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Financing America’s Dreams, or Mortgages Are Risky

December 19, 2017

The recovery from this latest real estate collapse poses some unprecedented challenges.

Since the real estate collapse during the recent Great Recession, home ownership has finally regained its footing as the consummate American dream. But as we look back over the previous seven real estate cycles, the recovery from this latest collapse poses some unprecedented challenges. Over-leveraging, a result of second mortgages and credit card debt, played a significant role in the 2008 financial crisis. Flawed government housing policies, subprime credit, and inadequate documentation compounded the problems.

While all housing cycles have the same components, each has its own distinctive characteristics. This time, uncertainty about the financial stability of government-sponsored enterprises Fannie Mae and Freddie Mac inflated housing prices due to the Fed’s easy money and lower interest-rate policy. The participation of a disproportionate number of cash buyers heating up markets fueled the fire. Less obvious contributing factors included stress on infrastructure systems and the challenges posed by climate change—most importantly, a potential shortage of adequate water supplies.

Cultural and environmental issues, particularly the availability of natural resources, are of concern to the long-range thinkers in the mortgage banking and real estate industries. The western states are beginning to re-experience the conflicting set of values between their urban and rural communities concerning such issues as congestion, water, fracking, zoning, land use regulation, schools, and health care. Critical to Colorado will be the availability of water for communities of the Western Slope and the Front Range. Hanging in the balance is water’s continued availability under the Colorado River Compact. If California and some of the lower Great Basin states exercise some of the provisions of the compact, the amount of water Colorado can take from the river will be reduced. That restriction would definitely hamper Colorado’s future growth. Additionally, the challenge of accommodating growth while mitigating the pressure to convert, and thus lose, our prime agricultural lands is another issue that will involve extensive public debate.

A number of conditions have already resulted in a serious shortage of affordable housing in Colorado and some other areas. One is the easy money policy of the Federal Reserve that has kept interest rates very low for the past decade. Such rates enable a greater number of people to qualify for loans, thus increasing the buyer pool. Another condition is a renewed influx of cash buyers, many anticipating turning a quick profit, now that the economy has experienced sustained growth for several years. Consequently, the surplus of available properties resulting from the foreclosure crisis has been reduced to the point that now the time on the market for residential real estate can be as little as a few hours to 30 days—far below the normal listing period of 90 days. The steady inventory decrease has caused prices to increase, thus creating a substantial shortage of affordable housing. The end result is an affordability problem, particularly for those entering the market for the first time.

Exacerbating the shortage problem are a number of major lifestyle public policy issues. Key among them is balancing density and sprawl. The City of Boulder, which is surrounded by open space, provides an excellent example. Its residents are currently confronting the issue of whether the city should lift building height restrictions to allow high-rise living in order to maintain open space.

The unprecedented increase of regulations imposed by the Consumer Financial Protection Bureau has also had a detrimental effect. Regulatory requirements have resulted in a huge cost burden on the industry that has created unnecessary financing barriers, particularly for middle-income buyers. All of these elements combined have made achieving the American dream more elusive, and it may become even more difficult.

Congress is aggressively working on overhauling the tax code. One current subsidy benefit enjoyed by both the middle-class and the wealthy is the mortgage interest rate deduction. Those at the upper end of the income brackets generally benefit more than those at the lower levels, who often do not itemize their tax returns. The current talking point is to reduce the eligibility for the interest rate deduction to mortgages valued at $750,000 and less; the current limit is $1 million. However, the National Association of Realtors, the National Association of Homebuilders, and the Mortgage Bankers Association oppose this change.

One of the elements of the current Senate tax reform proposal would eliminate the mortgage interest deduction on second mortgages, such as home equity lines of credit. I strongly support this proposal because I believe that it enables, and even encourages, homeowners to become over-leveraged by taking out second mortgages. Ultimately, these additional loans became a major contributing factor to the large number of foreclosures during the Great Recession.

Washington insiders believe that after tax reform legislation passes, reforming the two predominant government-sponsored enterprises related to housing, Fannie Mae and Freddie Mac, will top the Congressional agenda in 2018. Certainly the mortgage banking industry, in which everyone involved has “skin in the game,” is pushing for changes since both enterprises became insolvent and were taken over by the federal government in September 2008. But the key ingredient to the American dream is a 30-year fixed-rate mortgage; and that mortgage cannot happen without the unqualified US government guaranty that is the cornerstone of Fannie and Freddie. So any reform of Fannie and Freddie must continue that sacrosanct mortgage if the middle class is to achieve the American dream.

E. Michael Rosser is a member of the School of Mortgage Banking Master Faculty. He has served as president of the Colorado Mortgage Bankers Association, on the Colorado State Housing Board, and on the Colorado Foreclosure Prevention Task Force. He has received numerous awards from the Mortgage Bankers Association throughout his career including the Distinguished Service Award and Lifetime Achievement Award for his long commitment to industry education. With Diane M. Sanders, he is co-author of A History of Mortgage Banking in the West: Financing America's Dreams.

University Press of Colorado University of Alaska Press Utah State University Press University of Wyoming Press