One of the great anomalies of the American credit markets has always been the existence of the 30-year fixed rate home mortgage.
Long the favorite of homeowners, it has financed the majority of US residential property purchases since a Depression era housing stimulus program created them in 1938.
That is until now.
A perfect storm of institutional, political and economic factors is conspiring to bring an end to this type of loan.
Is it truly going the way of the dodo bird?
Look at the global credit landscape, and the 30 year fixed rate loan exists nowhere else.
Banks in all other countries only offer floating rate loans, where interest rates are adjusted monthly, quarterly, or annually to reflect the ebb and flow of the bond market. Thus, the homeowner assumes all of the interest rate risk.
So if you borrow money to buy a house and interest rates remain unchanged or fall, then so does your monthly payment. If rates rise, then so does your monthly nut. If they rise a lot, then you are toast.
The 30-year fixed only exists thanks to a massive government subsidy. That comes in the form of two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.
They buy home mortgages from banks, securitize them, and sell them on to end investors with a government guarantee. Thus the government took all the credit risk off of the banks and on to their own books. At the peak, the pair owned or guaranteed more than $5 trillion in debt.
And therein lies the problem.
When the 2008-2009 financial crisis came storming in, it didn’t take long for many of GSE’s home loans to default.
Thanks to the credit excesses of the 2000s, liars loans, and excess leverage, it turns out that many of the loans sold to them as prime credits were in fact junk. The default rates of some mortgage-backed securities exceeded 50%.
It didn’t take long for the GSEs’ capital to get completely wiped out. They effectively declared bankruptcy (the polite term used was conservatorship), and were only kept alive with a $360 billion government bailout.
