' 1 — .. 1 7"‘ ‘ _._,,.. " ‘ ‘-V——:., ~-;;Twuu_. _ gig‘. 33...--~ - -"" """" ""53!-—"..-.. CONGRESSIONAL RESEARCH SERVICE LIBRARY OF CONGRESS Issue Brief E I i E I U Mlilslsoulri mbia V i‘iei|sit"|of" 010-1 03860715 HOUSING AND THE ECONOMY ISSUE BRIEF NUMBER IB78086 AUTHOR: Barbara Miles Economics Division Bruce E. Foote Economics DiViSiOI1 THE LIBRARY OF CONGRESS CONGRESSIONAL RESEARCH SERVICE MAJOR ISSUES SYSTEM DATE ORIGINATED 09/O9/78 DATE UPDATED 08/19/82 FOR ADDITIONAL INFORMATION CALL 287-5700 0819 1 / , /5:.-.\\ ~\businessmen located throughout the country CRS- 1 IB78086 UPDATE-08/l9/82 / ISSUE DEFINITION are not million could starts the 15% Housing markets are in their fourth year of deep recession and expected to show any improvement in l982 over 1981 levels. The l.l housing starts in 1981 were the fewest since 1946. A weak recovery still begin in the late months of this year, but significant rises in or sales are unlikely unless mortgage interest rates drop below level. Even then, consumer resistance to adjustable mortgages, and shifts away from mortgage lending by thrift institutions could dampen any improvement. As has been true for the past three years, the current outlook for housing production suggests serious doubts that an expanding and highly mobile population can be housed without some reduction in traditional housing standards, and raises issues ranging from the viability of homebuilding firms and mortgage lending institutions as currently structured, to the affordability without assistance of either homeownership or rentals for a large part of the nation's households. BACKGROUND AND POLICY ANALYSIS HISTORICAL PERSPECTIVE It also small home is are Housing is one of the largest sectors of the U.S. economy. highly atomistic most homebuilders and real estate dealers and as the majority of purchases are financed with long-term mortgages, housing is one of the most sensitive of U.S. industries to changes in the cost and availability of credit. Because" of the industry's size and sensitivity to financial conditions, housing playsr a special role in macroeconomic stabilization policy. During periods of rapid inflation, .housing has usually been first major sector of the economy to respond to monetary policies designed to slow the rate of price increases. In addition, housing has traditionally been more severely affected by anti-inflationary monetary policies than virtually any other sector of the economy. and high If N record Thus, housing has earned its reputation as a For example, starts of new houses fell from a units in 1972 to 1.2 million units in 1975 a 50% decline. basis the drop was even greater with the low of 976,000 representing a 60% drop from the previous quarterly peak rate. 1]. Furthermore, the housing industry has often led the way‘ into both recessions and periods of sustained economic growth and has almost always declined or risen more than proportionately to the rest of the economy. This has led some policymakers to think of housing as a kind of economic "balance wheel" that helps smooth out the business cycles for the economy as a whole by bearing the brunt of economic contractions when interest rates rise, and recovering most rapidly when interest rates fall. "bust" industry. of 2.4 million On a quarterly starts (SAAR) [See Exhibit The relation of residential construction to the economy as shown by different rates of change in the Gross National Product (GNP) and in investment in residential structures. Measured in real terms (inflation Lcorrected), investment in housing generally comprises 4 or 5% of the total of goods and services produced in the economy. In the seven business cycles which have occurred since world war II, however, residential investment accounted for a far greater proportion of the change in GNP. Exhibit 2 in a WhOl€ iS the‘ CRS- 2 IB78086 UPDATE-O8/19/82 the Appendix to this Issue ,Brief shows changes in GNP and changes in investment in residential structures in the periods of economic recessionw i subsequent growth from the lst quarter of 1971 through the first quarter of 1981. 9 A FINANCIAL MARKETS Often when discussing housing markets, reference is made to the "basic" or "underlying" demand. This refers to demographics: in the current situation and'at least until 1990, demand for housing should be very strong as persons born during the 19505 baby boom come of age, form their own households, and enter, most probably, the homeownership market. This demand for housing is not entirely independent of economic factors --- households form more slowly during recessions, for example --— but is often used in forming estimates of housing "need." It is generally this notion of "needs? against which the housing industry's performance in supplying new units is measured. Regardless of the basic demographics, it is conditions in financial mar=~.. » ~ i si—+ which have the greatest impact on fidusing cycles. iIn the typical interest rate cycle, rising short-term interest rates produce outflows of funds from savings and loan associations (S&Ls) —- the nation's major mortgage lenders -- as depositors shift their money from limited interest deposits into higher yielding, open market securities. Since mid-1978, however, a series of regulatory and legislative changes have been made that are intended to increase the flexibility of the thrift institutions in responding to cyclical swings in interest rates and, it is hoped, smooth out mortgage lending and housing cycles. These developme” 5 include the introduction of high-yielding, variable-rate deposit certificates (e.g. six-month "mmcs" and 30-month "small saver" certificates), "Now" accounts, passage Of a Federal override Of State mortgage USUFY ceilings,‘ authorization for adjustable type mortgage loans, and the beginning of a planned phase-out of deposit rate ceilings under supervision of the Depository Institutions Deregulation Committee (DIDC). Further, the thrifts have been authorized to invest up to 20% of assets in consumer loans, commercial paper, and corporate debt securities, and powers of their service cooperations have also been expanded. These changes can be seen as adaptions to the realities of financial markets in an inflationary environment. For mortgage lenders operations continued well past the time that previously would have seen sharp lending curtailments. Depositors in the institutions have been able t0 obtain_ interest earnings more in line with market rates. Mortgage borrowers, on the other hand, have been forced to pay mortgage rates more closely attuned to capital market rates. The upshot of all this appears to be that it is no longer an outright unavailability of funds that periodically curtails housing activity, but rather mortgage interest rates reaching very high cyclical peaks which disqualify many would-be home purchasers. The major factors now affecting housing are high interest rates and shifts in financial capabilities of mortgage lenders and investors. FOP financial institutions, high interest rates signify the need t0 adj"st asset portfolios to lessen future interest .rate risk and proi ;t profitability. The basic problem faced by the depository lenders has been the very rapidly rising cost of deposit funds while the yield on assets has risen only slowly. Liability costs have risen not only because of the higher rates available to savers since mid-1978, but also because savers have CRS- 3 IB78086 UPDATE-O8/19/82 shifted out of lower yielding accounts and into the more costly certificates. At the end of 1978, for example, only about 17% of deposits were held as mmcs, jumbo ($100,000) or 2 1/2 year certificates; by Dec., 1981 that proportion was just under 65% and regular passbook accounts were about 19%. On the asset side, low yields reflect a preponderance of pre-1979 mortgages earning yields of 9 1/2% and less. New mortgages, at 15% and up are simply not sufficient to overcome the "drag" of the older assets. Further, assumability requirements and due—on-sale-clause avoidance by some sellers and purchasers are having the effect of prolonging the life of mortgages which normally could have been expected to be prepaid well short of their 25-and 30-year maturities (most mortgages turn over within 10 years). Thus, system—wide, the spread between asset and liability yields for insured S&Ls at mid-year 1981 was -0.59, compared to more normal spreads of about 1.5%. In the long run, adjustable mortgage loans (AMLS), which were authorized in April, 1981 may enable S&Ls to keep the spread in some desired range. With ALMS, S&Ls may adjust the rate on the loans as market rates change. AMLS may have little impact in the short run because (1) it takes time to implment the new loans and (2) it may be years before ALMS represent a significant portion of loans outstanding. At the end of 1981, the situation for the thrifts was one of deterioration: the net return on assets was negative, indicating that the industry as a whole was losing money. Indeed, at least 3/4's of the industry was losing money. Twenty arranged mergers (to avoid, liquidation) had occurred including four giant interstate merger, and there was one outright failure, the first in a decade. By comparison, voluntary mergers between healthy institutions has more than doubled. The general increase in mergers signals an attempt to gain the economies of scale necessary to take full advangage of new asset powers granted under the deregulation proceedings. The problems affecting the primary lenders are also being felt by the: major secondary market investors. Secondary market investors provide funds by making commitments to purchase mortgages and by purchasing existing. mortgages from mortgage bankers and thrifts, thereby replenishing the primary. lenders‘ funds for futher mortgages. The Federal National Mortgage Association (FNMA), a quasi-public tax-paying institution, and the largest secondary market investor, sustained losses throughout 1981, posting an overall $190.4 million loss. Currently, FNMA's held mortgages are yielding an average of about 9 l/2%, while the cost of financing the portfolio through debentures is averaging 15%. In October, 1980, FNMA announced that it would no longer purchase assumable conventional mortgages unless they carried variable interest rates; in those States where assumability is legally required, FNMA will require a 7-year "call" provision so that it can force refinancing and protect its earnings against long-term interest—rate risk. In the Spring 1981, FNMA announced a refinancing program for its mortgages in which it offered attractive terms to encourage home owners to refinance, or to enable them to sell to new borrowers who could obtain better than market financing from FNMA. More recently both FNMA and FHLMC have been willing to take "buy-down" mortgages -- those on which sellers of houses (especially builders) make part of the monthly payments for a few years to reduce the effective rate to the home buyer. These mortgages generally carry full market yields and raise earnings for mortgage holders. The importance of the federally sponsored secondary market institutions (such as FNMA, or the Federal Home Loan Mortgage Corporation (FHLMC) in maintaining the weak mortage resale market has been crucial. In 1981 the total of secondary market purchases of home mortgages was $55.8 billion or 57% of all primary market originations. Private investors (pension funds, CRS- 4 IB78086 UPDATE-O8/19/82 insurance companies, other savings institutions, etc.) accounted for only about $17.6 billion of that amount. Another $20.3 billion came from mortg pools, most of which are guaranteed by HUD's Government National Mortgage Association (GNMA). The rest of the investment came from State and local investment agencies, and the Federal credit agencies which alone took $12.4 billion or 22% of the purchases. 3 4 As mortgage interest rates change, or are expected to change, so do the yields obtainable by investors. Yields have been mixed at recent auctions of FNMA and FHLMC (see the listings below of Selected Interest Rates.) The FNMA auctions are for commitments of funds for four months. These auctions thus reflect expectations for the next four months. The FHLMC auction yields are considered a good indicator of current market conditions, because delivery of mortgages is mandatory while FNMA bidders may elect to hold or sell elsewhere if they can get a better price. The actions of FNMA and FHLMC and the GNMA become particularly important when mortgage lending is curtailed. Both FHLMC and FNMA are currently buying old, low-yielding mortgages from thrift institutions andr issuing their guaranteed securities against them. This aids the thrifts by) allowing .them to use the securities for collateral to gain liquidity, but still yields a small profit to FNMA and FHLMC. The "swaps" of securities have dominated mortgage backed securities markets since late-l98l. In early 1982, secondary maket purchases, for the first time, were greater than mortgage originations. For the Government-run GNMA, it is possible, if funds are available, GNMA to open its "Tandem" window to buy up mortgages (FHA/VA conventional) to get funds back into lender's hands. In 1974 and 1975, attempt to bolster housing markets, GNMA bought up mortgages with low interest rates, and then resold them to FHLMC and FNMA at a discount to reflect the below market.rate. The budget cost to the government was the difference between what GNMA paid for the mortgages and the discounted at which it sold them. The countercyclical or emergency tandem program expires this year. The importance of the secondary market is not only in the level of funding that it provides, but also in the regional impactx on flows of funds. Areas with active housing markets, but relatively low savings flows, have been able to continue lending by selling mortgates to investors from areas with relatively more capital and lower activity. Thus, interest rates on mortgages have tended to exhibit smaller regional differences in recent years, and there has been less of a tendency for one region of the country to be more affected by interest rate cycles than other areas. for and in 1 relatively Selected interest rates (in percents) Current period PI'€ViOL1S period Commitment rates on 75%, 25-year Conventional home mortgages FHLBB (July) 17.22 l7.l6 FHA/VA standard mortgages (August) 15.0 15.5 graduated_payment mortgages (August) 15.0 15.5 price CRS- 5 IB78086 UPDATE-08/19/82 FNMA auction rates (August 16) conventional 4-month 15.687 ' 16.209 commitments FHA/VA commitments 15.780 17.216 (August 16) FHLMC auction (August 13) conventional, standard immediate purchase 16.063 16.131 Adjustable mortgages 17.02 16.750 (June) Bank prime rate (August) 14.000 14.500 181-day U.S. Treasury bills 26 wk. (August 16) 9.821 6-month market certificates 10.952 11.614 (August 16) All Savers Certificates (August) 8.96 9.86 SINGLE FAMILY HOUSING MARKETS In general, single-family houses can be thought of as forming the homeownership market: data from the 1978 Annual Housing Survey show that 87% of single-family houses built after 1970 were owner4occupied after sale. By contrast, only 23% of units in new structures containing 2 to 4 units and only 9% of units in new buildings with 5 or more units were owner-occupied. Starts of single-family houses in the current quarter continue to be at very low levels (see Table 1), and Sales of both new and existing single-family houses have continued to slide in response to high interest rates CRS- 6 IB78086 UPDATE-08/19/82 TABLE 1 PRIVATELY OWNED HOUSING UNITS STARTED (Thousands of units, seasonally adjusted annual rates) MANUFACTURERS‘ SINGLE MULTI SHIPMENTS OF TOTAL FAMILY FAMILY MOBILE HOMES 1965 01473 964 509 217 1966 1165 779 386 217 1967 1292 844 448 240 1968 1508 899 608 318 1969 1467 811 656 413 1970 1434 813 621 401 1971 2052 1151 901 497 1972 2357 1309 1048 576 1973 2045 1132 913 567 1974 1338 888 450 329 1975 1160 892 268 213 1976 1538 1162 275 246 1977 1987 1451 536 277 1978 2020 1433 587 276 1979 1745 1194 551 277 1980 1292 852 440 222 1981 1084 705 379 241 1981 I" 1399 891 508 248 II 1173 783 390 255 III 962 644 318 244 IV 871 540 331 207 1982 I 920 594 327 238 II 954 604 350 246 July 1,211 614 597 NA Note: Quarterly data represent averages of months in the quarter (P): Preliminary by census. (R): Revised Sources: Bureau of the Census; Manufactured Housing Institute. CRS- 7 IB78086 UPDATE-O8/19/82 The inventory of newly constructed unsold homes has been high relative to sales once again. In the most recent period the inventory represented about 10 months of sales at existing sales rates. The absolute number of houses, however, has remained fairly low so that even a modest increase in sales could shorten the inventory to a more managable a 6 month rate. The high costs due to expensive construction period loans, of carrying completed houses for which there is no buyer, constitute the major reason for builder bankruptcies in housing recessions. In an attempt to alleviate this problem, HUD has twice made FHA long-term mortgage financing available to all FHA operative builders, and builders operating under the Home Owners Warranty program of the NAHB. Thus, builders in 1980 and early 1981 were able to replace short-term construction loans with 30-year FHA standard mortgages without finding a buyer for the houses. At this point, eligible activity under the program has ceased; it nonetheless is a potentially important countercyclical precedent. CRS- 8 IB78086 UPDATE-O8/l9/82 TABLE 2 SINGLE FAMILY HOUSING MARKET INDICATORS‘ NEw HOMES EXISTING HOMES . MEDIAN MEDIAN SALES(r) PRICE SALES(r) PRICE (000) MONTHS OF SUPPLY(l) ($) (000) ($) 1955 575 5.1 20,000 EA NA 1955 451 5.8 21,400 KA NA 1957 487 4.8 22,700 NA NA 1958 490 5.1 24,700 1,559 20,100 1959 448 5.1 25,500 1,594 21,800 1970 485 5.5 23,400 1,512 23,000 1971 555 4.5 25,200 2,018 24,800 1972 718 5,0 27,500 2,252 25,700 1973 534 8.3 32,500 2,334 28,900 51974 I 519 9.3 35,900 2,2725 32,000 1975 549 7.5 39,300 2,452 35,300 1975 545 5.3 44,200 3,002 38,100 1977 819 5.5 48,800 3,547 42,900 1978 817 5.1 55,700 3,853 48,700 1979 709 7.8 52,900 3,701 55,700 1980 545 8.3 54,500 2,881 52,200 1981 435 8.9 58,900 2,351 55,400 1981 - I 523 7.8 55,800 2,500 54,300 (r) II 455 8.7 59,400 2,530 55,400 III 359 10.4 59,200 2,250 57,500 IV ‘ 401 8.7 70,400 1,920 55,200 1982 I 387 8.5 55,700 3 1,930 55,800 II(P) 358 8.7 70,200 1,920 58,100 (1) Months of supply at current sales rates; averages of monthly ratios within each period. r: revised p: preliminary e: estimated Note: Quarterly data represent averages of months in the quarter, sales data are annual rates seasonally adjusted. Sources: Bureau of the Census; National Association of Realtors CRS- 9 IB78086 UPDATE-08/l9/82 PRICES and FINANCING COSTS Price increases for houses have clearly slowed, as high interest rates have resulted in monthly payments which disqualify many buyers. The median sales price of new houses in l98l rose only about 7% above a year earlier. For previously occupied houses the rise was the same. This represents a significant deceleration from earlier increases. Changes in median prices of houses sold occur not only because of price increases, but also because of differences in quality, location, and other characteristics of the houses which are actually sold. The index of new house prices attempts to correct for such differences and thus provides an approximation of "pure" price changes. The index has not changed in recent months. In fact, prices in a "real" sense may have slowed more than these figures suggest. Perhaps 60% or more of all current sales are thought to involve some form of "creative," or below-market financing. Such cut-rate financing masks the true market price of a house by allowing a higher price than the seller could get otherwise. It has been estimated by the Realtors and others that true prices have actually fallen in both l98l and l982. i 2 It is not unusual for prices to moderate when financing is difficult. some owners remove their houses from the market rather than reduce their asking prices. Others, who must sell quickly, lower the price to lower monthly payments at high interest rates enough to qualify potential buyers. If past experience holds, when interest rates ease, larger house price increases will resume. The restructuring of the financial system and development of adjustable mortgages which require borrowers to pay current costs of funds may effectively limit future demand-induced price increases, however. Using average commercial financing terms, the median priced new house in 1981 required a downpayment of $17,300 (25%), and monthly payments to principal and interest of $708 (l6.25%, 30 years). Comparable figures for l980 were $l5.550 and $544 ($l3.75%). The apparent decrease in housing affordability has long been considered a major deterrent to homeownership, particularly for first time homebuyers who do not have an existing equity to use as a downpayment. However, as noted above the expectation of continued increases in house prices relative to those for other goods and services combined with tax benefits for homeowners, have produced a strong propensity toward housing as an investment on the part of consumers seeking tax sheltered savings as well as a place to live. Tax benefits include the combined effect on taxes paid of progressive tax rates and mortgage interest (and property tax) deductability from income, provisions that allow capital gains from the sale of residences to be rolled over into sucessive home purchases, and escape from up to $125,000 of capital gains not rolled over after age 55. The tax expenditure for the interest costs alone for owner occupied homes is estimated to total $19.8 billion for FY81 and is expected to top $25 billion by FY82. Thus, the notion of what is "affordable" (and profitable) has changed. While the standard mortgage practice dictates that monthly housing payments (including principal, interest, taxes, and hazard insurance) should not exceed 25-28% of income, mortgages requiring up to 35% are no longer uncommon. According to the U.S. League of Savings Associations, about 45% of all homebuyers in 1979 committed more than 25% of income to home payments, up from 40% in 1977. MULTI UNIT HOUSING CRS-l0 IB78086 UPDATE-08/19/82 Starts of units in multi unit structures (including condominiums) have been rising slightly, but remain low Most of the new construction appears o be in condominiums, cooperative, or subsidized rentals rather than more traditional rentals. The basic reason for this is that, in general, rent increases have been inadequate to assure developers of a reasonable return on unsubsidized rental projects, in light of increases in construction and maintainance costs. when interest rates are both high and volatile, the potential financing costs of construction which will take l to 2 years to complete, discourage all but luxury or subsidized rentals and condominiums. The latter offer much higher returns than rental sales to developers so long as mortgage money remains available for individual purchasers. As a result of the moderate pace of construction, removals from the inventory, and conversions to condominiums, rental markets have been very tight, with the national vacancy rate averaging about 5%. Another indicator of relative rental demand is the market absorption rate for new apartments. Unlike vacancy rates, which measure vacancies for the entire stock of rental units and are affected by demolitions and condominium conversions as well as tenant moves, market absorption rates measure the ease with which new units are rented. Of units completed in the 3rd quarter of l98l, 79% were rented within 3 months (see table 3). Considering the small number of units being completed, this implies some weakness in demand, (which implies ability to pay), at least for the types of units newly offered. Sales of condominium and cooperative units have been reasonable as this form of ownership housing has become more accepted. 0f units completed in the 3rd quarter of 1981, 60% were sold in 3 months indicating recent weakness in this market also. In spite of the very recent easing, the rental market should still be characterized as tight. This tightness, however, has not brought about a more rapid rise in rents because the ability to translate physical shortages Of rental units iI1tO price increases iS weak. In some areas this may be due‘ to rent controls. However, nationally, the fact that renters on average have lower incomes than home owners limits possibility of higher rents. Also the increase in single individuals entering the ownership market may mean that further attempts to increase rents would simply accelerate the diversion from apartments of this traditional renter group. Federally subsidized housing provided support some to multiunit housing during l98l. By the end of the year there were about 48,000 section 8 new construction starts. Even fewer starts are expected in FY82 because of financing difficulties and proposals to rescind authorizations. Under the Section 8 program, HUD pays rent subsidies on behalf of lower-income tenants to landlords. To encourage new construction, HUD makes commitments to provide subsidies if developers will build for lower-income tenants. As further incentive, some private Section 8 developers receive FHA-insured permanent financing at interest rates of 7 l/2%. The low rate mortgages are granted by private lenders who sell them to the Government National Mortgage Association (GNMA) under a special "tandem" plan. GNMA either holds, the mortgages or resells them to other investors, taking a loss on the sale, and thus, providing an interest rate subsidy to the developer, a fee and replenished funds to the mortgage lender, and competitive yields from the discounted resale to secondary market investors. CRS-ll A IB78086 UPDATE-O8/19/82 TABLE 3 MULTI-FAMILY HOUSING MARKET INDICATORS Market Absorption Rates(1): Percent of units rented (or sold) within 3 months, by period of completion Rental p Rental Condominiums Vacancy Rate Apartments and cooperatives (NSA) (SA) (NSA) 1965 8.3 1966 7.6 1967 6.8 1968 5.9 1959 5.5 80(2) 1970 5.3 74 1971 5.4 69 1972 5.6 67 1973 5.8 69 I 1974 6.2 69 57 1975 6.0 71 44 1976 5.6 81 53 .1977 5.2 80 72 1978 5.0 82 77 1979 5.0 83 75 1980 5.4 75 72 1981 5.1 80 63 1981 - I 5.2 78 68 - II 5.0 81 67 III 5.0 78 60 IV 5.0 84 56 1982 - I 5.3 na na (1) Privately financed, non-subsidized, unfurnished apartments, and condominiums and cooperatives, in buildings with 5 or more units. (2) Last quarter completions only. Source: Bureau Of the CEDSUS CRS-12 IB78086 UPDATE-O8/19/82 CURRENT LEGISLATIVE DEVELOPMENTS Current proposals to assist the homebuilding industry fall into either of two basic catagories: those that seek to stimulate homebuilding and sales through reduced rate mortgages or other purchase subsidies; and those that seek to assist ailing financial institutions or otherwise encourage and expand the private supply of funds available for mortgage lending. Direct aid: The direct stimulation category includes low-interest rate loans supplied through the Government National Mortgage Association (GNMA), such as the "Brooke-Cranston" program which was used during the l973-75 housing cycle; interest payment supplements such as those in the Section 235(q) FHA program; various other interest rate buydowns, including "Lugar"; tax credits for purchase and tax benefits for savings for home purchase. The essential features are as follows: (1) Brooke—Cranston or tandem (Section 313 of the Housing Act. of 1974) allows GNMA to make funds available to lenders for origination of home mortgages at interest rates specified by HUD. Current law sets maximum subsidy at three percentage points below the market rate as measured by FHLBB closings statistics, mandates a house price limit based on area medians, and where possible gives priority to moderate-income families. Legislation loosening limits and allowing deeper subsidy has been proposed. Major advantage: there is experience with the program which could be used quickly. Major disadvantage: immediate budget impact from purchasing completed mortgages is very high unless immediately resold to private investors at a loss. (2) Section 235(q) allows the FHA to make payments to a lender on behalf of a qualified mortgagor to effectively lower the cost of the FHA-insured loan. Current law has house price limits and income limits varying by’ region, maximum subsidy limits, and a recapture of subsidy upon resale. Legislation proposes extension and amendment of the program which otherwise expires Sept. 30, 1982 (S. 2327, H.R. 5731). Major advantage: potential tight control over recipients of loans, minimizing equity problems. ‘ Major disadvantage: may be too restrictive to stimulate much home building, particularly in high cost areas. (3) Buydowns. The prototype, since vetoed by the President was the "Lugar" bill, which would have allowed GNMA to pay up to four percentage points of the interest on an FHA-insured mortgage for a new house for a 5-year period. A growing equity (GEM) feature annually increased the monthly payments to principal over that same period, thus effectively cutting the mortgage term to 19 years instead of 30. Legislation proposed mortgage limits of $67,500, income limits of $30,000, both limits higher in high cost areas maximum write-down to ll%, recapture of subsidy (without interest) on resale of house. Major advantage: relatively low budget impact. Major disadvantage; mortgage and income limits, and formula for allocations of funds to states may dilute effectiveness of program. (4) Tax credits for purchase provide credits against income taxes for anyone purchasing a qualified (new, unsold) home. H.R. 5322 provides up to $5000. Major advantage: administrative simplicity. Major disadvanta .: previous experience with credits (in 1975-6) indicates large tax revenue losses were mainly windfalls to households which would have purchased in any case. CRS-l3 IB78086 UPDATE-O8/19/82 (5) Tax benefits for savings mainly take the form of allowing use of individual retirement accounts for one home purchase or setting up a parallel program of individual housing accounts. The accounts allow a deduction for savings as well as accumulation of tax—deferred interest for the, purpose of making a down payment. (H.R. 5800, H.R. 5769) Major advantage: assistance to first-time purchasers with no existing equity. Major disadvantage: a long—term program, it would not provide immediate stimulus. Indirect aid through assistance and encouragement to mortgage investors: This category includes both immediate capital infusion and mortgage warehousing assistance for thrift institutions, long-term restructuring of asset powers of mortgage lenders, restructuring of the Federal Home Loan Mortgage Corporation, and easing of rules affecting pension funds. All Capital infusion and warehousing proposals basically attempt to relieve thrift institutions of protfolios of low-yielding mortgage assets to cure their unprofitability and make future lending possible. To some extent, because of bookkeeping methods, programs of FHLMC and FNMA, the major secondary market makers, have already been addressing this problem. For a growing number of institutions, however, greater assistance may be necessary to avert failure. One warehousing proposal would allow regulators to exchange capital certificates yielding the average Government borrowing rate for old mortgages, with the Treasury paying to the assisted lender the difference between the interest due on the certificates and that earned on the old mortgages. The exchange could last for up to 5-years before redemption of the certificates would be required. H.R. 5568 (St. Germain) is a capital guarantee plan that allows the banking regulators to issue certificates to S&LS, which would be redeemable only in the event the institution failed and had to be liquidiated. The proposal sets maximum net worth and other financial requirements for an institution to be included in the program. Potential cost is about $8 billion. Major disadvantage: no immediate budget outlays. Major disadvantage: creates large contingent Federal liability, slows market adoptation of thrifts. Lgl Restructuring proposals generally allow thrift institutions to .become more like commercial banks, enabling them to seek profitability through more flexible lending capabilities than at present. S. l703 would also overturn state laws prohibiting due-on-sale clause enforcement, and broadens authority of Federal insurers to aid troubled institutions. S. 1720 (Garn) incorporates S. 1703 and also expands asset powers and flexibility of all depositories. Major advantage: recognizes and adapts to radically changing nature of financial institutions in recent years. Major disadvantage: frees thrift institutions from any mortgage lending requirement, thus leaving the housing S€COtI' With I10 dedicated primary lenders. ASL Restructuring of the Federal Home Loan Mortgage Corporation (FHLMC) would take the Corporation out of its current status as a wholly-owned subsidiary of the Federal Home Loan Banks, would allow sale of stock to users and other investors, and by thus expanding the capital base of the secondary market maker, would allow expansion of its housing and mortgage programs. Major advantage: would expand capabilities of a major conduit for investment in mortgages, thus increasing efficiency and funds available for housing. Major disadvantage: FHCMC expansion in the current market could create severe financial difficulties for FNMA the other, larger, federally-sponsored agency. (4) Easing of rules and other changes affecting pension funds includes a variety of proposals to encourage the large and growing pension funds to CRS-14 IB78086 UPDATE-O8/19/82 invest in mortgages. Some proposals would amend ERISA rules governing pension investments to allow greater mortgage purchase (H.R. 6781). Many E these proposals (plan asset and prohibited transactions rules) are being pursued currently through regulatory mechanisms and may not require‘ legislation. Major advantage: the pension funds are the largest potential source of long-term funds which could support long-term mortgages. Major disadvantage: it is conceivable that unwise investments, particularly in low-interest rate loans, could harm funds. lgl Tax changes to encourage mortgage investment include the Al1—Savers Certificates and IRAs as a means of lowering the cost of funds or securing a supply of funds by lenders. ASCs will expire Dec. 31, 1982 and are unlikely to be renewed. IRAs, at present, are not inexpensive and are not tied to housing except to the extent that the acquiring lender makes mortgages. A new proposal, Mortgage Interest Reduction Act (to be introduced), allows lenders or holders of special mortgages to receive a 25% ‘exclusion from income of interest earned on the mortgages. Qualifying mortgages would have to bear interest at a rate 10% below market rates. Major advantage: thrift institutions could profit on such mortgages through use of the secondary market, potentially enticing new sources of funds by taking advantage of. the spread between taxable equivalent yield and the stated mortgage interest rate. Major disadvantage: the interest rate reduction may be too small to create much stimulus. This legislative summary does not include proposals for construction of subsidized housing for low— and moderate-income renters (or homebuyers under programs not intended to be cyclical in nature). Such legislation, including H.R. 5731, could have a stimulative effect depending mainly on how rapi f activity under such programs could be started or accelerated. For more information on such proposals see IB79058: "Housing Assistance to Low- and Moderate-Income Households." - OUTLOOK The housing market is operating in an environment that is quite different from previous periods and is still changing. Federal policies favoring housing are being eroded. Institutions which were mortgage financing's. mainstay have lost protection from market forces and are being granted ~other lending powers, and Federal underwriting of mortgages is under credit limits. Regulatory changes have resulted in the continued availability of mortgage financing but at a higher, and sometimes prohibitive, price. As a result of this environment and the recession, privately owned housing starts in 1981 were an estimated 1.1 million units -- the lowest total since 1946. Housing is expected to recover somewhat late in 1982 but starts for the full year are unlikely to exceed about 1.1 million units. If mortgage rates fall to a 14 and 15% range, sales of new and existing single—fami1y housing may be stimulated as builders and sellers "buy-down" the rate to 12% or less to entice and qualify buyers. This outlook will be altered, however, if the mid-year tax reduction results in increased Federal borrowing, or if expected recovery of non-housing sectors of the economy results in increased credit demands and places upward pressure on interest rates. In any case, decliros in short-term rates are expected to be more substantial than declines n long-term rates. If more borrowers are willing to accept adjustable rate mortgages (whose rates are tied to short-term rates) then the recovery in housing will be stronger. CRS-15 IB78086 UPDATE-O8/l9/82 For multi-family housing, most construction is thought to be either built for the condominium market or for the subsidized rental housing market. Both markets are affected by high interest rates.‘ High rate disqualify many would-be condominium buyers and make it difficult for developers to profitably provide rental units. While new depreciation rules and other tax changes may stimulate some rental construction. Federal subsidies to aid the construction of rental housing face possible cutbacks. Thus multi-family housing is not expected to recover substantially. LEGISLATION P.L. 97-35 Budget Reconciliation Act. Housing and Community Development Amendments of l98l. For Section 8 and Public Housing rental subsidy, authorizes $907.0 million and $l8.087 billion for annual contract and budget authorities for FY82; tightens tenant eligibility requirements and increases required contributions of tenants in rental subsidy programs; ends new assistance under Section 235 homeowners subsidy program; authorizes funds for other subsidized housing programs; extends authorizations for insurance and guarantee programs of FHA, FmHA, and GNMA; other changes. Signed into law August 13, 1981. P.L. 97-34 Tax Incentive Act of 1981. Creates 1-year maturity, tax-exempt "A11 Savers Certificates" tied to mortgage lending; liberalizes terms on IRA and Keoggh savings accounts; increases amount of capital gain on home sale which is tax exempt for taxpayers 55 and over; increases roll-over period to avoid tax on sale of home for younger households; liberalizes depreciation rules for investment properties; cuts individual and corporate tax rates. Signed_ into law August 13, 1981. S. 1703/S. 1720 Alternative versions of the Thrift Institutions Restructuring Act. Removes asset limitations of savings and loan institutions; prevents state prohibition of due-on-sale clauses; provides-for the acquisition. of thrift institutions by bank holding companies in emergencies. H.R. 5922 Emergency Supplemental 1982 authorizations contains $3 billion for a mortgage buydown of up to 4 percentage points on FHA-insured growing equity mortgages for houses started after passage of the bill. Income limits are $30,000, higher in high-cost areas; funds must be committed by Jan. 1, 1983; set aside of $400 million for unsold houses in builder inventories; state. allocation formula based on population, unemployment, and housing starts decline. Passed June 18, 1982. Vetoed by the President June 24, 1982. New bill does not contain emergency housing provision. H.R. 6781 (wyden et a1.) 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