Obama's Housing Plan: Subsidizing the Terminally Stupid

By: Money_Morning

Martin Hutchinson writes: President Obama on Oct. 24 announced yet another housing bailout.

This time, borrowers who are underwater by more than 25%, are on time with their payments, and have Fannie Mae/Freddie Mac mortgages dating before March 2009 will be allowed to refinance their home mortgages at cheaper rates.

That looks to me like subsidizing the terminally stupid.

Housing loans are non-recourse in most states. So if you're underwater on your home loan by more than 25% and you're paying an above market interest rate of say 6% on your loan, you're paying around 10% of the value of your house to the bank every year (including principal) while being unable to move. Since rental yields are in the 4% to 6% range, you'd be much better off walking away from the house, taking the hit to your credit rating, and renting for a few years.

The problem with all these federal schemes to assist underwater homeowners is that they prevent the market from clearing. That leaves an overhang of properties with owners who either cannot pay the mortgage or have a mortgage hugely larger than the value of their home.

In a free market, a tsunami of foreclosures would have occurred by now, and buyers could be sure that a price bottom had been reached. But in today's market, even though the S&P/Case-Shiller 20-city home price index has shown signs of bottoming out, buyers know there is a lot of artificial support being applied and have no assurance that the market won't lurch downwards again after they have bought.

Yet, economically, conditions are right for the housing market to bottom out.

Third-quarter gross domestic product (GDP) was up at a 2.5% rate, and, more importantly, private sector output rose at a 3% rate. That isn't a raging boom, but it shows that there is no immediate prospect of the economy sliding back into recession.

Interest rates are close to record lows. House prices, having returned on average to about 2002 levels, are now as affordable as they were at the bottom of the last downturn in the early 1990s.

The rental market also is showing considerable signs of strength. Economic recovery and an uncertain housing market are driving people into renting and pushed rents up. That, together with the overhang of pre-foreclosure homes, is now the principal obstacle to further housing recovery.

Of course, in the more economically vibrant areas of the country, such as the Mountain states and Texas, where unemployment is low, both home purchase and buy-to-rent deals are very attractive for those who can obtain mortgage finance.

The U.S. Federal Reserve is tilting the playing field in favor of those attempting to get mortgages by keeping interest rates ultra-low. The Senate also has voted to tilt the playing field in their favor, by raising the limit of Freddie Mac and Fannie Mae guarantees back to $729,750 - an absurdly high amount for a program that was meant to help the middle class.

However, the banks themselves are being very cautious, restricting lending to those well within traditional parameters of no more than an 80% loan to value ratio and no more than 25% of income consumed by mortgage payments. That helps the rental market, by preventing well-qualified renters from buying homes, but it does nothing for housing market recovery.

Given the restrictions on mortgage availability and the continued overhang of foreclosures and pre-foreclosures, housing stocks remain unattractive. Their land inventories remain a burden and the pace of new home sales remains extremely depressed. Further, even when the housing market recovers it will do so first through the absorption of existing inventory, so the demand for new building will remain low.

A few weeks ago I recommended apartment stocks on the basis that demand for rentals is increasing, rents are increasing, and finance remains cheap. However, they remain highly leveraged and currently sell at a rich multiple of both book value and earnings.

The housing market is bottoming out and if you can get a mortgage, a house is an increasingly good investment. But for equity market investors, there's not much to go for.

Source : http://moneymorning.com/2011/11/07/obamas-housing-plan-subsidizing-the-terminally-stupid/

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