The Feds Keep Lowering Mortgage Rates. But What are the Long-Term Implications?

In June 2020, Freddie Mac reported U.S. home sales increased by the most on record since 1968 when NAR began its tracking, and homebuilding increased the most in four years. Why? The 30-year fixed mortgage rate hit 2.98%, the lowest since 1971. But is lowering the interest rates a sound economic policy?

It has been said that insanity is doing the same things over and over again and expecting different results.

After the Great Recession of 2008, the Financial Crisis Inquiry Commission (FCIC) was established to examine the causes of the financial crash—an economic crisis that gripped our country—and to explain its causes to the American people. My book, Stealing Home, How Artificial Intelligence Is Hijacking the American Dream, discusses the top five top causes of the Great Recession as outlined by the FCIC. We will now turn our attention to the number three cause, Deregulation.

You see, before 2008, the housing market was also strong. Between 1995 and 2000, prices rose at an annual rate of 5.2 percent. Then between 2005 and 2007, the rate hit 11.5 percent. However, to sustain this strong growth, the credit requirements had to be loosened.

In May 2008, Fannie Mae reduced the Debt to Income (DTI) ratios between 55 and 65 percent. Lending standards collapsed, and there was a significant failure of accountability.

Loans were often premised on ever-increasing home prices and were made regardless of ability to pay.

The Federal Reserve lowered the interest rates, and the FCIC reported the move as one of the primary reasons for the crash, as was greater access to mortgage credit for households who had traditionally been left out—subprime borrowers.

John Taylor, a Stanford economist and former Undersecretary of Treasury, blamed the crisis primarily on this action. If the Fed had followed its usual pattern, he told the FCIC, short-term interest rates would have been much higher, discouraging excessive investment in mortgages. “The boom in housing construction starts would have been much milder, might not even call it a boom, and the bust as well would have been mild,” Taylor said.

In retrospect, the FCIC concluded that the Federal Reserve’s monetary policy, including the lowering of interest rates, along with capital flows from abroad, created conditions in which a housing bubble could develop. However, these conditions need not have led to a crisis. The Federal Reserve and other regulators did not take necessary actions to constrain the credit bubble. In addition, the Federal Reserve’s policies and pronouncements encouraged rather than inhibited the growth of mortgage debt and the housing bubble.

In my book, Stealing Home, I discuss the housing markets’ current state in more detail. However, let’s pull the curtain back and take a high-level look. In 2019, the Federal Reserve reported that large financial institutions pose the highest risk and are considered the institutions representing the highest systemic risk to the U.S. economy.

Furthermore, in January 2019, the Office of Inspector General (OIG) reported in GAO-19-239; specifically, loan-to-value ratios and debt-to-income ratios have increased, while average borrower credit scores have declined. In fact, the ratios are worse off than those before the 2008 crash. Furthermore, most recently, roughly 25 percent of all new mortgages FHA backed had debt-to-income levels above 50 percent, the highest level since 2000.

On October 2, 2019, Damian Paletta of the Washington Post reported that the federal government has dramatically expanded its exposure to risky mortgages, as federal officials over the past four years took steps that cleared the way for companies to issue loans many borrowers might not be able to repay. This article is based on interviews with twenty-four senior administration officials, regulators, former regulators, bankers, and analysts, many of whom warned that taxpayers’ risks have built up in the mortgage sector with minimal scrutiny.

Also, it has been reported that “We are starting to see different kinds of capital coming into the multifamily market,” said Josh Grossman with money management firm LEM Capital LLC. “There’s more capital allocated to multifamily, with a significant amount from overseas,” said Steven DeFrancis, Atlanta-based CEO of Cortland.

Before 2008, the Regulators argued that financial institutions, with strong incentives to protect shareholders, would regulate themselves by carefully managing their own risks. However, in the end, the regulators found this not to be the case, leading to the conclusion that self-regulation is a failed policy.