.

        1. irvine_home_owner

          @5ym:

          I understand what you are saying, I’m just wondering if in Canada, the cost of a home is low enough for people to be able to afford 5-year mortgages.

          In Irvine, it was only 10-15 years ago when SFRs were below $300k, now those same homes hover around $600k+… back then I don’t think people could have afforded 5-year mortgages and much less now since incomes haven’t really doubled since then.

          Then again, I don’t think homes cost over twice as much to build now as they did in 1995-2000.

          1. AZDavidPhx

            People have been building houses for a LONG time way before this 30 year mortgage slavery thing became so fashionable.

          2. Anonymous

            You don’t pay the house off in 5 years, you just pay some more down there. It’s like a 5 year fixed that you have to refi at whatever the prevailing rate is when your 5 years are up.

          3. irvine_home_owner

            @anon:

            Gotcha… mixing the original Canada post with 5yearmax’s one.

            So what loan amount do they finance for the 5 years? Is there some guideline to say of the total this house is worth, this is how much we are going to finance and this is what the residual will be after 5 years.

            Sounds like auto leasing.

          4. irvine_home_owner

            Hmm…. couldn’t find how they determine what you are financing for 5 years but I did see the part where they mention at the end of the finance term, you need to refinance again.

            I used their mortgage calculator with an income of $200k per year and $150k to put down (should easily buy you a $750k house here) and used a 5-year amortization… the total price of the home it spat out was $387k.

            I’m assuming reasonably sized SFRs cost that much in Canada… but do people there that make $200k/year buy homes for that much?

          5. r€nato

            and if you can’t afford the new interest rate, just sell your house and move! It’s no big deal, after all… it’s just another market choice, like selecting a different brand of breakfast cereal.

    4. Frank

      They do a similar thing in Switzerland. Borrowers need 20% down and have a fixed rate for 5 years. After 5 years, a new 5-year, fixed loan is made at the prevailing rate. The killer is that loans are amortized over 100 years! It’s essentially an interest-only loan for 15 years, then it becomes a multi-generational loan. They also have an interest tax deduction (on all loans, including credit card loans), so most people constantly refinance in order to keep that deduction.

      I don’t know what the amortization schedule is in Canada.

      1. irvine_home_owner

        Yes… it seems the Canadian mortgages aren’t really 5-year mortgages but more like 5/X “renewable” loans.

        The rate is fixed for 5 years and then you have to refinance again… but the length of the amortization is 25 years (even as high as 35).

        Doesn’t seem too different from U.S. ones other than you can’t lock into a rate for an extended period of time. Not sure how well this mitigates risk other than the 20%-50% required down payment but I guess prices are more closely tied to interest rate.

    5. clone12

      Once upon a time mortgages in the US was just like Canada, where the length of the mortgage was 5 years and borrowers were forced to effectively refinance at the prevailing rate and capital supply every 5 years, there was no government intervention.

      That was 1929.

      So if you’re going to argue that this market structure is the reason why Canada does not have a single bank failure from the current housing bust (which they also experienced, but at a lower level), you have to explain why American bank failed en masse during the Great Depression even though everone had these awesome libertarian-approved 5-year-mortgages back in the roaring 20’s.

  5. winstongator

    This is a nice house, and 12% off 2004 price level…but it sold new for 501k in 2002. Is that right? Was there any remodeling done between the 2002 sale and the 2004 sale? Do you really need to remodel homes after 2 years?

  6. John

    IR,

    How much did Palladio pay for this house?

    it always bother me that if someone flips a foreclosed/auctioned home, the price they bought (usually significantly lower) doesn’t seem to matter for the comps when surrounding homes are listed. the comps seems to discard that low price as if it’s just a aberrant #. and seems like the idiot buyers don’t seem to care either!

    1. IrvineRenter

      Palladio paid $708,000. Trustee sales are not usually listed as comparable sales because they happen in the all-cash market rather than the financed resale market. The argument people make is that these transactions are apples and oranges and only the resale comps should count.

      Trustee sale prices — if it isn’t taken back by the bank — are 15% to 20% lower than resale. If appraisers were required to consider these, loans would stop being approved at resale comp levels, and prices would certainly fall. It would deflate the bubble quicker, but it wouldn’t stop the fall in prices at affordability levels as each new trustee sale would continue to lower comps until prices were well below an affordable equilibrium. As a renter, I think that would be great — at least until the day I bought, then I would want it to stop….

  7. AZDavidPhx

    I agree with the author that our current implementation of the 30 year mortgage with FHA subsidized pathetically low down payments is a big crock. The author also makes a valid point that most buyers have been conditioned to think in terms of payments on a 30 year loan.

    The author does give way too much credit to the role of the 30 year FRM and completely ignores the 0 down mortgages, liar loans, and bank laziness that resulted in way too many deadbeats buying houses. The ARMs just came into play after the banks milked the 30 FRM for all it’s worth.

    Either way, 30 year loans make no sense today where most people sell within 7 years.

    The answer is 50% down payments and 15 year loans. 30 year loans do nothing but pump up the prices.

    Do you seriously think prices will stay at current levels if banks begin offering 50 year mortgages instead of 30 year mortgages? Of course not. The prices will rise to whatever monthly payment can be afforded under that loan product.

    Duh.

    1. irvine_home_owner

      The answer is 50% down payments and 15 year loans. 30 year loans do nothing but pump up the prices.

      Do you seriously think prices will stay at current levels if banks begin offering 50 year mortgages instead of 30 year mortgages? Of course not. The prices will rise to whatever monthly payment can be afforded under that loan product.

      But that doesn’t necessarily mean the opposite will be true… at least not proportionately.

      Will prices on current homes drop to the point where you would have the same payment on a 15-year? Or to a point where 50% down is equal to the same as 20%?

      It’s not just about the financing… the cost (not the price) of the home/land/materials isn’t something you can just magically change based on financing (downward at least).

      1. AZDavidPhx

        I think of it in terms of equity. If you go with 50% down payments then you ensure that the market is not tipped to heavily to the IOU versus cash side. The 15 year time span just ensures that the debtor will escape in a reasonable time period.

        And yes, I think this would absolutely devastate the current pricing in today’s market. Look at how dependent the buyers are on FHA – it is basically what every first timer is using to get a house since they have such crappy down payments. It’s the only way they can keep the music going at this point. Without it, prices would have to drop to levels that these first timers could afford without all the government “help”.

      2. E

        I think that you are putting the cart before the horse here.

        Who’s to say that prices of labor and materials to build a house can’t plummet also. You don’t change them “magically”…it’s all about supply and demand. In this case…it’s the supply and demand for dollars.

        Wages and raw material costs in the U.S. seem to be bubbly too.

          1. lowrydr310

            Ah, but is deflation going to affect the magical value of mystical Irvine land?

            They aren’t building any more land you know…

    2. darms

      My humble opinion is that if all mortgage loans are required to be amortizing (essential!) the key to keeping prices sane is requiring a 20% down payment. Once that is met it seems like the loan term itself doesn’t matter all that much except to the purchaser of course. 20% of ‘WTF’ is a lot tougher to come up with than 0% or today’s 3.5% meaning it would be a great deal less likely the purchaser could pay the ‘WTF’ price. Also very few folks could manage 50% of even a ‘normal’ price. For my $250K house here in Austin I could find $50K down but not $125K.

    3. matt138

      Eliminate gov/t subsidy and let the businessman decide which loans offer the best risk/reward ratio and let the savers decide which bank to deposit funds into based on conservative lending. govt intervention simply distorts this wonderfully efficient dynamic.

      1. r€nato

        yes, businesses never collude and conspire to not offer the products which best benefit consumers… businesses never engage in predatory practices…

        1. matt138

          Yes, breaking the law should be against the law. And that is what govt is for – enforcing laws.

          There will always be a competitor to break the cartel, always.

          And this is the importance of limiting the scope of govt because if you don’t, business and govt collude and conspire by changing the laws.

  8. Major Schadenfruede

    We can talk all day about what the right loan product is for purchasing a house: 15 year with high down payment? 30 year fixed? Perhaps 50 years or ARM’s?

    The correct answer is whatever a lender is willing to provide a borrower, PROVIDED that the LENDER eats the loss if they miscalculated the risk!

    Unfortunately, Washington & Wall St. have prevented this free market dynamic from occurring; the former through the BS of MBS’s and the latter through the BS of GSE’s.

    We will see affordable and stable house prices when their collective interference is removed.

    1. AZDavidPhx

      And we all know that the lenders in today’s market are not willing to risk their own profits. Without Uncle Sam co-signing mortgages, there would be no mortgage market. Government needs to GTF out of the mortgage business and stop trying to “help” everybody. Stick to the constitution – I am with the Libertarians on this one.

      1. matt138

        This inevitably must happen. We can’t afford any more socialization. We are pretty close to critical mass with our debt and economic conundrum. Let’s all put on our big girl pants and start voting for people with the guts to stop the spending/subsidizing because they understand the economic gravity of the situation.

        It’s time to duck the Bush/Obama knockout punch.

      2. Major Schadenfreude

        “Without Uncle Sam co-signing mortgages, there would be no mortgage market.”

        No, there certainly would be a mortgage market. It would be whatever a rational lender believes a borrow could afford. Of course, this would mean house prices would come waaayyyy down.

        Down to rational prices that people can afford!

  9. awgee

    The answer is that it is nobody’s business what term or rate a borrower and lender agree to. the answer is for the government to get out of the real estate and mortgage and interest rate business completely. It is not the length of the loan or the interest rate or the ease of credit or overleveraged banks that is the problem. It is the government’s intervention in those issues that is the problem.

    Get the government out and let banks fail and let homeowners lose their homes to foreclosure, and there would be less of both.

    That which is subsidized will increase. That which is penalized will decrease.

    1. AZDavidPhx

      Exactly right. Without the government greasing the wheels, let’s see what kinds of products these banks are willing to sell us.

    2. Laura Louzader

      Agree with you absolutely. Government intervention created this debacle by insuring lenders against all risk while easing interest rates. Our policy makers created this by policies that promoted debt creation and asset inflation as the means of economic “growth”. Our policymakers then removed all the natural constraints that would have acted as brakes on the recklessness of the financial institutions.

      Unfortunately, government intervention is going to be with us for a long time, because the bulk of the population insists on it, and because it serves the financial concerns so well. So as long as we are forced to bear the costs of the recklessness of lenders, then we have to regulate. All we can do now is insist that regulators put some kind of brake on the risk-taking and insist on appropriate risk management.

      Would it be that we’d never done the S&L or LTC bailouts. Our financial firms would have taken the lesson to heart, that they must bear the consequences of their own recklessness. When we did these two bailouts, we reinforced their recklessness, telling them, in effect, that we would always be there to rescue them from the consequences of their recklessness and malfeasance.

      1. matt138

        Wonderful!

        financial firms, auto industry, the list goes on… this is costing our economy a fortune in real growth.

        any politicians and voters out there who understand this, speak out for it, and stand up for it?

  10. irvine_home_owner

    So get rid of 30-year mortgages AND the mortgage interest deduction?

    Can we get world peace, corporate accountability, efficient government spending, and a unicorn while you guys are wishing for the impossible?

    1. Major Schadenfreude

      “So get rid of 30-year mortgages AND the mortgage interest deduction?

      Can we get world peace, corporate accountability, efficient government spending, and a unicorn while you guys are wishing for the impossible?”

      The “impossible” may be imposed upon us by the bond market.

      Maybe it happens, maybe it doesn’t. If most people don’t think it will happen, then it probably will!

  11. Sam

    I watch this site from a distance (Australia), and often have questions because I lack the relevant context. One of the questions I often consider is that a 30 yr fixed rate mortgage that can be refinanced at any time is difficult to hedge. That is, whoever owns the asset (a bank or a securitised bond/note holder will have to include a premium on the interest rate for any asset/liability mismatch, or the hedge to reduce the mismatch to a more prudent level. Does anyone know how this works?

    I would characterise these loans as a capped rate loan (not a fixed rate loan) – ie the upward rate risk is capped, but the downside available to the borrower. An option in one word.

    The Australian market is predominantly variable rate mortgages (25 or 30 years), with the interest rate risk firmly with borrower. The fixed rate market is there (and is used as upside protection), but the loans include break costs, so the rate risk is again with the borrower. These are easy to risk manage for the lender and we seem to get along fine (GFC provided its potholes). It seems perfectly adequate to create our very own property bubble – the existence of which is under debate at the moment.

    1. scottinnj

      Sam – do you know what debt/income ratios are used by the Aussie Banks to approve loans? The problem in the US was that we essentially allowed extremely high DTI since (a) only a portion of interest was paid in cash (eg option arms) and (b) we didn’t verify income (Subway Sandwich Artists making $150k). I don’t think these have happened in Australia yet the property bubble seems to remain high (except arguably Sydney where there has been some softness as I understand)

      You are right there is an embedded premium in the 30 yr fixed rate loan and to hedge this risk is very difficult. You may recall that in the early 2000’s the National got caught out on this on its Homeside Lending unit in the US (which resulted in a multi billion loss).

      1. Sam

        The general rule I understand has been no more than 30% of post tax income used to service/repay for a prime loan. There is flex on this, subject to other positive factors.

        There is debate about the macro level of average DTI – the debate has used average loan values to family income. The range has been put from 7.5 times (the bears) to 5x or lower (the RBA, among others more sanguine) – go figure. Serviceability has been improved by the lower interest rates on offer until recently. This blog is for the positive (no bubble) http://christopherjoye.blogspot.com/ if you want more. You may note he had a trip to the US to talk at one of Obama’s talk things in thelast year or so.

        Recall the NAB/Homeside issue vividly.

        General view amongst most of my colleagues is that homes in desirable areas are overpriced – I rent in one (I’ve moved a bit), and can’t make sense of the values. However, having run the numbers, the power of leverage to net worth accretion is evident – buy a $1.0m house with 10% equity, or rent a $1.0m house keeping 10% invested and the leverage strategy wins even at very low return rates – you just lose cashflow flexibility. What you need is downside protection – short the housing market. If few people believe the downside story, the downside protection should be cheap.

        The only thing that saved Australia from broader use of stated income loans, very low teaser rates etc was being late to the party. All of our interest was cash paid, and we do have a consumer credit code (UCCC) which is meant to ensure a lender doesn’t provide a loan that the borrower can’t afford. It was starting, and had spread worringly. Thankfully, the wholesale funding model that the non-banks proliferating some of these loans used has collapsed.

  12. Foxhunter

    Careful, McCardle will take to Twitter to defend herself. As seen here:

    http://twitter.com/asymmetricinfo/status/19497467529

    She is the primary reason that my subscription may not be renewed in 2011. I’ve found the content of the magazine (save James Fallows and the occasional J. Green) to be woefully inadequate compared to years past.

    Which sucks.

  13. Bill H

    “I wonder if she it receiving compensation from banking interests?”

    Um, not only yes, but hell yes. That is what she does. You didn’t hear the nonsense she paraded on the “health care reform” debate? I was no fan of that “reform” myself, wanting something targeted more at health care and less at insurance, but her arguments made the Democratic defenses look sane, reasonable and awesome.

  14. Halloween Jack

    Good grief, man, don’t try to engage McArdle on the facts. She’s the kind of glibertarian who had a privileged upbringing due to her dad getting rich off the public tit, and tends to use a lot of technical economic terms and tropes from her MBA to disguise the fact that she doesn’t know what the hell she’s talking about. Whenever a commenter shows up on her blog that can effectively refute her, she threatens to ban them. I wouldn’t be terribly surprised if the Atlantic replaces her soon with one of the kids who subbed for her during her recent honeymoon.

  15. Dave L

    Irvine Renter said:

    “I would rather see the 15-year myself. Unfortunately, here in Orange County, that would put a median wage earning family in a 1/1 condo.”

    Here, let me rephrase that a bit; how does it sound in this version?

    “I would rather see the 15-year myself. Unfortunately, here in Orange County, that would imply a 50% fall in average home prices.”

  16. newhavenguy

    Thorough, and well done.

    After I canceled my print subscription, a nice young woman from the Atlantic called to ask me why. I told her, “Because you give Megan McArdle six figures to impersonate an economics editor.”

    She laughed, and said “We’re getting a lot of that.”

    They have some good writers— Coates and Fallows, Fallows and Coates— but they also have Jeffrey Goldberg… and now, this. UGH.

    She’s exhausted the kids at FMM, and even Susan of Texas is getting fatigued. A brutal and demoralizing job, and I thank you for doing it. I hope that reading the… “work” of Princess Megan does not cause you brain damage, as it has to so many before you. (I am interested in a class action suit, myself.)

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