| During President Bush's second term, higher
mortgage rates are as sure as death and taxes. On other housing-related
issues, nothing is so certain.
Many housing topics are likely to arise over
the next four years: The mortgage interest deduction could
end up with a target on its back. Or it might survive and
be joined by a deduction on mortgage insurance payments. Fannie
Mae and Freddie Mac probably will be required to serve low-income
homeowners more than they do now. The president is expected
to push again for a zero-down payment program and possibly
for tax credits for first-time home buyers. Home builders
will press for reduced regulations.
Of all these issues, the most important in people's
daily lives is the direction of mortgage rates: when they
will rise, and by how much.
It's the housing-related issue that Bush has
least control of: Presidents influence mortgage rates only
indirectly, through taxing and spending policy.
Rates will rise, deficit
Economists and bankers are unanimous that mortgage rates are
headed up from today's rock-bottom levels. Mortgage rates are
bound to rise as the economy starts to create jobs in earnest
and as the Federal Reserve continues to jack up short-term rates,
as it did this week.
The wild card is the effect of the federal budget
deficit on interest rates. The deficit is expected to hit
a record $422 billion this year, about 3.6 percent of gross
domestic product. Big budget deficits generally are believed
to increase interest rates, yet the Bush deficits haven't
had that effect -- at least, not so far.
"I think that from what we can judge from the
first Bush term, the implications for mortgage rates are not
favorable looking forward. The persistence of federal budget
deficits is a situation that adds upward pressure to interest
rates," says Richard DeKaser, chief economist for National
There are two types of budget deficit: cyclical
and structural. The government uses cyclical deficits to smooth
out business cycles, especially recessions: It spends more
than it takes in to stimulate the economy. Cyclical deficits,
when used correctly, benefit the economy.
Why deficits may
Structural deficits, which occur when the government spends
more than it takes in, no matter what's happening with the
business cycle, stimulate the economy in the short run, and
impede the economy in the long run by "crowding out" investment
-- money has to be spent on debt rather than on more constructive
things. At least, that's the theory. DeKaser cites a Federal
Reserve study that concluded that, over time, real long-term
interest rates rise one-quarter of a percent as the budget
deficit rises by 1 percent of gross domestic product.
In the last year of the Clinton administration,
the budget surplus reached almost 2.4 percent of GDP, so the
move to a deficit of 3.6 percent of GDP accounts for a swing
of 6 percentage points. According to the Fed theory outlined
by DeKaser, the 6-point swing implies that long-term rates
are 1.5 percentage points higher than they should be. But
with rates so low, that obviously isn't the case. So what's
Several things. First, more time probably has
to elapse. Second, budget surpluses and deficits are a mix
of cyclical and structural. Much of the Clinton surplus was
a result of the dot-com boom's overheated economy, and some
of the Bush deficit results from the aftereffects of the recession
that began around the time Bush took office in early 2001.
DeKaser estimates that today's structural deficit is 2.5 percent
of GDP, while David Seiders, chief economist for the National
Association of Home Builders, puts it at under 2 percent.
Third, there are plenty of jobless people, empty
offices, idle trucks, unused bandwidth and shuttered factories.
Supply for all these things exceeds demand, and that keeps
inflation at bay. "The economy hasn't been growing fast enough
to generate the activity to cause crowding out," says Michael
Cosgrove, an economist and principal of The Econoclast, an
economics consulting firm.
Beijing has more say than
Cosgrove adds that corporations are flush with cash, so they
don't have to borrow -- and the low demand for money keeps rates
low. And foreigners, especially the Japanese and Chinese counterparts
to the Fed, have a tremendous appetite for U.S. Treasuries,
keeping bond yields -- and interest rates -- low.
"I think the foreign sector is probably the
bigger decision in terms of influence on interest rates, rather
than the fiscal situation here at home," Cosgrove says. By
buying billions of dollars in Treasuries, Japan and China
are parking money in a safe place while lending the money
that America needs to buy Asian goods. It's a win-win situation
as long as the dollar's value doesn't fall in relation to
Although rates are bound to rise, no one can
predict exactly when or how fast. You would be crazy to try
to guess where rates will be in, say, five years, says Bob
Walters, chief economist for Quicken Loans.
"What we do know is that most people are
in their mortgage for five or six years," he says. "What
we do know is that interest rates are really low. What we
do know is that interest rates are on their way up. But there's
no reason to think they're going to go sky-high."
In the long run, it would be wise to shrink
the budget deficit to prevent the resulting rise in interest
rates. Democrats say that higher taxes are needed; Republicans
say further tax cuts will stimulate the economy and result
in higher tax revenues. Since the Republicans control the
White House and both houses of Congress, we will know someday
if they are correct.
Mixed messages on tax
Bush and the Republicans in Congress also will have final
say over changes in the tax code. Bush has sent mixed messages
about tax breaks for homeowners.
A month before the election, speaking in the swing state
of Ohio to a gathering of home builders who greeted him with
cheers of "Four more years," Bush endorsed the idea of adding
a tax credit "to help you build between 40,000 and 50,000
new affordable homes every year." He added, "I believe that
the mortgage interest deduction enables more Americans to
achieve the goal of homeownership. It is an important part
of our tax code."
Two days after the election, the president was talking about
another priority: tax simplification. In his post-election
news conference, Bush said he wants to change the tax code
in a way that's revenue neutral, fair and free of loopholes
benefiting special interests. "And so the simplification would
be the goal," he said.