Problems With a Federal Rental Program

Rumored for some weeks now, the Obama administration today announced its intention to develop a rental business from foreclosed homes owned by Fannie Mae and Freddie Mac. The idea is currently in the research stage, as federal officials will be seeking comment from investors on how to set up such a program. The goal of this initiative is primarily to take pressure off of housing prices by removing some of the supply of homes for sale.

The primary reason this federal rental program is a bad idea is that we need housing prices to continue to fall for there to be true recovery. The bureaucratic nightmare of having the federal government manage a couple hundred thousand rental properties is an additional, but lesser factor for why this project should be dropped.

This past April we wrote about the myth of homeownership wealth creation. A common thought is that rising housing prices are good thing because it means housing as an investment is gaining value. However, when you adjust for inflation, homeonwership isn’t that great of an investment. Consider the following two charts:

For the 50 years following 1946 (the end of World War II and a shift in the U.S. economy back towards normalization) the real price of housing grew just 3%. Not until the mid-90s do we see housing prices double—and that was the housing bubble.

Currently, the Case-Shiller Index adjusted for June 2011 dollars is at 131.49. In 1996, right before it took off, it was at 116.38. And looking at the historical trend back to 1946, the average in real terms was about 120. This means housing prices still need to fall 11% to get back to 1996, pre-bubble levels. Or 9% if we just want to be at the historical norm.

This means attempting to keeping housing prices from falling is essentially trying to maintain the housing bubble. In 2005 if Treasury had suggested that the government buy homes off the market to rent them and keep supply pressures from influencing prices, would we have supported this to keep the bubble inflated? Probably not. So why support a similar policy now? Who is to say that today’s housing prices are a good floor?

Secretary Geithner says the program will be good for neighborhoods that have a deluge of vacant homes. FHFA Acting-Director DeMarco says the program may provide enough revenues to stem losses at Fannie Mae and Freddie Mac (which in turn would save taxpayers from having to extend their $168 billion GSE bailout). Both of these arguments are appealing, but short-sighted.

If the housing bubble deflation is stopped, and housing growth built on an artificially stabilized housing price floor, we are only going to see another housing bubble pop in the future, destabilizing the housing market. Are neighborhoods full of empty homes good? No. Do we want more GSE losses? Definitely not. But there are other solutions.

Why not remove all housing support programs that are trying to keep prices up, including the Fed’s interest rate gaming system, to have home values fall quickly to their historical norms. This would make sellers upset to be sure, but if they bought their home in the bubble then they have an overpriced mortgage anyway. And if they bought their home before the bubble then any value they thought they gained in the last decade was a mirage in the first place. And this would make homes more affordable for buyers, who would be more willing to enter the market at lower prices than today’s still inflated values. Neighborhoods would eventually fill back up.

As to the GSE losses, we certainly shouldn’t try to intentionally make losses greater for Fannie and Freddie, but we also shouldn’t be trying to resurrect them either. WSJ reports:

Mortgage giants Fannie Mae and Freddie Mac sold a record 100,000 homes during the second quarter. Together with the Federal Housing Administration, the entities owned about 250,000 homes at the end of June, or around half of all unsold, repossessed properties. Another 830,000 homes backed by the entities are in some stage of foreclosure, according to Barclays Capital.

I would prefer selling these homes to private rental management companies or individuals to run the business and get the homes off the GSE balance sheet for good so we can shut them down and remove their distortionary existence from our housing market. But even that has its own set of problems with unfairness, picking winners and loosers, and appeal to crony capitalism.