Analysis & Comment

Opinion | America Has a Mortgage Problem

Americans love fixed-rate mortgages, but their fixation on them puts the economy in a fix. That’s a problem for the central bankers who are gathered in Wyoming this week for the annual Jackson Hole Economic Symposium.

You see, one reason the Federal Reserve has had such a hard time lowering inflation is that consumer spending has stayed strong. That’s partly because most homeowners with mortgages — who account for 40 percent of American families — have scarcely felt the effect of the Fed’s rate-raising campaign, so they haven’t curbed their spending.

In the past two years, the average rate on new 30-year fixed-rate mortgages has zoomed to more than 7 percent from less than 3 percent. But the average rate on all outstanding mortgage debt — i.e., not just new loans — edged up to 3.6 percent in this year’s second quarter from 3.3 percent a year earlier, according to the Bureau of Economic Analysis. That’s scarcely noticeable.

The Fed can’t accept defeat, though. To have an effect on the economy, it raises rates higher and keeps them high longer than it would if all mortgages had adjustable rates. Its big increases eventually hurt business investment, which is vital for long-term prosperity. “You really hammer interest-rate-sensitive sectors,” John Campbell, an economist at Harvard, told me.

Fixed-rate mortgages create other problems. Less sophisticated borrowers are slow to refinance when rates drop. The fixedness of rates benefits the rich and knowledgeable at the expense of the poorer and less knowledgeable. That’s because in a competitive market, some of the extra revenue that lenders get from borrowers who don’t refinance is passed on in lower mortgage rates. (Less savvy borrowers who don’t quickly refinance get the lower rates too, but they’re the ones whose mistakes allowed the rates to be lower for all.)

Also, fixed rates can destabilize the financial system. That happens when banks hold fixed mortgages that lose value when rates rise. True, most banks sell off most of their mortgage loans these days. But some re-expose themselves to rate risk by buying mortgage-backed securities. When Silicon Valley Bank and Signature Bank went bust this year, they had a combined $114 billion in face value of mortgage securities on their books.

At the moment, we’re seeing another downside of fixed rates: “rate lock,” in which people who want or need to sell their homes don’t do so because they don’t want to trade the 3 percent rate on their current mortgage for a 7 percent rate on a new one. The macroeconomic effect of rate lock is to decrease societal mobility. It causes people to turn down out-of-town job offers, for example. That impedes productivity.

Now I want to talk about another negative aspect of fixed-rate mortgages that requires a first, second and third glance. Bear with me.

At first glance, rate lock decreases existing-home sales and increases sales of new homes, as buyers who can’t find an existing home — because those rate-conscious owners aren’t selling — crowd into the market for new construction. Indeed, seasonally adjusted sales of new homes rose 31 percent in July from a year earlier, while seasonally adjusted sales of existing homes (a bigger market) fell 17 percent over the same 12 months.

You see the problem here? The Fed raises rates to cool off the housing market and the inadvertent effect is to increase housing construction. (The strong demand outweighs builders’ own higher borrowing costs.)

On second glance, this chain of logic makes no sense because the rate-locked people who aren’t selling houses also aren’t buying houses, so rate lock would seem to have no net effect on the availability of housing.

On third glance, though, rate lock really does screw up the housing market. Robert Dietz, the chief economist of the National Association of Home Builders, explained to me why. Home buyers like it when there is a high volume of transactions, because they’re more likely to find a house they like where and when they want it. When the inventory of existing homes for sale declines because of rate lock, “the matching process that has to occur becomes more complicated,” he said. In May the inventory of existing homes for sale, 1.08 million, was less than half its average since 1999.

All this kind of makes you wonder if U.S. policies that favor fixed-rate mortgages should shift to be more neutral or to outright favor variable-rate loans. “The U.S. might be better off if our system were to shift in the direction of the Canadian system, with mortgage rates fixed for only five years,” Campbell wrote in a slide presentation in May hosted by Princeton’s Markus Brunnermeier. “Monetary policy would be more effective, and the banking system more stable.”

Lisa Sturtevant, the chief economist of Bright MLS, a listing service for the Mid-Atlantic states, told me that fixed-rate mortgages are good because they increase the rate of homeownership and provide a hedge against rising inflation (as we’re seeing now). Campbell acknowledged that adjustable rates expose homeowners to tighter monetary policy, but he said that from the perspective of economic management that’s a feature, not a bug. And he said most people are naturally shielded from higher rates because their incomes tend to rise faster at times when the Fed is tightening rates in response to strong growth and high inflation. He said fixed-rate loans make the most sense for people living on fixed incomes.

One rap on adjustable-rate loans is that homeowners are lured in by artificially low teaser rates and can’t pay when they reset upward. Campbell agrees with that criticism and said he opposes teaser rates. When the initial rate is set appropriately high, though, it will fall, not rise, if the economy has slowed down, unemployment has risen and the Fed is cutting interest rates, Campbell said. That happens automatically, without the hassle of refinancing that people with fixed-rate mortgages have to go through. It happened that way in the recession of 2007-9, he said.

The traditional fixed-rate mortgage “does not deserve the strong political support it has received in this country,” Campbell wrote in his presentation.

America is not ready to quit fixed-rate mortgages. But it would be nice if they could at least be, um, fixed.

The Readers Write

Carbon trading, which you wrote about, is just another scheme that fleeces the rubes. There will be either a huge double-counting problem, or poor countries will find themselves having sold off their emissions-reduction credits to rich countries and then having to go into the market to buy them at the marginal cost (much higher than they sold them for). And the world will simply burn. The way to reduce emissions is that everyone has to reduce emissions.

John Gear
Olympia, Wash.

The reforms to our economic system — and our standards of living — that are needed to avert outright environmental catastrophe are huge, fundamental, and would be wrenching. But not writing about them is just fiddling while Rome burns.

Brian Watson
Swampscott, Mass.

Regarding your newsletter on stock options: Start-ups can attract better talent by offering an ownership stake and a potentially big payout later, especially because established businesses such as Google, Facebook and Apple can always win on cash. I would want to see more real analysis or evidence that ambitious start-ups could still succeed against established players if they had to compensate employees only with cash.

Dan Frankowski

I made a rule that if I had vested stock that increased 15 percent in price, I would sell. I’m sitting at a desk bought with such proceeds, and I have a handcrafted dining room table and chairs that were paid for the same way. But I never regarded the money as certain — it was a gamble I was forced to take as part of the cost of employment. My children who have worked for start-ups have had it worse. Two start-ups have folded, and while the executives have taken their golden parachutes and gone on to mess up elsewhere, my children have watched the “fool’s gold” of their options — again, that they were forced to take — vanish into dust.

Lauren McGillicuddy
Malden, Mass.

Hi, nice reporting on the drop in wheat prices, but why is a box of Wheaties so darn expensive?

Richard Hawley
Cambria, Calif.

Quote of the Day

“Spanish real estate bubbles, American mortgage derivatives, and copper mining in Chile are all part of a single system in which distortions in any one part must have automatic consequences for all the others.”

— Michael Pettis, “The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy” (2013)

Elsewhere in Opinion

I recorded a segment on marriage for Opinion Audio. You can listen to it here.

Peter Coy has covered business for more than 40 years. Email him at [email protected] or follow him on Twitter. @petercoy

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