One of the most thought-provoking articles I’ve read in the past year was from this Substack newsletter by former hedge fund manager Marc Rubinstein, discussing how the most common way to pay for a home in the United States, the 30 year fixed rate pre-payable mortgage, doesn’t exist anywhere else in the world (except Denmark, interestingly).
Partly it was thought-provoking because I was a little peeved with myself for being very interested in real estate and economics, but never having realized that American mortgages make no sense.
Here’s why they don’t make sense. They’re fantastic for homebuyers, who can spread out the cost of their home over decades, lock in their interest rate (the fixed rate part) so they are protected from interest rates going up, and can pay the mortgage off early with no penalty (the pre-payable part). The pre-payment allows a homeowner to save thousands on interest by re-financing if interest rates go down.
As a result, whether the market interest rate goes up or down during the life of the mortgage, it’s heads the homebuyer wins, tails the lender loses. To quote Rubinstein:
“From the consumer’s perspective, it’s an amazing product. It’s a simple loan that offers stable repayments, kept low because they are spread out over such a long period of time. Its kicker is a free option to prepay, which shields the borrower from interest rate risk. If rates go up, borrowers can commend themselves on a great bargain; if they go down, stay calm—the loan can be refinanced without penalty. Win/win.
All the characteristics that make it terrific for the consumer make it terrible for a traditional lender. Thirty years is a long time to have something sitting on your balance sheet, watching the credit risk compound. Especially something that’s loaded with as much interest rate risk as this. If it’s win/win for the consumer, somebody has to be on the other side of that trade.“
And who is that somebody?
Our dear old Uncle Sam.
The U.S. Government controls two-thirds of the American mortgage market though the “government sponsored enterprises” Fannie Mae and Freddie Mac. By assuming the risk of these mortgages, the Feds have managed to take a terrible investment (from the lender’s perspective) and make it the second most easily resold financial investment in the world after US Treasury Bills.
Why? Because it’s ingrained in the American mind that home ownership is one of the highest and best goals for an American to have. If the government got out of the business of propping up mortgages, what would happen?
Mortgages would likely only be available at higher, adjustable rates with shorter terms. Because the monthly cost would be so much higher, fewer people could afford to buy a home.
The market value of existing homes would plummet due to less demand. Speculative development of single-family homes would likely stop, and prices for construction materials would fall.
It even seems likely that the market for appliances would change. Most rental homes do not have elaborate ranges, refrigerators, and washer/dryer sets.
In short, a massive part of our economy is based on one little belief (“Homeownership is Good”) and one rickety government apparatus to support it.
And this general principle of a single idea affecting a huge part of the world is fascinating to me. Rubinstein mentions in the same essay how in the United Kingdom, the National Health Service occupies a similar unquestioned position in people’s minds as one of the most important parts of Britishness.
These unquestioned assumptions aren’t just extremely influential, they provide a shortcut for people when making decisions. Propping up mortgages in America and funding the NHS in Britain are immune to partisan bickering because almost everyone agrees that the outcome is positive and worthwhile.
That is just the practical example of the principal. To take a more philosophical tack, consider the following.
Richard Weaver, a professor of rhetoric at the University of Chicago in the 1940s and 1950s, wrote a book called the Ethics of Rhetoric. One of the aspects of rhetoric he dealt with was how societies that have broad agreement on fundamental ideas are able to advance new ideas and solutions, because they don’t need to continuously reestablish basic agreement on those fundamentals.
On the other hand, a society that doesn’t have broad agreement on basic ideas about morality, the nature of humanity, what it means to live a good life, and to what degree public policy should promote such things is going to be stagnated in a fierce battle over those concepts.
In America today we are living with the consequences of such a society. Most of the areas of public policy agreement are, like the mortgage system, agreed upon because there are major institutions reliant on a stable policy that doesn’t vary depending on which party is in power. Meanwhile, basic questions like freedom of speech, thought, religion, and even the nature of when human life begins are up in the air.
So we fight each other tooth and claw over things that a healthy society might have considered settled long ago by much wiser minds, and ignore other assumptions that might be more worthy of our questioning.
Like why we spend more and get less for our national defense every year. Or why a nation that built an interstate highway system half a century ago can’t seem to maintain it now. Or how we are going to keep paying out Social Security benefits with fewer and fewer working people per retiree.
Those are the questions a healthy society asks. Questions on how to maintain and improve what we have, not questioning if we should tear everything down and go back to square one. Those are questions we need to ask, before we run out of time to ask them.
But if we spend our time relitigating the nature of human life and human rights, we probably won’t have the time or willingness to discuss how to fix an inefficient government.
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