Irvine Housing Blog

Another Ignorant and Misguided Attack on the 30-Year Fixed-Rate Mortgage

Posted: 28 Jul 2010 03:30 AM PDT

The 30-year fixed rate mortgage provides a reasonable balance between affordability and buying power. Historically, it has been associated with stable housing markets. Despite these facts, some foolishly want to see it replaced with adjustable-rate mortgages.

Irvine Home Address ... 14 IRON Spgs Irvine, CA 92602
Resale Home Price ...... $839,000

I was born with the wrong sign
In the wrong house
With the wrong ascendancy
I took the wrong road
That led to the wrong tendencies
I was in the wrong place
At the wrong time
For the wrong reason
And the wrong rhyme
On the wrong day
Of the wrong week
I used the wrong method
With the wrong technique

Wrong
Wrong

Depeche Mode -- Wrong

I recently wrote the post Government Bureaucrat Recommends Against 30-Year Fixed-Rate Mortgages. The author of that article wrote a scathing and dismissive rant against the 30-year fixed rate mortgage, and he provided no rational arguments for his opposition to its widespread use. I thought it was a one-off written by a crank who had too much coffee that day. Apparently he has company.

I am prone to write stinging rebukes to poorly written garbage on the web, but when I call someone out, I will devote the post to building a factual argument as to why they are wrong. I never ask anyone to just take my word for it because I am some kind of expert. Authority comes from the presentation of data in a compelling argument. Mindless rants don't make authors an authority, it makes them lunatics.

The source article for today's post is horrible. I don't know if the writer is a lunatic, but she certainly is very wrong about her reasons for opposing the 30-year fixed rate mortgage.

The Government's Role in the Housing Bubble

Megan McArdle -- Jul 23 2010

I never would have guessed that years in, we'd still be debating the role of the government in the housing bubble. Conservatives are still pinning most of the blame on the Community Reinvestment Act, while liberals are saying that there's no evidence that government played any significant role--unless, perhaps, it was all the fault of Alan Greenspan.

As it happens, I think that the government did play a role. A big role. But I think it's rather subtler, and thus, rather more problematic, than most people on either side are discussing.

To me, the unsung villain of the mortgage crisis is the 30-year fixed rate self-amortizing mortgage with no prepayment penalty. This hothouse creature is beloved of liberals, who like any product that gives the consumer the power to shaft banks whenever it is to their advantage. And it is beloved of conservatives because it smacks of sober citizens taking on modest, stable obligations they can meet.

The 30-year fixed-rate mortgage has been popular among progressives and conservatives alike because it is a good loan product. (Note she used the old term liberals demagogueed by the Right rather than the more fashionable progressives.) She makes a ridiculous straw-man argument that the Left is out to screw the banks. Perhaps some die-hard conservatives who are willing to believe anything bad about progressives will believe that, but the reason the Left likes the 30-year loan is because it provides a means for average wage earners to acquire wealth. Paying down a mortgage through the forced savings of an amortizing mortgage used to be the primary wealth generating mechanism of the middle class -- that is until we allowed everyone to rob the piggy bank with HELOCs.

Did you notice the writer setting the emotional groundwork with the phrases "unsung villain" and "hothouse creature" and "the power to shaft banks?" This dismissive language is not presenting a sound argument based on facts, it is setting the stage for an emotional argument based on hyperbole.

But this product is about as stable as a nitroglycerine shot with a TNT chaser.

That statement is complete and utter bullshit. Actually, bullshit is a statement with a casual disregard for the truth -- realtorspeak is a good example. The statement above is an intentional lie. A lie cloaked with emotional baggage to disguise its intent.

The 30 year fixed rate mortgage was ultimately at the heart of the Savings and Loan crisis.

That statement is a half-truth used to support a weak argument. The heart of the S&L fiasco was an asset-liability mismatch. Banks often borrow with short-term funds and lend on a long-term basis. The 30-year fixed rate mortgage contributes to this problem, but ultimately this is a financial management problem at banks. Nobody forces banks to underwrite these loans, and nobody forces them to match those loans with short-term deposits. This is a choice banks make that sometimes blows up in their face. Banks could float long-term bonds to match their loans, and they can also offload them to the secondary market; in fact, that is one of the primary arguments for keeping a secondary market in place.

Yes, yes, deregulation set the stage for the ultimate denouement--but the Savings and Loans were deregulated in such a haphazard fashion in part because they were being slowly driven into bankruptcy by their huge collection of low-interest, long-term real estate loans, in an environment where Paul Volcker had briefly driven short-term interest rates up to 20%. While fraud and abuse were certainly rampant, the enormous scope of the problem was not due to S&L officers suddenly becoming more thievish, or regulators more tolerant of thievery, but because everyone in the industry was flopping as wildly a a beached sturgeon in an attempt to keep their banks solvent atop large portfolios of low-interest loans. Meanwhile, whenever interest rates dropped, people would refinance, meaning that even the high-interest loans they did make didn't help much.

The answer to this, as you may recall, was . . . the creation of the massive private market in mortgage bonds. In an environment with a floating currency and considerable worries about inflation, the only thing that can neutralize the risks of the 30-year mortgage is laying them off to as large a pool as possible.

Selling low-interest loans in the secondary market is still the answer. There is no problem here. Banks are currently under no obligation to keep any loans they originate on their balance sheets. During the debates on financial reform, there was a proposal for banks to keep 5% of the loans they originated on their balance sheets, and it was defeated by intense opposition from the banking lobby. Their primary argument was that it created asset-liability mismatch. They were right.

MIchael Lewis chronicles what happened next in the still-terrifyingly-relevant Liar's Poker.

Give me a break. She has now associated all the evils of Wall Street with a 30-year fixed rate loan? Did she really think nobody on the web would call her on that nonsense?

Moreover, this product exists, as far as I can tell, only because of massive government intervention into the markets, a point that Reihan Salam and Chris Papagianis made in their recent, excellent piece.

"As far as I can tell?" I respect that she has the courage to flaunt her ignorance so publicly. The product exists because people demand it. People demand it because it is a good and stable loan product that builds wealth for ordinary Americans. The government supports it because it provides stability in housing markets.

Until the Great Depression, the mortgage was a very, very different product. There was no amortization, and down-payments were often massive--half or more of a home's value. They lasted perhaps 3 or 5 years, and were rolled over if borrowers could not meet the balloon payment. The default crisis of the 1930s resulted from the inability to roll those loans, and so the government stepped in, causing the fifteen year self-amortizing loan to proliferate. This process was especially accelerated by the VA loans that were offered to returning veterans. Eventually, the payment terms stretched out to allow more and more people to buy homes.

This had some curious effects. As aforementioned, it was ultimately not good for banks that were restricted to the kind of boring business many commentators would like to see banks return to: loaning money to consumers and small businesses, and taking deposits.

Yes, that is exactly what banks are supposed to do. Is that boring? Are we supposed to have an exciting banking system? Did everyone enjoy the volatility in our economy over the last several years? It was certainly exciting. Financial innovation is a fallacy. Banks are supposed to be boring, stable institutions. What does she want?

The mismatch between their short-term obligations and their long-term assets too easily becomes catastrophic.

Nonsense. If banks do not properly utilize the tools available to them to prevent asset-liability mismatch, they can certainly go broke, but that is only a catastrophe for the poorly managed bank. It isn't a catastrophe for the economy. She is pointing to some bogeyman that doesn't exist.

It also--at least according to economists I've interviewed--contributed to the long, broad run-up in housing prices that took place in the latter half of the twentieth century.

She must have interviewed some real idiots. The transition from a 50% down interest-only loan market of the Great Depression to the 20% down conventionally amortizing loan market beginning after WWII did see a runup in prices. However, once prices stabilized in the early 1950s, the 30-year fixed rate mortgage provided a stable price-to-income structure with excellent affordability for the next 25 years (see graph below). Even then the system broke down in the late 1970s because allowable DTIs got out of control, not because of the mortgage product.

People price their homes by their monthly payment, and what the bank will lend them. As banks lent more, and longer terms lowered the monthly payment for a given loan amount, people bid up the price of housing. This created the expectation of steadily appreciating home values--something that had not been historically true.

This statement is inaccurate. Robert Shiller did detailed studies on this subject for the book Irrational Exuberance. His studies showed that expectation of appreciation was not present prior to the late 1970s. The 25 year period of stability from 1950-1975 -- the heyday of the 30-year fixed rate mortgage -- did not have expectation of appreciation. If you look carefully at the chart of inflation-adjusted home prices, you see that prices did not rise faster than the general rate of inflation during this period.

Over time, people began pricing expected appreciation into their purchase price as well, a phenomenon that again, tended to accelerate over time.

No, this was a phenomenon of the first bubble of the late 70s, and with each successive bubble and continued "innovations" which allowed people to access appreciation for spending money, the expectation of appreciation and the desire for free money has created an entire population of kool aid addicts.

Most subtly, and most perniciously of all, it created generations of buyers who thought of all mortgages as thirty-year fixed rate loans.

Perniciously? I wish everyone thought of mortgages as 30-year fixed-rate loans. If they did, we wouldn't have a demand for interest-only and Option ARMs -- the real culprits of the housing bubble.

People in other countries understand that their mortgage rate resets when interest rates go up.

I think the author is revealing her hidden agenda here: she is pandering to banking interests that would rather issue adjustable rate mortgages at the bottom of the interest rate cycle. Banks would certainly rather have everyone on ARMs because it offloads the interest rate risk. When interest rates go up, the value of fixed-rate annuities goes down. The value of fixed-rate loans held on bank balance sheets will plummet. I wonder if she it receiving compensation from banking interests?

Even the people who theoretically understood that they were taking on an adjustable rate mortgage didn't have any cultural context for them--no unhappy childhood memories, no newspaper stories, no parents or friends to warn them about what would happen when the loan rate reset. And of course, many very naive people simply assumed that their floating-rate mortgage was fixed--and were rooked by unscrupulous mortgage brokers.

I am not sure what she is arguing for here, but the fact that we have had 25 years of steadily falling interest rates is exactly why some boneheads continue taking out adjustable-rate mortgages when it makes no sense to do so. The next bailout of the mortgage and housing industry will come from those idiots taking out ARMs today. The ARM reset issue hasn't gone away, it has only been temporarily deferred by even lower interest rates.

As I see it, this decades long intervention in the housing market took a terrible toll. And whenever this product went bad, rather than reconsidering its support, the government staged another intervention to keep this type of loan alive.

The first statement is true: government intervention has certainly ruined the housing market, but the connection to the 30-year mortgage is a figment of her imagination.

It gave an implicit guarantee to Fannie and Freddie, deregulated the savings and loans (and then bailed them out), had its regulators and lawmakers help create the market in mortgage securities, and so forth. All the while, it gave a giant tax subsidy to mortgage interest that convinced people they were fools not to buy.

No, the National Association of realtors is what worked to convince people there were fools not to buy. They are bullshit artists who will use any tool available. (Graphic below is from 2006.)

As of this writing, are we rethinking any of it? Will the new head of the CFPA crack down on mortgages that offer prepayment options?

I certainly hope not.

Will lawmakers finally break up Fannie and Freddie and cut off the flow of cheap capital they glean from the implicit government guarantee? Will it get the FHA out of the business of propping up the conventional loan market?

I certainly hope so.

Of course not. There is no constituency for such a thing except for a few crazy libertarians.

It is rare that I find an article that annoys me as much as that one. I don't mind that people promote their agendas. I do it. I just prefer it when people do so with rational arguments based on facts and data. The piece of crap this woman wrote reads like something from a tawdry political blog. Many of the best articles I have read on the web have come from the Atlantic. This isn't one of them.

Palladio Properties is at it again

These guys are very active in the Irvine market. Today we have yet another flip.

The previous owners did not buy at the peak, and they did not abuse their HELOC, but they still over borrowed and lost their home.

This property was purchased for $952,000 on 6/16/2004. The owners used a $714,000 Option ARM first mortgage with a 1.25% teaser rate and a $238,000 down payment.
They quit making payments in early 2008 and squatted for over two years before being kicked to the curb.

Foreclosure Record
Recording Date: 05/18/2010
Document Type: Notice of Sale

Foreclosure Record
Recording Date: 07/25/2008
Document Type: Notice of Default

If you would like to learn how you can get involved with trustee sales, please contact me at sales@idealhomebrokers.com.

Irvine Home Address ... 14 IRON Spgs Irvine, CA 92602

Resale Home Price ... $839,000

Home Purchase Price … $708,000
Home Purchase Date .... 6/10/2010

Net Gain (Loss) .......... $80,660
Percent Change .......... 11.4%
Annual Appreciation … 106.3%

Cost of Ownership
-------------------------------------------------
$839,000 .......... Asking Price
$167,800 .......... 20% Down Conventional
4.62% ............... Mortgage Interest Rate
$671,200 .......... 30-Year Mortgage
$166,286 .......... Income Requirement

$3,449 .......... Monthly Mortgage Payment

$727 .......... Property Tax
$225 .......... Special Taxes and Levies (Mello Roos)
$70 .......... Homeowners Insurance
$100 .......... Homeowners Association Fees
============================================
$4,571 .......... Monthly Cash Outlays

-$828 .......... Tax Savings (% of Interest and Property Tax)
-$865 .......... Equity Hidden in Payment
$291 .......... Lost Income to Down Payment (net of taxes)
$105 .......... Maintenance and Replacement Reserves
============================================
$3,274 .......... Monthly Cost of Ownership

Cash Acquisition Demands
------------------------------------------------------------------------------
$8,390 .......... Furnishing and Move In @1%
$8,390 .......... Closing Costs @1%
$6,712 ............ Interest Points @1% of Loan
$167,800 .......... Down Payment
============================================
$191,292 .......... Total Cash Costs
$50,100 ............ Emergency Cash Reserves
============================================
$241,392 .......... Total Savings Needed

Property Details for 14 IRON Spgs Irvine, CA 92602
------------------------------------------------------------------------------
Beds: 4
Baths: 2 full 2 part baths
Home size: 2,600 sq ft
($323 / sq ft)
Lot Size: 3,755 sq ft
Year Built: 2002
Days on Market: 12
Listing Updated: 40370
MLS Number: S624557
Property Type: Single Family, Residential
Community: Northpark
Tract: Aldc
------------------------------------------------------------------------------

Beautiful home located in Northpark Square. 4 Bedrooms and 1 Den. Granite countertop. Hardwood flooring. New carpet & New paint. Built-in BBQ in backyard. Move-in ready.