Pushing Down Mortgage Loan Rates Unlikely to Bring New Home Buyers

Housing prices continue to plummet largely because new home buyers are unwilling to buy these bargains. Faced with fears of continued housing depreciation, mounting job losses, and declining economic conditions--they are staying on the sidelines and saving their cash. However, the US Treasury thinks pushing mortgage rates down to 4.5 percent is the answer.

The logic seems sound and there is historical precedent with similar programs.

The theory is simple: Make homes more affordable and buyers will come off the sidelines, absorb excess housing inventory, and reverse the trend of falling housing prices. This is the formula the Treasury now wants to try. The program would target a new home mortgage rate of 4.5 percent, nearly 1-1.5 percent lower than the current prevailing market mortgage rates, by funding Fannie Mae and Freddie Mac purchases of below-market rate mortgages. To do this the Treasury would need to issue government debt at an even lower rate.

The idea is not unique. In 1974 the Ford administration engaged a similar plan under similar economic and market conditions--recession, climbing unemployment, and excess housing inventory. Under that plan ("Tandem"), Ginnie Mae was used to purchase FHA/VA mortgages at set mortgage rates. The results was a restart of the new home purchase market.

Despite the similarities, the US mortgage market has evolved significantly since the 1970s making this program challenging to effectively replicate. Most challenging may be root of the current housing crisis.

Unlike 1974, housing markets are not stalled because of unaffordable home financing and an overhang of vacant new construction. The core problem in the current housing market is the continual flood of foreclosures and bank sales triggered by economic crisis, depreciating home values, and irresponsible lending programs. This takes enormous confidence out of the home buyer even considering real estate a good investment.

In addition, targeting mortgage rates may also be difficult in the current environment. With long-term treasury yields at just over 3 percent it doesn't give much room to buy down rates and the US Treasury is already expected to exceed $2 trillion in 2009.

Even the Federal Reserve thinks targeting mortgage rates may be harder in the current housing market. Responding to questions at a recent housing market conference, Federal Reserve Chairman Ben Bernanke indicated he felt it would be challenging to target mortgage rates. "I don't think we would be either willing or able to target house price. I think that would probably be an impossible thing to do, given the size of the national housing market."

Instead Bernanke challenged traditional thinking on structuring mortgages. "I think we should think more generally about the structure of our mortgage contracts," explained Bernanke, questioning the conventional 30-year fixed-rate mortgage.

His vision for halting the housing market decline would have the government purchase at-risk mortgages in bulk and refinance them. Sounds like we are coming full circle--anyone for the Resolution Trust Corporation (RTC) idea?