Thursday, November 17, 2011

Lunch with Ben Bernanke and the Future of Housing Finance

Last week I wrote about eating lunch with Federal Reserve Chairman Ben Bernanke, who was in El Paso on Thursday, November 10, to greet returning troops and Fort Bliss and to participate in a town hall on the military base.  As an added part of his trip, he had a private lunch with a dozen or so business people from El Paso.  The purpose of the luncheon was to allow Bernanke to hear from the business community about our concerns and the factors which are affecting our ability to grow and to hire others.

As I explained last week, we each had two minutes to speak about whatever topic we wished.  After we had each made our statement, Bernanke made a general statement addressing some of the concerns raised (for specific points from that discussion, see Part I of this blog). Cindy Ramos-Davidson, CEO of the El Paso Hispanic Chamber of Commerce, who had actually coordinated the event,  then allowed some of the business owners to ask follow up questions.  One of the businessmen asked a question about what Bernanke believes will be the future of Fannie Mae and Freddie Mac.  These huge bloated corporations which have been in conservatorship since September of 2008 have cost taxpayers hundreds of billions of dollars so far.  And with huge bonuses for the executives of the corporations making news this week, today seemed to be  a perfect time to examine Bernanke's answer.

In brief, Bernanke responded that there is a lot of talk of privatizing Fannie Mae and Freddie Mac.  If they were privatized, the government might offer some sort of insurance to back the mortgages.  This would restore their status very much to the pre-2008, pre-conservatorship arrangement that existed for many years.  Under that system, Fannie Mae and Freddie Mac were both largely private corporations with the U.S. government owning a minority interest in both.  The issue with this was that most investors bought the mortgages Fannie and Freddie securitized with the implicit understanding that the mortgages were backed fully by the US government.  And when gross mismanagement drove both corporations into bankruptcy, the U.S. taxpayer had to pick up the tab.

Most conservatives favor privatization today.  I am included in that number.  In my opinion, the insurance backing the mortgages should be private as well.  In my experience, people watch their own money more carefully then they watch their neighbor's, and they certainly watch their own money much more carefully than they watch the taxpayers'.  As long as the shadow of the Treasury Department and a possible bailout loom over Fannie and Freddie, the entities will never have incentive to behave responsibly.

Having said that, every housing professional knows that Fannie Mae and Freddie Mac are an indispensable part of the U.S. housing finance process.  That leads me to Bernanke's second comment.  He indicated that Fannie and Freddie might be done away with completely in favor of a system of mortgage lending that more closely resembles Canada and Europe, where nothing similar to Fannie and Freddie exist and the banks finance mortgages through the sale of bonds.  He added that Canada and Europe have home ownership rates similar to the U.S. and implied that since their system works well for them, it could work well for us too.

As a thirteen and a half year mortgage veteran, I was very intrigued.  I decided to check out the facts about housing finance in Canada and Western Europe--for the purposes of this discussion I looked at the United Kingdom, France, and Germany and Switzerland to see how their systems of mortgage finance compare with ours.

To set the baseline for comparisons, according to the U.S. census bureau current U.S. homeownership rates are at about 66% which is down from close to 70% during the height of the boom. Not surprisingly, the median average home price varies by region.  According to the National Association of Realtors, in August of 2011, the median home price in the North East was $244,100, in the Midwest it was $141,700, in the South $151,000, and in the West $189,400.  Our most popular mortgage product is the thirty-year fixed rate mortgage with the interest rate fixed for the entire term of the loan--I saw statistics indicating that 9 out of 10 homeowners have a thirty-year fixed rate mortgage. These conventional conforming mortgage products have no prepayment penalty. While this product is criticized by some who say it is outdated because Americans no longer stay in their homes thirty years, it has remained a safe, secure form of financing. Currently about 5.82% of U.S. homeowners are 60 days or more past due on their mortgage loans--which means that over 94% of U.S. homeowners are making their mortgage payments on time.


I started with our neighbor to the north as I expected that it would probably be most similar to the U.S. in terms of lifestyle of the residents including home ownership rates.  About 60% of Canadians own their own homes.  In the 35-44 age group, 58.2% are homeowners.  Conventional mortgages typically require 25% down, but mortgages of over 80% of the sales price or appraised value are available with insurance provided by the Canada Mortgage & Housing Corporation.  I saw one website that claims that GE Capital provides private mortgage insurance financing as well, but the Canadian Department of Finance website states that the Canadian government backs all mortgages over 80%.  A typical mortgage in Canada is fixed for 5 years with an amortization of 25 years.  After the fixed period ends, the rate becomes variable.  Interestingly, all Canadian mortgages appear to have prepayment penalties.  Royal Bank's website is advertising mortgages fixed for 4, 5 and 7 year terms at special pricing of 5% interest fixed for seven years. 

Property in Canada is more expensive than the United States.  Wallet Pop says that prices have increased approximately 7.7% since 2010; the average cost of a home in Vancouver is now $517,000, and in August of this year the average home price in Canada was $349,916.  According to Realty Times, residents of British Columbia need to earn $157,000 to be able to qualify for an average home.  This locks out young couples and first time homebuyers, who are now being encouraged to "rent to own" and to go to builders who specialize in assisting first time buyer.  Wallet Pop recommends that young buyers try Daniels First Home--a builder of condominiums and town homes.  Their website advertises that potential buyers can move into their new condos, which start at $199,000, by making deposit payments until they can qualify for financing. 


Next, we hop across the pond to the UK.  The mortgage system in the UK also provides amortizations of up to 25 years.  The website of one UK mortgage broker advises that mortgages are typically fixed for 2, 3, and 5 years; right now the rates are fairly comparable among those three terms as the Bank of England has kept rates low to shore up the economy.  It is possible to fix a rate for the entire term of the loan, but the interest rate becomes higher as the term is fixed for longer periods, making this virtually impossible for many borrowers.  After the fixed rate term ends, homeowners pay the Standard Variable Rate, which is 1-2% higher than the Bank of England base rate.  Some borrowers also take advantage of capped rate mortgages which are linked to the Standard Variable Rate but which "cap" the interest rate for a period of time.  Fixed rate mortgages cost the borrower an additional fee which has risen sharply in the last few years, making these mortgages initially much more expensive than Variable Rate mortgages.

Although interest rates are low, qualifying for a mortgage is very difficult, particularly for first-time homebuyers.  The National Housing Federation has a report from Oxford Economics showing that, on the averag,e first-time homebuyers need to put down almost 30% of the sales price in order to purchase and they can borrow only about 2.8% of their income. (Financial Times August 30, 2011).

Homeownership rates have been as high as 72% in the UK (2001), but right now homeownership is on the decline. Current homeownership rates are at 67% and that number is expected to drop to 64% by 2021.  In London, 6 out of 10 Londoners are expected to be renters by 2021.  The average house price in Greater London is 440,230 pounds (approximately $880,460 USD).  A detached home in London (what we would think of as a regular single family residence) costs 810,234 pounds  ($1,620,000 USD approx.)  For Londoners, this means that the average Londoner would need to triple his current salary in order to be able to buy the average home.   Only 4 London burroughs have an average house price of 250,000 pounds ($500,000 USD). This has created a huge housing problem.  According to Kate Dodsworth, Assistant Director of the National Housing Federation, "London has become unaffordable for ordinary, hardworking (people) who have no real chance of buying their own house."  David Orr, chief executive of the National Housing Federation adds, "Homeownership is increasingly becoming the preserve of the wealthy and, in parts of the country like London, the very wealthy."  Currently 800,000 Londoners are on the social housing waiting list and 200,000 are living in over-crowded conditions.  Private rents have increased 30% since 2008.


Any plan to utilize the strategies of Western Europe should include a discussion of France.  The Wall Street Journal On-Line reports that homeownership in France is about 57%.  Required downpayments range from 50% to 10%--French taxpayers can borrow up to 100% of the sales price.  However, Banque de France sets very strict underwriting requirements for mortgages.  The mortgage company qualifies the prospective borrower using 1/3 of his gross income.  Therefore a borrower making $100,000 a year would be qualified on $33,333 of that income.  From that amount, the lender subtracts all taxes, debts and the proposed mortgage payment.  French banks also require that borrowers over 55 submit to a health exam and purchase life insurance to pay off the mortgage upon their deaths.  Because of the difficulty in obtaining a French mortgage, most of the mortgage sites I consulted recommend that would-be buyers from the U.S. and UK might want to get mortgages in their own countries against their own homes and pay cash in France.

Housing is very expensive in France, particularly in Paris.  According to France Today's website, the average price of an apartment in Paris at the end of last year was euros 7000 (approximately $9561.00 USD) per square meter (which is approximately 11 square feet)  That works out to about $868.27 per square foot. According to the Paris Chamber of Notaires, none of the 20 districts of Paris reported prices under euros 5000 ($6829 USD) per square meter.   This would make the low-end pricing $620.81 per square foot for an apartment in Paris.  Since several sites that I consulted last night indicate that the average wage in France is $42,390.00  and French mortgages require the lender to qualify the borrower on 1/3 of his income, I strongly suspect that the majority of the 57% of French who own their properties probably are living in homes that their families have owned for a long time and that these rates are not the result of new purchases.

As an interesting aside, I learned in researching this piece that France's VAT tax is included in the real estate commission and virtually all services.  One ex-pat wrote about her experiences buying radiators in France and said that she paid a professional to install the radiators rather than doing the installation herself because the 19% VAT tax is reduced to a little over 5% if the installation is purchased at the time as the service.  The net effect is that it is cheaper to hire laborers than it is to do the work yourself.  Also, virtually everything in France requires a license, including television sets.  When a individual purchases a television set, the seller is required to report the sale to the French government who then requires that the new owner purchase a license in order to be able to watch television.


Germany actually has the second largest mortgage market in Europe, just behind the UK.  Sixty percent of new loans originated from 2003-2008 had fixed rates of 5 years or more.  In September of 2010, the average price of an existing home in Germany was euro 265,500 ($398,250.00 USD); the average price of a new home was euro 232,500 ($348,750 USD) and the average price of an apartment was euro 140,000 ($210,000 USD).  According to WSJ On-line, approximately 46% of Germans own their own home.

WSJ On-line cites Swiss homeownership at 37%.  I was unable to find out much about their mechanisms of financing mortgages, but I did determine that in Switzerland the government discourages homeownership by taxing homes both as income and as assets.  The majority of Swiss prefer to rent.

In Summary

While it is fine to say that Europe and Canada enjoy the same rate of homeownership as the U.S. the statistics don't bear that out.  Where mortgage financing is difficult to obtain, buyers cannot buy their homes and sellers cannot sell.  The ultimate effect is that rents become very expensive and properties are soon priced out of the reach of average people.  Home ownership becomes a privilege of the wealthy rather than a goal to which all citizens can aspire. 

So the question is, do we want to import Europe's system of housing and housing finance to the U.S? What do you think?

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. For more information, visit her website at


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