Will Fixed Rate Mortgages Disappear In U.S.?, The Crux Of Fannie/Freddie Regulation

Will Fixed Rate Mortgages Disappear In U.S.?
A new study of lending practices in 12 developed countries shows that the U.S. is an outlier in offering fixed rate mortgages. The study results showed that 95% of new loans made in the U.S. in 2009 were long-term fixed-rate products compared to 1% in Spain, 2% in Korea, 10% in Canada, 19% in the Netherlands and 22% in Japan. As for percentages of ARMs in 2009, the results were 5% in U.S., 92% in Australia and Korea, 91% in Ireland, 47% in the UK and 38% in Japan. The study also showed that other countries have more prepayment penalties for borrowers. The main reason for these core differences is because of Fannie Mae and Freddie Mac securitizing most U.S. mortgages. Without them, loan terms in U.S. would be shorter, borrowers would face prepayment penalties, and would also be prevented from and penalized for ‘walking away’ from mortgages because banks would set the rules on lending—rightly so since they’d be taking the risk on the lending and the securitizations. But winding down Fannie/Freddie probably won’t come for awhile, maybe never based on how new regulations for private securitizations conflict with the Fannie/Freddie model—more on this below.

The Crux of Fannie/Freddie Regulation
Portfolio lenders can only lend out so much of their capital to jumbo and Alt-A production. Since the ability to securitize this product is very slow right now, big banks know this, and in the absence of being able to securitize their production tend to focus their production efforts in their retail branches rather than in wholesale or correspondent lending. Unfortunately for Alt-A and jumbo specialists, the FDIC approved a proposal that would require lenders to keep 5% of the credit risk for securitized debt if they want protection from new accounting rules governing failed-bank assets. Agency MBS’s (FHA, VA, Fannie, Freddie) are exempt from this requirement, set to begin 1/1/11, but “private label” securities are not. Financial Accounting Standards Board rules completed last year require banks to bring most securitizations onto their balance sheets. The Dodd-Frank Act, includes a provision that requires most lenders to hold at least a 5 percent stake in debt they package or sell, in theory making them more attractive to outside investors (“the issuer has skin in the game”). As we know, however, the FDIC’s action will not only keep the government involved in the MBS market but seriously harm a bank’s ability to sponsor a new securitization, and/or push future securitizations outside of a regulated structure – and is that what we want?

U.S. Home Vacancy Rate Now 11% vs 7.7% Historically
With all of the housing stats and housing price stats that are thrown our way every week, sometimes it is interesting to take a step back and look at the big picture. Over the very long run, the U.S. builds just over 1.5 million housing units per year, which equates to 1.3 million new households formed plus 250,000 units that are demolished. Overbuilding in the boom years, however, led to an overhang of 2.0-2.5 million units, and household formation tends to be depressed during recessions – people live with friends or family.

Deutsche Bank reports that according to the Census Bureau, the entire US housing stock consisted of about 131 million units as of 2009. This includes single-family, multi-family, mobile homes and apartments. The government data also show total year-round vacancies excluding seasonal rentals of about 14 million units, giving us a national home vacancy rate of 11%, well above the historical average of roughly 7.7% from 1965 to 2005. How long it will take to bring the vacancy rate in line with its long term average? On the supply side, if housing starts remain at their year to date average of 600,000 per year, and on the demand side household formations stay at about 1% per year, then 1.1 million housing units need to be created every year just to meet population growth. Throw in some dilapidation 250,000, and economists come up with net new housing starts equal to 300,000.

With population growth lifting starts by another 1.1 million units, the annual absorption rate is 0.8M units (1.1M units less 0.3M net new housing starts). So smarter folks than me estimate that it will take until mid-2012 for the current absorption rate to bring the vacancy rate down to 7.7% from 10.9% currently. In absolute terms, there are currently 4 million units of excess housing inventory that need to be worked off. Of course, if the labor market improves more noticeably, and household formations accelerate-they have actually averaged 1.6% over the long term-then supply could more quickly be absorbed, possibly by late next year.