CAMBRIDGE, Mass., December 1, 2011—Houses financed with government-backed loans through Fannie Mae and Freddie Mac are, on average, $2,000 more expensive than similar homes bought with unsubsidized mortgages, according to new research by Antoinette Schoar, professor of finance at MIT Sloan School of Management.
“What we've gone through the last four years is a very changed housing market,” says Schoar, who is also a fellow at the National Bureau of Economic Research. “In the late 1990s and into the early 2000s, we had a boom: houses were bought, sold, and renovated at a speedy pace, prices rose, and credit was easy to come by. In 2007, the bubble burst and the trend reversed: credit tightened, and house prices fell precipitously.
“As financial analysts and economists try to get a handle on what exactly went wrong, one of the central questions they’re wrestling with is whether easy access to credit and the reduced cost of credit were responsible for fueling the boom in housing prices, or whether other forces were at play. In other words: do prices drive credit or does credit drive prices? Policymakers in Washington are spending a lot of time and money trying to support the housing market and make credit cheap, so this causality matters a great deal.”
Fannie and Freddie – both government-sponsored enterprises (GSEs) – underwrite home loans that fall beneath the conforming loan limit (CLL), an amount set by Congress each year. In 2000, for instance, the CLL for high-cost living areas was $379,050; this year, the CLL is $625,500 for those areas. Mortgages for amounts greater than the CLL are considered non-conforming loans or jumbo loans. Prior to 2008, Fannie and Freddie owned or guaranteed about 60% of all US mortgages.
Schoar and her colleagues, Manuel Adelino at Dartmouth College and Felipe Severino a PhD candidate at Sloan, examined deed records from ten big US cities, including New York, Boston, Las Vegas, Denver, and Phoenix for the ten-year span of 1995-2005. The team compared the sale prices of houses that were eligible for financing through Fannie and Freddie with houses that were sold for prices just above the CLL. (Schoar and her team controlled for variables such as the year of construction, the size of the house and lot, as well as other characteristics such as number of bedrooms, bathrooms, and fireplaces.)
They found that houses that were eligible for Fannie and Freddie loans cost $1.10 more per square foot than houses that can only be financed with jumbo loans. The average home size is 1,800 sf, which represents a disparity of $1,980 or a .5% difference in price per square foot from year to year. House prices in the US increased two-fold in nominal terms between the beginning of 2000 and the end of 2006; mortgage rates fell by approximately 25% over the same period. Also during that time, the housing market saw a reduction in credit standards, including the growth of new mortgage products such as subprime mortgages that made credit more widely available.
“The availability of more and cheaper credit has a big impact on the price of houses,” says Schoar, who is careful to point out that the results do not suggest that the overall excesses of the housing market prior to 2007 were driven by Fannie and Freddie.
“Mortgages underwritten by Fannie and Freddie are ostensibly supposed to help homebuyers. True, buyers do have access to cheaper credit, but that credit is capitalized in the price of the house, which is a big benefit to sellers. Ultimately this means that the money spent to support the GSEs only partially benefits the group the policy is hoping to help: first time homebuyers. But a significant fraction of the benefits is inadvertently passed on to the sellers of homes.”
The findings have big implications for how lawmakers set policies around mortgage lending. The government bailed out Fannie and Freddie in 2008. “Many in Washington have signaled plans to reduce support for Fannie and Freddie,” says Schoar. “Our results suggest that we would surely see a reduction in the average price of houses, which in the current economic environment, could have negative knock-on effects.
“And yet, prices have to readjust. It would be wise to have a long-run policy to reduce the role of Fannie and Freddie in the housing market, perhaps by unwinding them over a determined period of time. That way, the impact on house prices would be smooth, and relatively incremental, rather than a big shock.”
* Credit Supply and House Prices: Evidence from Mortgage Market Segmentation By Manuel Adelino, Dartmouth College, Antoinette Schoar, MIT and NBER, Felipe Severino MIT (Forthcoming)