Take The Long View

After giving up early gains, the Dow Jones Industrial Average (DJINDICES:^DJI) broke out of the red and was up 26 points at 1 p.m. EDT following an array of positive earnings releases. The cause of the blue-chip index's up-and-down day? There is tension in Eastern Europe, yes. There is the ever-present threat of a zombie apocalypse, of course.

But there is something else souring the markets right at your doorstep, in your kitchen, and even watching you as you sleep!

It's your home. Or rather, it's the housing market. And it's causing serious anxiety for many investors.

After six years of this story, you'd think the housing market would have fixed itself by now!
It appears then that this year's spring selling season has stumbled badly out of the gate. This week's new home sales report for March showed a 14.5% seasonally adjusted drop -- the second monthly decline and the lowest level in eight months. Investors, unsurprisingly, were not pleased.

Step back from the actual numbers, and the problem becomes more clear and much, much larger.

Interest rates began rising last year and are poised to increase further as the Federal Reserve scales back its near-zero rate policy over the coming quarters. At the same time, home prices across the board are rising to levels not seen since the heyday of 2006. One economist this week went so far as to call the market "overheated."

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts.

Worse yet, there are more fundamental problems in the market beyond simple affordability.

Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC) remain under the control of the U.S. government while functioning as the only real players in the secondary housing markets. As it stands, Fannie and Freddie are the only entities in today’s secondary market willing to buy and then resell mortgage loans made by banks. This could limit banks' ability to make more loans in the event that Fannie or Freddie encounters problems. In essence, all of our mortgage eggs are in the one Fannie and Freddie basket.

It's a systemic problem
The housing crisis was a very unfortunate result of imperfections in the system, but the fact is that Fannie and Freddie are very effective at making homeownership viable for millions.

Without Fannie and Freddie the costs of owning a home would increase dramatically. Mortgage interest rates in the U.S. are as low as they are in large part because the mortgages can be sliced and diced, securitized, and sold to investors across the world. We have Fannie and Freddie to thank for that.

Home New Construction

The standard 30-year mortgage in the U.S. is a rarity in global real estate markets. In many developed countries, the mortgage market only tolerates a 15 or 20-year mortgage. The ability to pay back the loan over that extra 10 years makes the monthly costs of homeownership dramatically lower. The result is an appreciably higher standard of living.

And for the vast majority of Americans, homeownership is a good thing. I've written before that homeownership may not be best for everyone, and I stand by those arguments. However, the empirical truth is that Americans who own their home have a net worth that is significantly higher than those who rent.

How does it play out from here?
The bottom line is that until Freddie and Fannie are either fixed, changed, or replaced, and until there is a clear path to ensure affordable 30-year mortgages for American homeowners, we will still have issues in the housing market. 

Yesterday, Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) Chairman Warren Buffett more or less backed a plan led by President Barack Obama and a bipartisan group of senators to wind down the two entities. Buffett said the government could assume the role of insurer of last resort, which would bring sufficient confidence to the new system to enable a smooth transition.

Buffett Georgtown

Warren Buffett. Source: Georgetown University

Buffett added that Berkshire Hathaway and other private companies could step into a larger role in the housing market, though he was clear that there is no place at Freddie or Fannie for Berkshire. 

Others believe Fannie and Freddie should be turned into privately controlled entities and that their business model remain more or less unchanged. The only real change would be that the government would no longer have an ownership stake. 

At this point, it's premature to say what the outcome will be. It's a very positive sign that leaders from the investing world are involved in the discussion, as the solution will almost certainly require private capital and nongovernmental entities to work. 

Whatever the outcome, it can't come soon enough. There are short-term risks in implementing any change of this scale, but the long-term risks of failing to make the needed changes are absolutely massive. The government needs to act quickly, but also prudently and transparently, to fix the systemic problems. 

The future of home ownership in America depends on it.

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