The Politics of Four Percent Mortgages

In the midst of the recent stimulus debate, an innovative Republican proposal emerged that would allow banks to refinance mortgage loans at fixed interest rates as low as 4%. But if you missed it, it’s understandable. It was immediately killed by the Democratic majority and essentially ignored by the mainstream media. However, since late December, the Federal Reserve has been pushing mortgage rates lower, both through the purchase of mortgage-backed securities and by providing more capital to Freddie Mac and Fannie Mae. Rates for qualified borrowers fell from 6% to 5% in barely three weeks and have remained at that low level.

So will mortgage rates fall to 4%? And should they? And why exactly was that Republican proposal defeated?

First, let’s be clear as to how much money falling mortgage rates can put in consumers’ pockets. The average home price is about $200,000, and let’s assume that entire amount is financed with a 6% mortgage.  A reduction to 4% would save the homeowner $4,000 in interest costs every year. Multiply that by the 85 million homes in America and we get $340 billion in interest savings.

And this isn’t a one-time economic stimulus. That $4,000 is a permanent reduction in household expenses that the borrower can rely upon, as long as they continue to make their mortgage payment. Imagine the boost that could provide to the economy and the pressure it could take off America’s cash-strapped families. It may even jump-start the new home sales market.

If a straightforward mortgage rate reduction that puts $340 billion in homeowners’ pockets every year and could slow or stop further housing declines sounds like a simpler and better alternative than the $787 billion of phony tax rebates and pork barrel spending that was just passed by the Democratic Congress, then you’re probably starting to understand why this Republican alternative wasn’t widely debated.

What’s even more egregious is that as the massive spending bill was being written in marathon backroom deal-making sessions, President Barack Obama continued to make the false claim that Republicans wanted to do nothing in the face of the crisis. This proposal for lowering home mortgage rates was just one of many alternatives that was introduced by the Republicans, including Senator Lindsey Graham’s package of personal and corporate tax cuts.

The mortgage rate reduction proposal was killed, not because Democrats didn’t agree with it, but precisely because it was a reasonable alternative that could have sparked intelligent discussion on the best way to improve the economy. When you’re trying to push an $800 billion spending spree through Congress in the dead of night, the last thing you want is an intelligent discussion. But the fear mongering and false choices worked and the stimulus bill was passed. Where does that leave interest rates? Falling quickly most likely.  Now the Democrats need the economy to recover to ensure a 2010 reelection, and the easiest way to do that is to keep interest rates and mortgage rates as low as possible.

However, the Democrats have a problem. Lower interest rates don’t help everyone equally. If you have a million dollar mortgage, then a 2% mortgage rate drop will save you $20,000 per year. But if you only have a $100,000 mortgage, then the savings is just $2,000. And you only receive the reduction in mortgage rates if you are able to refinance your loan. If your credit is bad, or you have no equity in your home or cash to bring to the table, then you’re out of luck. Your only hope is that someone else with good credit may be able to use that 4% mortgage rate to buy your home and take it off your hands at a reasonable price.

Thus, the availability of lower mortgage rates is a benefit that encourages and rewards financial responsibility and helps wealthier borrowers the most. What’s wrong with that? If you’re a liberal, everything. Free markets are unfair, we’re all victims of evil corporations, America’s racist, etc. This ideology leads directly to the latest mortgage relief plan, a well-intentioned mess that encourages borrowers to cry poverty to their lenders and then understate their income in order to get the largest government subsidy.

But while we scratch our heads and wonder why the so-called intelligentsia can’t understand basic concepts like financial responsibility and incentives, the good news is that as the mortgage relief package stands now, 90% of homeowners won’t be eligible to take advantage of it. So let’s get back to lower mortgage rates.

The Wall Street Journal has published two Republican op-eds on the subject recently, one titled “Low-Interest Mortgage Are the Answer,” by R. Glenn Hubbard and Christopher J. Mayer, and a second titled “The GOP Has a Dumb Mortgage Idea,” by Ed Glaeser. Just from the titles you may have guessed that we don’t quite have a consensus.

Hubbard and Mayer’s viewpoint is pragmatic. Now that U.S. treasury rates are at historic lows, why not use some of this capital to benefit U.S. homeowners? They argue that lowering rates will help stabilize falling home prices and put more money into consumers’ pockets, and also provide a nice boost to the mortgage industry. This is most likely the route that the Federal Reserve and the Obama administration will take: giving Americans mortgage rates of 4.5% or perhaps even 4.0% later this year.

Ed Glaeser’s argument is that government intervention helped create this mortgage mess and we shouldn’t expect more intervention to get us out. That’s a principled criticism, but if you take that line of thinking too far, you’re arguing against the Federal Reserve and its ability to set key interest rates and manage the money supply to regulate inflation and fight recessions.

Still, his piece does raise important questions as to whether politicians can be trusted to have their hands on the controls on the $10+ trillion mortgage market, especially given their failures with regulating Freddie Mac and Fannie Mae. There’s no indication that they’ve learned any lessons and certainly no admission of responsibility.

Refinancing mortgages to 4% is only effective if the new loans make economic sense. If, instead, we just put more people in houses they can’t afford using taxpayer subsidies and guarantees, we will have squandered one of our best tools to lead a recovery and merely exchanged one crisis for another.