Invisible Mortgage Debt Drags Us Down

Yesterday, MoneyShow personal finance expert Terry Savage explained why individuals are better off paying their mortgages than walking away. Today, she continues with a look at the big picture of how debt defaults are running out of control quickly.

Former football quarterback Dan Marino must have a heavy conscience these days.

If you’re a sports fan, you remember his legendary prowess on the field, leading the Miami Dolphins. If you’re a homeowner, you may remember him better as the guy who pitched you on that “easy home-equity loan...so you can remodel your kitchen, pay off your bills, or take a vacation.”

This commercial ran ad nauseum. I even wrote a column at the time, predicting Marino would regret lending his name to this venture. And who can forget those DiTech Funding television commercials, enticing you into a home-equity loan?

DiTech was a subsidiary of General Motors back then. How bad could they be? That was in the days of “what’s good for General Motors is good for America!” We all know how that turned out!

Now comes a report from real-estate data firm CoreLogic showing that those who took cash out of their homes a decade ago are “underwater” (owing more than the home is worth) on their homes at twice the rate of those who didn’t borrow against their home equity.

(A caveat: These statistics are only based on home-equity loans or second mortgages. They don’t include homeowners who completely refinanced, and likely took some cash out in the process.)

You Had Help Getting into Trouble
When I wrote about the dangers of simply “walking away” from your mortgage loan, several readers commented that, in effect, the banks were allowed to walk away from the packages of mortgage loans they guaranteed.

These readers noted that the taxpayers bailed out Freddie Mac and Fannie Mae—the “quasi” government agency that had guaranteed the mortgages. So if the taxpayer could rescue the banks, why not the help the individual homeowner?

Good point. And, I’d leave it there, because the murky world of high finance can rightly bore you to tears. But I can’t resist pointing out that the mortgage packages “insured” by Freddie and Fannie had the implicit backing of the United States government—a promise to make good if the borrowers defaulted.

And who gave substance to this guarantee? You.

You elected representatives in Washington who wanted to keep their voters happy by subsidizing housing with low interest rates.

Few remember Rep. Barney Frank opposing the proposal to transfer control of Fannie and Freddie to the Treasury department, instead of keeping them under Congressional oversight. At the time, Frank declared that the agencies were not in danger of any financial crisis, and needed to keep making loans to encourage “affordable housing.”

(Okay, forestalling the next argument, I agree that then-Federal Reserve Chairman Alan Greenspan was also culpable, keeping interest rates low and memorably urging people to take out more debt through these low-rate, adjustable loan mortgage deals. I was astounded at the time, and wrote about it.)

NEXT: The Debt Bubble Will Burst

OK, once we’re past blaming the former Fed Chairman, Congress, TV pitchmen, and your own undeniable greed, can’t we just forget about the whole thing and start over?

Unfortunately, the answer is a resounding no. That debt is still out there, hanging over the United States like a huge cloud—even though it doesn’t appear on the books of the government!

For that explanation, here’s an excerpt of testimony that was recently given to Congress by Alex Pollock, of the American Enterprise Institute. Pollock is worried that all this mortgage debt is your responsibility as a taxpayer—but not even acknowledged in the offical national-debt figures.

The huge debt of the non-budget agencies and government-sponsored enterprises (“agency debt”) fully relies on the credit of the United States, which means by definition exposure of the taxpayers to losses, but it is not accounted for as government debt. As the Federal Reserve carefully notes in its “Flow of Funds” report, non-budget agency and GSE debt is not “considered officially to be part of the total debt of the federal government.”

Not “considered officially,” but what is it really? It puts the federal budget at risk, or more precisely, subjects it to major uncertainties of credit losses. It represents a kind of off-balance sheet financing for the government.

The vast majority of agency debt goes to finance housing though Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the FHA/Ginnie Mae combination. Fannie and Freddie in particular have not unreasonably been characterized as “government SIVs,” which failed.

In 1970, agency debt represented only 15% of Treasuries. By the peak of the housing bubble in 2006, this had inflated to 133%. At the end of 2010, agencies were 81% of Treasuries, or about the level of 1997-98, just before the housing bubble, still a notably high level.

Pollock points out that this government-guaranteed agency debt now seems relatively lower, only because we are borrowing so much more money to fund our “official” budget deficits.

In other words, the government is hiding its true debt, the debt that we taxpayers are on the hook for, through this “off-balance sheet financing.” That’s how the Web site www.TruthinAccounting.org gets its estimate of the real US debt of $77 trillion!

If you applied for a new loan (which the government does every time it sells new Treasury bills, notes, and bonds) and hid the true nature and amount of your debt, they’d call it bank fraud. When the government does that, they call it Treasury refinancing.

Remember how good it originally felt when you took out that home-equity loan to remodel your kitchen, figuring you’d worry about repayment someday down the road?

Well, we’re “down that road” now—whether it’s home-equity loans or government mortgage guarantees. And that’s The Savage Truth.