Federal government guilty of hurting housing market by guaranteeing mortgages, inflating home values

When you search for the causes of the financial meltdown and the following recession, look no further than Fannie Mae and Freddie Mac, the government-sponsored mortgage entities.
The government will make money on its bailout of the banks and may even break even on the auto industry, but according to Gene Epstein, the economics columnist for Barron's, the housing market has already cost taxpayers $164 billion, and the tab seems likely to climb.
Epstein, who calls it "a failure of crapitalism," makes a quite simple point. When the government guarantees, or seems to guarantee, losses, the "behavior of private actors gets fatally distorted," says Epstein.
Mortgage firms and banks, as well as individual homeowners, take undue risks, knowing the taxpayer will stand behind their mistakes. If they are right, they make a big profit. If they are wrong, we will bail them all out. This is, in Epstein's words, "Heads I win, tails you lose."
It seems logical to think that government should not be underwriting everyone's mortgages, but since the financial meltdown, things have actually gotten worse, not better. With banks nervous about lending and with tens of millions of homeowners underwater, more than 90% of all mortgages are being guaranteed by the government - and that means by you and me.
Further, in the past Fannie and Freddie were only quasi-government agencies. But now that we have bailed them out they are actually part of the government - which means that we, the taxpayers, are financing more than 90% of all mortgages and covering the losses of anyone who is underwater.
With the government guaranteeing mortgages, home values have become artificially inflated. You may think home prices are attractive, but if the government stopped guaranteeing 90% of all mortgages, they would be lower.
Without government guarantees, banks would have to tighten their standards. They would raise rates, demand higher downpayments, and require stiffer income tests. This means housing would be much less affordable than it is now.

One way or another, the President and Congress will have to start looking for ways to wean government from the housing market. Government can't go cold turkey. If it stops its guarantees, values will come crashing down, plunging the country into an even more severe financial crisis. The poor and lower middle class will be especially hurt, and this will be politically and economically untenable.
However, it is not a question of if, but rather when and how the government cuts back on its support of housing. My guess is that it will be a gradual process, perhaps taking a decade to get banks and mortgage brokers to take up most of the slack. During that time, the housing market will be under pressure.
While housing prices have come down, they are still well above their inflation-adjusted average for the period since 1970, and if the government is going to have to get out of the mortgage business, prices could drop below their trend line.
So what does this mean for you? If you have a good balance sheet, this could be a good time to take out a new mortgage. One way or another, rates will start to creep up. Do not speculate on housing as an investment. Prices may have come down, but there are millions of homes underwater and the government will have to get out of the business of guaranteeing losses. So in my view, there is more downside.
Companies operating rental properties will do relatively better, as home ownership declines. However, given the overhang of underwater properties, I am not buying these stocks. Home builders are still vulnerable, because they have to compete with distressed sales.
I am also concerned about companies that cater to the home market or the consumer, especially the middle to lower end. With tougher mortgage standards, people will not be able to pull money out of their homes to build pools or finance renovations.
Housing prices have come down, but with 90% of all mortgages guaranteed by the government, there will be more pain before we solve, in Epstein's words, our failure of crapitalism.
Your Money columnist Peter Siris is an investment manager at Guerrilla Capital in
Source http://www.nydailynews.com/