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October 24, 2014

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Would shift in mortgage risk-taking affect Nevada’s rebounding housing market?

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Steve Marcus

A carpenter works on a new home at a residential construction site in the west side of the Las Vegas Valley in Las Vegas, April 5, 2013. Las Vegas Strip casinos are shown in the background.

A long-simmering plan to phase out home lending giants Fannie Mae and Freddie Mac got a boost from President Barack Obama this week, increasing the chances that Congress will tackle housing market reform this fall.

But this is one occasion when Nevadans might actually want Congress to drag its heels a bit.

“We’re probably still three to five years out from a market that has matured into positive growth, where people will once again have confidence in their home value,” said Marcus Conklin, associate director of the Lied Institute for Real Estate Studies at UNLV. “The trick here is to assist the market in recovery. … You have to make sure the timing isn’t off.”

The federal government is considering reducing the outsized role it has been playing in insuring mortgage securities since taking over Fannie Mae and Freddie Mac in 2008, and passing credit and mortgage risk back to the private sector.

In the Senate, those plans have taken the form of a bipartisan bill to replace Fannie and Freddie with a new Federal Mortgage Insurance Corporation that would back loans, but more sparingly (since the housing crash, Fannie and Freddie backed almost 90 percent of new loans). In the House, leading Republicans advocate transferring that role to a non-governmental nonprofit agency, effectively fully privatizing the industry.

The idea is that asking the private sector to assume more risk while allowing it a greater role in determining that risk will help the housing economy grow faster in the long run.

But in the short run, shifting risk to the private sector means mortgage rates will rise — and that is where things get tricky for Nevada.

“Interest rates going up have a negative effect, because people get priced out of the market even if there’s no price change in housing,” Conklin said.

For years, low interest rates were the only saving grace in the distressed Nevada economy, as they made buying a home attractive for anyone who could muster up a down payment on underpriced real estate.

Now that prices are rising again, Southern Nevada’s housing economy is experiencing a measurable recovery: The share of local mortgages underwater has fallen from 80 to 45 percent, and median home prices have risen by 32 percent over a year ago.

But that positive trend means some buyers are finding themselves priced out of the market.

“The first-time homebuyer market has unfortunately dried up of late because of the increase in sales prices,” said Jon Copeland, president of the Southern Nevada chapter of the Mortgage Bankers Association. “They can’t get their offers accepted.”

Copeland estimated that about half of current sales are cash — a far cry from a year ago, when the majority of home sales were financed through either a conventional loan or through the Federal Housing Administration, which insures bank loans at lower rates and generally makes homes more accessible to people of lesser means. That suggests that more people are finding it difficult to afford a home.

But others argue that at this point, as long as available real estate is being gobbled up, it doesn’t matter who is buying.

“It might be that the traditional homebuyer is being squeezed out by a lot of those purchases,” Conklin said, estimating that about half of cash purchases are investment properties. “But if the market heals and finds its equilibrium, the number of people becoming first-time homebuyers will go up.”

Indicators suggest that the average Nevadan still needs help affording a home. According to Kenneth LoBene, Las Vegas' field office director for the Department of Housing and Urban Affairs, FHA is endorsing about 20,000 new loans a year and backing about 20 percent of existing loans in the Las Vegas Valley — higher than what is ideal for a healthy economy.

“As the conventional market becomes stronger and more competitive, I suspect and hope that our market share will go down to what we believe is more rational … somewhere around 10, 13 percent,” LoBene said.

But LoBene warned of one potential hiccup in that plan: If mortgage rates rise faster than home values, it could complicate the recovery.

“You hope that the interest rates stay at least rational, so you can have a larger adjustment of debt to value,” LoBene said. “That's because the market isn’t going to heal until all the debt gets adjusted to the value of the homes … which means that could take a bit longer if interest rates went up higher.”

Another factor threatening to complicate Nevada’s housing recovery is a lack of housing supply.

The recent sharp increases in home prices have some economists speculating that the area may be headed into another housing bubble. A lack of available housing for purchase could keep prices artificially high, putting more pressure on builders.

“We could probably build 10,000 homes easily this year, because the demand is there. ... But they don’t want to put out a bunch of specs, because (then) we’re losing the farm,” said Nat Hodgson, executive director of the Southern Nevada Home Builders Association. “The land sellers have jacked up their prices by 300 percent. Fuel’s up. Labor’s up. And our workers left when we were devastated. ... A lot went to Arizona, where they’re in a solid market. How am I going to get them back?”

“We need to make sure we don’t lose money to build homes,” Hodgson added.

Hodgson said the homebuilding industry is at the end of the chain of entities that will feel the effect of a change in government’s policy on insuring home loans. He is wary of what privatization will bring.

“Government shouldn’t be the majority of the business, that’s not healthy for anybody. ... But really, I’m a little nervous about going all private now,” Hodgson said. “We don’t know how to value homes, we have nothing except ‘what did your next-door neighbors sell for.’ They don’t put value on the house, they assign risk. ... But in the Las Vegas market, we don’t know what the middle is. We don’t know what moderation is.”

Hodgson isn’t the only one worried about what havoc private lenders might wreak once freed from government control. So are some lenders.

“There are individuals out there who would take total advantage, in my opinion,” Copeland said. “That’s why I think the government needs to retain some involvement in the system, to help with accountability.”

But Copeland argued that the flexibility lenders would gain under plans to phase out Fannie and Freddie, in exchange for assuming more risk, would make the housing market more accessible for would-be homebuyers, no matter what happens with average home prices or interest rates.

“I think there’s a lot of good to what the government has done, but there’s also bad, because they’ve gone to the extreme,” Copeland said. “We need some flexibility in regard to looking at borrowers who have had credit issues in the past.”

How satisfied Nevada’s various home lending players will be with the changes will depend on the specifics of Congress’ plans, which have yet to be considered in the House or Senate, much less be resolved between the two bodies.

“It all depends on how they change things in the guidelines, and how the guidelines are enforced,” Copeland said.

“It’s easy to agree with the platform, but the devil will be in the details here,” Conklin said. “Having the government completely out will have a greater potential of returning us back to the position that we started from.”

There is cautious optimism, though, that eventually, Nevada will be ready for the change.

“I suspect it will likely have a three-, five- or seven-year time frame for Congress to fulfill its goals — and by that time, the housing markets will have recovered,” Conklin said. “These are choices that need to be made slowly and methodically.”

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