By Peter Fugiel

Something funny happened to America on its way to enjoying what should have been, the second leg of an unprecedented housing boom. We screwed up.

Not since 1910 has this nation experienced a more substantial immigration boom. And if we play our cards right, the second leg of the housing expansion will more than offset the negative demographic effects of the ’graying of the Baby Boom.’

Here is a short list of how the housing industries and government should be able to get back on track. If we do right, we might start enjoying our status as the destination place for the talented, the ambitious, and the freedom-loving.

Number One: Change Our Outlook on the Country’s Future

In the housing business, demand is destiny. Back in the late 1970s, investors nearly tripped over their own feet, not noticing the huge influx of first-time homeowners that were coming into the housing market. The Baby Boom had arrived, only we didn’t know what to call the surge. Fifty years later, and it is their children who need housing. AND, to nearly everyone’s surprise, the U.S. Census now projects a hundred million additional Americans immigrants and their offspring. As a result, this country is headed for 438,000,000 citizens by the middle of the century. Even without any further illegal immigration, the U.S. population will be close to 400 million. Truly, this is shaping up to be a millennial generation.

By the year 2050, America’s population will be as big as the combined populations of Russia, Germany, France, Great Britain, Spain, and Italy combined. Where in these statistics is there any indication of a U.S. housing collapse? Have we already made big financial and political mistakes? You bet. But does the nation’s housing market face weak demand?  Not.

For a careful analysis of what all of this population increase means for the country, review the Pew Research Center’s February 2008 report on U.S. Population Projections 2005-2050, is based on the mid-range population projections released by the U.S. Census Bureau. Key among the findings is that the so-called dependency ratio, the ratio of non-working citizens to those employed, will not be as negative as the people thought twenty years ago. In fact, the dependency ratio in 2050 is expected to be lower than it was back in 1950. That means there will many more younger working adults, and a lot of school-age children at mid-century. By then, American demographics will not at all resemble those of Europe and Japan.

Number Two: Replace Excess Housing Consumption with Housing Investment

The misrepresentation of housing demand in this country encourages high-end consumption rather than a more “markets-oriented” national investment strategy. The housing story for this new century is not just the story of the Baby Boom loading up on suburban and retirement housing, with no one else waiting to be housed. In fact, the housing story is of a new wave of demand – albeit cost-sensitive demand needing to be served.

The problem is that over previous decades, the U.S. tax code has adopted several policies favoring homeownership over investment in rental housing. No one is blaming anyone about these policies, Washington responds to what interest groups want. And, of course, good faith arrangements made over time with private investors need to be honored. This is no time to take existing tax subsidies away from high-end housing.

But it may be time to fashion newer production policies as well. Housing production and preservation need to be stimulated. Adjusted for household incomes, rental housing has increasingly become more expensive. And the high cost of rental housing is making urban investment and redevelopment more and more difficult.

No industry ever wants to examine is tax privileges, even when those policies have become counter-productive. But if policies don’t change, we will continue to have to offer federal first-time owner programs to bridge the gap between household incomes and tax-induced housing prices.

We need to remove the excess consumption of upscale housing from the tax code, where a high proportion of the mortgage interest deduction is taken by the top 20 percent of all U.S. households. Other tax-advantaged policies such as passive loss provisions and the use of retirement funds could also stimulate investment in workforce-preservation housing and new affordable rental housing in fast- growth markets. U.S. housing policy needs an overall investment strategy – not one that only promotes our famous, enviable habit of owner unit ’consumption.’

Home ownership has always been a laudable goal. But we cannot bend credit rules and simply order ownership rights for all. As an alternative, we need to preserve the rental housing inventory we already have. Ownership comes with time, and with a positive credit record. No one in Washington should ’target’ more home ownership in exchange for the dubious federal guarantees that were offered to the agencies that said they meet artificial federal ownership targets.

In fact, even the federal insurance programs have to be run with an eye towards long-term solvency based on market forces. Home ownership by itself does not improve a household’s credit profile. Housing values are mostly based on community viability. And HUD has to be aware of the connection between lending and community viability. The twin goals of providing housing and urban development still make sense.

Number Three: Mortgage Securitization Structures Need to Reflect Local Differences

The securitization of home mortgages needs to be redesigned. Securitization is great, if the investors know what the credit risk is ’inside the box’. Cash flow is only one characteristic of mortgage pools that investors want disclosed. They also need to understand how the assets are performing over time. But the capital markets have been spoiled by high-grade credit guarantees – bogus or otherwise.

The fear is that if the credit track record of mortgage pools were known over time, the market for mortgage securities would vanish with the U.S. guarantees. And then the enviable borrowing costs offered to homeowners would also disappear. To make matters even worse, the markets are convinced that geographic concentration of the assets in mortgage pools will necessarily be unacceptable to investors. “Too much risk … too much risk,” some will say.

Still, we have tried high-grade federal ’guaranties,’ and the concept practically pulled the world financial system down with its anti-local practices. Let’s try a different approach, maybe one that shows how mortgage assets track over time, even those pools with loans originated from similar markets.

The municipal market has long supported the notion of one-market pools. Mortgage securities are supposed to increase the supply of housing to specific local markets, and not just serve as ultra-exotic portfolio instruments. The track record that individual mortgage pools post over time should be based upon the disclosure of that pool’s credit trend and cash flow. Credit trends necessarily are affected by where the loans were originated. Local markets rise and fall, as do the loans originated in various markets. There is no harm in having inter-market differences expressed in mortgage pool accumulation, pricing, and trade value over time.

The municipal bond market has financed locally originated mortgage pools for thirty years. The perceived credit risk of these pools has both improved and differentiated over time. The various programs have performed as any class of diverse assets would perform. There is nothing inherently risky about geographic concentration, provided the underwriting is transparent, the track record is monitored, and the issuer adjusts for the known credit risks posed by unusually high home prices, and especially when it comes the risk posed by wind, water and seismic activity.

Number Four: U.S. Housing Policy is too Federal

It is no secret that the drift to Washington in the housing industry has been very pronounced. The tax code, when combined with high grade federal guarantees, has stimulated the construction and financing of owner housing whose quality is unrivaled.

Yet rental housing in many urban areas is under-capitalized and not favored. Washington is a political city. Its agencies serve the political process. Yet the demand for housing is a local community function. A federal guarantee of local – or “one-market” – mortgage pools would enhance local market concentration and solutions. Decentralization in the housing industry more easily coincides with market and real estate practices. It is a goal well worth pursuing in federal housing policy.

Even when federal agencies claim to be serving affordable housing goals, those goals are defined in national terms, not as local community goals. And so the federal guarantees and easy access to capital have hurt many local urban communities more than anyone would have expected.

The production and valuation of housing is a local phenomenon. Over time, it is local market conditions that will affect loan portfolio performance and asset valuations. Not to expect to invest in local differences in the housing markets is to deputize the federal government and its various guaranty agencies as the sole arbiters of what kind of housing is needed in the various markets around the nation.

Number Five: Federal Guarantees Promote a False Sense of Housing Affordability

By distorting the cost of living in certain markets, federal guarantees and agency insurance are encouraging Americans to live in places that are either higher risk or simply too expensive for “common folk.” Hurricane damage, flood damage, and default risk due to very high home prices necessarily add to the economic cost of living in certain markets. Our nation has witnessed cities – and entire local real estate markets – devastated by flooding and by category five storms. And more recently, coastal housing prices have collapsed because the cost of housing is so far away from local incomes.

Federal insurance and a variety of agency guarantees are still encouraging people to live and to buy homes in locales where the economics should be more prohibitive. Population growth is slowing in Florida because private insurance policies at least are being priced to known risks. It would be wise if all of the federal agencies were to apply a cost-benefit approach to their insurance and guarantees.

About the Author:

Peter Fugiel, Ph.D. and realtor.

Peter Fugiel was active in the formation of the state and local housing finance sector in the municipal market. He was a leader in the establishment of ongoing disclosure practices for mortgage pool issuers in the tax-exempt market. Pete’s real estate research website is