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American Enterprise Senior Fellow Ed Pinto on the pitfalls of the 30-year fixed rate mortgage.
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The thirty year fixed rate mortgages the most common way Americans finance -- house but my next guest says be wary.
These types of mortgages he says may be inflating the next housing bubble.
Ed Pinto is resident fellow for the American enterprise -- institute and served as the executive vice president.
And chief credit officer for Fannie Mae until the late 1980s welcome back to the show Ed.
Yeah I'm gonna tell -- like -- everybody's favorite tool for buying a house.
And the reason is is that you get to lock in your interest rate exposure keep that rate the same for thirty years if you want to.
How can a thirty year mortgage be a bad thing.
It's it's a bad thing because the interest rate on it is fixed for thirty years and interest rates go up and down.
And if interest rates go down they pay off more quickly if they go up there on the books are very long time.
And so these loans have to be owned by somebody.
Or the securities that -- -- -- owned by somebody and it turns out that that somebody is -- least someone guaranteed by the federal government or a government agency.
Sell it and so -- interest rate at -- it's bad for the Internet as not necessarily the people who hold the mortgage.
Right out that it has a downside for the people who have the mortgage and that they they pay off incredibly slowly.
And what I traveling to people is -- we -- five years into this downturn.
If we'd had some shorter term loans even twenty or 25 years we be a lot better off on deleveraging.
Then we are today the amount of amortization that occurred last five years literally rounds to zero and it's because of these very long term mortgages.
And -- -- not consumer friendly from that point.
Well except that you get a new loan.
At a different rate if you -- you were getting out.
But I think what you're talking about it out of the -- -- risk that's really critically important and I want to talk a little bit about why this is such an issue.
You say keeps interest rates artificially low.
-- Right so we have the government.
Keeping long term rates artificially low keeping short term rates artificially low.
They subsidize through credit subsidies the thirty year rate so it's even lower than it otherwise would be.
They set the capital requirements for banks and thrifts and invest -- -- at near zero because they're guaranteed by the government.
And then.
They these instruments end up on the books of entities that are either guaranteed by the government or or the government themselves and so if interest rates go -- at some point in the future.
Then the value these insurance changes dramatically and what has happened every time there's been a dramatic change in interest rates the these ended up it the thrifts the savings and loans -- early eighties Fannie.
Was insolvent in the early eighties because -- that a lot of these loans.
Most people don't remember that FA Freddie Mac and Fannie Mae had trouble rolling over their debt.
For their portfolio back in 2008 why because they had huge amounts of fixed rate loans on there books.
And it could be 234 -- -- now we don't know all we know is these rates will turn.
And I do they'll pop with a vengeance well Danielle -- value of these securities dropped.
You see that as a primary risk right now.
What has to be an equitable rise in rates at some point right.
Right right and so they're being kept down artificially low.
And the government is subsidizing and even lower and then sometime in the future and again I'm not saying when it's all it is it will happen.
And when it happens it turns out that the taxpayer usually ends up holding the -- So my Canadian sister in law has a five your mortgage.
And they -- right every five years would that be a better system and how does that help consumers.
Well that that the best system and in my opinion and in the five year 87 year.
It is a good timeframe but you could also have.
Fifteen year loans twenty year loan -- could have a thirty year loan with a fifteen year.
It's set fixed rate you have a lot of different options the problem is those options don't get to develop in the United States.
The cost the government subsidizes the thirty year fixed rate making it cheaper and then squeezing out the other options at the same time.
It's very difficult to church prepayment fees.
-- a modest prepayment fee and you mentioned near here in Canada.
There they have what's known as yield maintenance if you even if you pay that five year loan off early.
You have to make up the difference and so you can't constantly refinancing refinance that was another problem that we had -- the constant re financing.
Allowed people to take out so much money.
That again they were over leveraged and so -- a system that promotes over leveraged.
And we need to get to a system that does the opposite because the problem we have is over leveraged.
Well and what I -- saying is that the consumers had something of a free ride.
In this -- -- and sleep the and other instinct thing of course that thirty year.
Term.
Doesn't actually at the time people typically stay in house people on live -- house like seven years.
Right so so if you want it at seven or ten year term you'd end up by default getting a thirty year term because it's probably going to be cheaper.
If if -- wanted the thirty year term rather than paying for it you get it.
Cheaper because you have a free prepayment -- -- -- and so you're not paying for what you want and if people want something shorter really aren't paying for what they want.
And and so we have distortions that are going on our markets we have distortions both on the loan side.
But then.
-- my point about this -- bubble on the investor side.
Is that we have distortions also on the investor side so that this market is filled with distortions and -- the distortions.
That create future problems.
-- Intel thanks for bringing that to us fascinating stuff.
Okay thank you -- was a pleasure happy new year happy new year -- use.
