“The free market for all intents and purposes is dead in America.” – Senator Jim Bunning, September 19, 2008
House Prices Go Vertical
The housing crisis of the mid-to-late-2000s had a devastating impact on countless Americans, some of whom have yet to bounce back. Now, it seems that history is repeating itself.
Recently, the Federal Housing Finance Agency (FHFA) published its U.S. House Price Index (HPI) for September, indicating that U.S. house prices surged by 18.5% from the third quarter of 2020 to the same period in 2021.
In contrast, consumer prices experienced a 6.2% increase over the past year, which feels substantial. Yet, this figure pales in comparison to the nearly threefold rise in house prices during the same timeframe.
Take the Los Angeles Basin, for instance, where the housing market is so misaligned that a 1,200-square-foot fixer-upper in a modest neighborhood is only attainable for the wealthy. Clearly, the astute analysts in Washington have a fix for this.
The skyrocketing housing prices have compelled the FHFA and the government-sponsored enterprises (GSEs) it oversees, Fannie Mae and Freddie Mac, to raise the limits for government-backed loans to nearly a million dollars in select areas.
Specifically, the baseline conforming loan limit for 2022 will be set at $647,000, nearly $100,000 more than the previous year. In high-cost regions, conforming loans are 150% of this baseline, reaching up to $970,800. What’s behind this?
Recall that ultra-low interest rates implemented by the Federal Reserve after the dot-com crash initially fueled the housing bubble of the 2000s. Still, it was really the loosening of lending standards by Fannie Mae and Freddie Mac that magnified the bubble, creating an unlimited flow of credit into the mortgage market.
The GSEs aimed to make housing accessible for all Americans, but their actions had the opposite effect, inflating housing prices beyond reach for the average citizen. Eventually, as fraud proliferated and the credit market suffered, many were left devastated.
It wasn’t until late 2008, when credit markets seized up, that the Federal Reserve initiated aggressive quantitative easing (QE). Importantly, QE did not spark the previous housing bubble; that distinction belongs solely to ultra-low interest rates and GSE actions. QE was a response, not a cause.
Currently, in this new housing bubble, the Fed has been purchasing $40 billion in mortgage-backed securities each month since June 2020. Is it any wonder that house prices have skyrocketed during this period?
As the Fed begins to taper its mortgage and treasury purchases, Fannie Mae and Freddie Mac are increasing their conforming loan limits. This could potentially lead to even more alarming house price increases.
Next, we’ll delve into the motives behind these interventions by the GSEs, but to appreciate their tactics fully, we must revisit some recent history.
Socialized Losses
A moral hazard arises when a party shielded from risk behaves differently than someone fully exposed to it. For example, someone with automobile theft insurance may neglect to secure their vehicle since the insurer bears the cost of theft.
Government bailouts of both lenders and borrowers lead to moral hazards; they foster risky lending and speculative behavior because participants believe they won’t bear the full brunt of possible losses.
Think back to the Savings and Loan crisis of the 1980s. The U.S. government ultimately absorbed around $125 billion to cover the collapse of over 1,000 savings and loan institutions. The roots of this crisis stretch back to Franklin Delano Roosevelt’s establishment of the Federal Deposit Insurance Corporation (FDIC) during the Great Depression.
Afterward, neither borrowers nor banks worried about the possibility of losses, believing the government would step in. This mindset contributed to the Savings and Loan crisis and set the stage for the subsequent subprime fiasco.
During the 2008-09 financial crisis, a significant bailout led to socialized losses, and the Fed’s QE further exacerbated moral hazards. These factors have paved the way for the current housing bubble—and the inevitable crash that will follow.
The government’s guarantee of mortgage securities—up to nearly $1 million in certain regions—encourages reckless lending practices. Banks are less cautious about lending since they can securitize loans and sell them to investors. Meanwhile, investors feel emboldened to engage in speculation because the government has their backs.
Once again, we are witnessing a “heads I win, tails you lose” scenario where banks and investors profit immensely while taxpayers shoulder the losses, setting the stage for widespread fraud.
The Anatomy of a Swindler
FDR, the 32nd President of the United States, was instrumental in establishing Fannie Mae. However, another FDR—Franklin Delano Raines—was responsible for wreaking havoc on its reputation.
The son of a janitor in Seattle, Raines grew up understanding the struggles of the less fortunate. He internalized the belief that having wealth was preferable to being without it.
His time at Harvard University and Harvard Law School exposed him to a different world, leading him to advocate for taxpayer-funded philanthropy for those in need.
Following a lackluster three-year stint in the Carter Administration, Raines transitioned to an investment bank, where he thrived financially. His big break came in 1991 when he became Vice Chairman of Fannie Mae, giving him significant influence over the housing market.
In search of guidance, Raines learned from former President Bill Clinton, serving as the Director of the U.S. Office of Management and Budget from 1996 to 1998. He realized the importance of having a grand vision—a mission so bold it would captivate the world.
In September 1997, while pondering over chicken soup, Raines envisioned a society where everyone had a car, a pot for cooking chicken, and, most importantly, a home. It was then that he devised a plan to increase homeownership, thus setting the stage for his ultimate quest for profit.
Fraudulent Earnings Statements
Raines’s strategy was straightforward, consisting of four main points:
- If low interest rates make housing affordable, then even lower rates will enhance affordability further.
- If a 20% down payment is prohibitive, then 10% will do better, and zero down is ideal.
- If a borrower’s credit score falls short, simply relax the standards.
- If a borrower’s income is insufficient, allow them to state whatever income is necessary to qualify.
With these guidelines in place, Raines launched a program to extend loans to low- and moderate-income earners while easing credit requirements for loans that Fannie Mae purchased.
He promoted the initiative with the claim that it would enable those who were “a notch below current underwriting standards” to access homeownership.
Here’s the process: banks extended loans to people who couldn’t genuinely afford them, and Fannie Mae then bought the bad loans, packaging them with good ones into mortgage-backed securities. Wall Street rated these securities as AAA, selling them globally and generating substantial profits.
Raines actively benefited, overstating earnings and shifting losses while accumulating bonuses that a janitor’s son had only dreamed about. As reported by Jonah Goldberg in a September 19, 2008 article titled, Washington Brewed the Poison, Raines “made $52 million of his $90 million compensation package due in part to fraudulent earnings statements.”
Reform attempts were stymied by Democrats in Congress, unwilling to lose the financial support flowing from Fannie Mae to their campaigns. As stated, “Barack Obama, the Senate’s second-greatest recipient of donations from Fannie and Freddie after [Christopher] Dodd, did nothing.”
Now, just over a decade later, Fannie Mae and Freddie Mac have resumed their old habits.
Here We Go Again
In June 2021, the Supreme Court ruled in Collins v. Yellen that the President could remove the FHFA director without cause. The following day, President Biden replaced Mark Calabria, Trump’s FHFA director, with a temporary appointment.
The FHFA, which regulates Fannie Mae and Freddie Mac, had been working under Calabria to mitigate potential economic damage from these GSEs.
Biden’s appointee immediately reversed this direction, reinstating the very social engineering policies linked to the housing market crash of 2008. Acting Director Sandra Thomas stated:
“There is a widespread lack of affordable housing and access to credit, especially in communities of color. It is FHFA’s duty through our regulated entities to ensure that all Americans have equal access to safe, decent, and affordable housing.”
One might confuse these sentiments with those once expressed by Franklin Delano Raines. The parallels in the impending consequences are undeniable. As the Wall Street Journal notes:
“The administration sees the problem of high housing and rental prices. However, the ongoing inflation caused by its own policies is not deterring it. […] The administration aims to enable those who would typically rent to transition into homeowners. Young families will shoulder the mortgage risks, while Fannie Mae and Freddie Mac will make it more affordable. Investors will purchase these risky mortgages, assured by government backing.”
“Here we go again. The only difference from the events leading to the 2008 financial crisis is that the economy is already grappling with inflation, worsened by the administration’s actions. This will heighten the risks associated with homeownership. Moreover, Fannie and Freddie are now considering mortgages of up to $1 million, rather than the $450,000 limit of the past.”
“The government’s relaxed underwriting criteria will also lower standards for private lenders. Banks will have to adjust their mortgage offerings accordingly to stay competitive. Homeowners will then rush into the market taking advantage of low down payments, driving prices up even further and facilitating cash-out refinancing, sometimes spending that equity on luxury items. This cycle will continue until prices escalate so rapidly that sales slow down, leaving many homeowners unable to settle their mortgages. This can trigger a significant crisis.”
But there’s more to this story…
The Upshots of the New Housing Bubble Fiasco
House prices have already entered bubble territory across numerous regions in the country. Who is driving this demand?
Wall Street. Pension funds. BlackRock Inc. And many others.
Institutional investors have effectively securitized the residential real estate landscape, creating competition for everyday homebuyers and fueling skyrocketing prices.
Take Invitation Homes, for instance, a public company spun off from BlackRock in 2017. This entity receives billion-dollar loans at interest rates around 1.4 percent—roughly half of what regular buyers pay. Often, they purchase homes outright with cash.
According to a recent SEC disclosure, Invitation Homes holds a portfolio valued at $16 billion and generates approximately $1.9 billion in annual rental income. Remarkably, it only takes about eight years of rental payments to recoup the cost of a typical acquisition.
Currently, Invitation Homes owns more than 80,000 rental properties and boasts a market capitalization of $24.6 billion. This financial muscle puts everyday buyers at a distinct disadvantage.
The reality is unsettling. While institutional investors are merely seeking yields in a capital market distorted by the Fed, Washington’s interventions have exacerbated the situation.
The White House fact sheet states:
“As supply constraints have increased, large investors have amplified their purchases of single-family homes in urban and suburban areas. This move fuels the transition of neighborhoods from homeownership to rentals and drives up prices for lower-cost homes, making it more challenging for potential first-time and first-generation buyers.”
“President Biden is dedicated to leveraging every possible tool to rapidly increase the supply of affordable housing for families in need, rather than large investors.”
This rationale supports the FHFA’s decision to raise conforming loan limits. In essence, Washington aims to enhance affordability through the issuance of larger, subsidized mortgages. With this reasoning, one could assume that the decision-making parallels that of a box of rocks.
We all understand where this trajectory leads. First-time buyers, competing against institutional investors, will utilize the government’s lenient lending standards to drive prices even higher. Eventually, the mortgage market will be overwhelmed with fraud and corruption, ensnaring millions of Americans in unmanageable loans. What follows will be the unimaginable…
House prices will decline, shattering the dreams of many.
Sandra Thomas will be perplexed as Congress socializes the losses once more. Public discontent will likely lead to the emergence of another Occupy Wall Street movement. The situation could spiral into chaos.
These are the troubling ramifications of the looming housing bubble.
Sincerely,
MN Gordon
for Economic Prism
Return from The Upshots of the New Housing Bubble Fiasco to Economic Prism
