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Hello, everyone. I'm Kimberly Adams. Welcome back to Make Me Smart, where none of us is as smart as all of us. And I made me Scott in for Kai Ristall. It's Tuesday, July 9th, and it's time for our deep dive episode. Today, we are digging into the origins of the 30-year fixed rate mortgage, which has been the norm in the United States for a long time, but it's actually pretty unusual compared to other countries. And it's kind of gotten us into a mess in the housing market recently.
Right. It's creating what's known as a lock-in effect in the housing market. We're homeowners with low rates are disincentivized to sell and buy a new home at a higher rate. And we're wondering if there's a better way to do housing. So here to make a smart about this is Andrew Gantt, Professor of Finance at the University of Utah. Welcome to the show. Thanks so much for having me. Where did the 30-year mortgage come from? It hasn't.
It origins back to at least the Great Depression. If not, you could argue earlier. Our residential mortgage system kind of started with these building and loans. If you ever watched the movie, it's a wonderful life. That's a great introduction to building and loans and home mortgages in the United States as they existed in 1920s. And those actually were largely fully amortizing. And explain what amortizing means. This is one place I always get tripped up. Absolutely. Fully amortizing means that over the term of the loan,
you will fully pay off the principle. Okay. And so that means as opposed to an interest only loan, we're at the end of the loan, you still owe what you started with, or something we call partially amortizing, which means that you've paid off some of the principle, but not all of it. Those sorts of loans also existed in the 1920s.
And those were largely made by life insurance companies and mutual savings banks into a lesser extent commercial banks. But all of these loans had relatively short term. And the ones that weren't fully amortizing had a lot of problems when we got into the Great Depression. We had falls in home prices of 20%, 30%, sometimes worse,
and personal income fell by 30%. So you have massive distress in the housing market. And what we did is we created all these institutions that are still with us in the housing market today, starting with the FHA, which allowed homeowners to refinance into a 15 year fully amortizing fixed rate mortgage. And that was sort of the start of a very standardized financial instrument for mortgage finance in the US.
So before we had all these different mortgage types out there, and then we have the FHA step in. And gradually over time, Fannie Mae, we create also in the 1930s and starts buying up these FHA mortgages. We step forward to the 1960s, and we also create Freddie Mac to buy what we call conventional mortgages, which were no longer fully insured by the federal government, but they will buy things that don't have a prepayment penalty.
So what's really unique about the US is not just that we have long term mortgages, but that they are fixed rate, and you can prepay as much as you want of the principle at any time with pretty much no penalty on most mortgages. And that's been pretty great for homeowners, right, because they have a fixed cost, housing cost. And if rates fall, they can refinance with, like you said, no penalty.
I guess they have to pay some closing costs, but you can you can lock in a lower rate for as long as you own the home. Those are the advantages, right? What are the disadvantages? So right now, you're seeing that we have this lock effect, which you're exactly right. We have a bunch of homeowners out there that have mortgages at 3% and they're not going to move.
Because they would face a 6 and 1 half 6 and 3 quarter percent rate, maybe even 7% and so they might not be in their ideal house, but because they have this great deal. On a mortgage right now, they are we sort of have mismatch and that's fine for existing homeowners, but then you have homeowners that want to get into the housing market and we just have very little liquidity in the housing market.
The other disadvantage of this fixed rate mortgage system with, again, no prepayment penalties typically, is it creates risks for financial institutions. And this might be less obvious to your average homeowner, but the risk to the financial institutions that make these loans is that, you know, it's sort of as a homeowner, as heads, I win, tails, you lose because if rates fall, we all rush out and refinance our mortgages.
But on the other hand, when rates go up and banks would have to pay depositors more to get the deposits, we don't, then there's sort of mismatch between their cost of funding and what they're earning on their assets, which is the home mortgages, because then I will not refinance my loan. Those are quite a two disadvantages. There's a less obvious one, which the research is just coming out on now, which is that there seems to be differences in who refinances when rates fall.
And in particular, it seems to be white homeowners refinance at higher rates. And so they kind of benefit from this subsidy effectively that we have VFannie Mae and Freddie Mac, and minority homeowners don't refinance at the same rate, so they don't get quite the same advantage from this fully prepayable 30 year fixed rate mortgage.
So there's some sense that there's a little bit with your level of financial sophistication, but in my mind, it would be better if we sort of just Fannie Mae and Freddie Mac, who buy most of the home mortgages in the United States if they encouraged Lenders to charge prepayment penalties so that everybody will on the same playing field. I want to hear about some alternatives in a bit, but before that, what does this do to the broader economy?
Because like it feels like with the lock-in effect in the 30 year mortgage, something like the Federal Reserve adjusting interest rates might take longer to impact the economy because there's this whole section of the economy that really doesn't care. I see what you're saying. I see what you're saying. So the monetary past through mechanism. Yes, absolutely. What? The monetary past through mechanism. So you're absolutely right, central banks.
When they're trying to defect the economy, they're like, what are the levers we have, right? And the big one they have is race. So if we were sitting in England where most mortgage rates are adjustable, then that changes how much people are paying out of pocket every month. Then that has a very fast transmission mechanism.
You're absolutely right that it sort of takes away one of the Federal Reserve's levers when most people are going to be fairly, most homeowners right now are fairly unaffected. So it does make the monetary transmission mechanism a little harder. And so that may lead the Fed to use other tools to influence the macro economy. So I want to go back to something you were talking about, the prepayment penalty. I'm not clear on why that would level.
The playing field and might be a better system if we actually had to pay a penalty to pay off our mortgage early, which people do all the time when they move or they refinance, right? Yeah, absolutely. So the thing is that lenders charge a higher average interest rate because they know they face this prepayment risk. But because it selectively exercised this option, so everybody's paying a slightly higher rate because lenders have to be compensated for the risk, right?
But because it's selectively exercised, it doesn't benefit everybody equally. So let's suppose that the average rate, if we had, if we charge prepayment penalties, the way they do in Canada or Denmark or most other high income countries, let's suppose the average rate would work out to be 6.25%. And now because of the prepayment risk, let's suppose lenders, the average rate of the US is 6.75%. Do you see what I'm saying? Is everybody sort of paying a higher rate?
And some people benefit because they sort of pay a ton of attention to financial markets and they think very opportunistically and then other people don't and they just end up paying this higher rate. So then what can we do? I mean, first of all, do you think we should do anything differently? And what are some options for easing this lock-and-effect that we would have going on? So the short answer is right now, we're stuck with what we got.
We have a lot of homeowners who are going to be mismatched at the local level and this is not a national matter as much as a local issue. We can allow home builders to build more supply, new supply by changing our zoning regulations and changing our building codes, just making it easier to build housing. As you may be aware, housing has gotten increasingly difficult to build, both single family and multifamily housing, particularly in well-located places, near jobs, near social connections.
So that would be the ideal thing on the sort of overall housing market.
In terms of the mortgage market, what the federal government could do through its influence on our two government-sponsored enterprises, Fannie Mae and Freddie Mac, they could encourage them to have Lenders' charge-prepayment penalties so that we don't have this sort of heads-up, heads-eye-win, tails-you-lose situation with when rates fall, homeowners all refinance, and when rates go up, Lenders are stuck lending out money at a lower rate than what they can earn.
One thing I wanted to ask you about is the idea of an assumable mortgage. So I was reading about Denmark, you mentioned, they have a different situation. And one thing is that a qualified buyer can just assume a seller's low interest mortgage. And I know some people have done that, maybe informally, here, but why can't we do something like that? It seems like it would move a lot more houses. It's a great question.
And we do in commercial mortgage loans, so on income-producing properties, so on an office building, an industrial building, a shopping mall, often those mortgages are assumable. You're absolutely right. On residential, they're not typically assumable. I think it's tricky because you can't really change the contract after it's already been made. I think that would violate the contracts clause unless you got the originator of the first loan to agree to it.
And then you have to sort of change it after the fact. So you have to sort of incentivize the lender to agree to these changes. So even if it's in the homeowners interest and some future homeowner of the same home, so you could get more liquidity in the housing market, it's not obvious how you incentivize the original lender. It's a great idea. I'm glad you brought this up, but I think it's tricky to insist that you can't change the contract without the lender's consent.
Yeah. Well, it seems like we have some things to learn from how other countries do this, but as you said, we may be stuck with the system we've got for a while anyway. Yes. All right, Andrew again, does a professor of finance at the University of Utah. Thank you so much for joining us. Thank you so much for having me on the show. Cheers. So much. The Denmark example is really interesting and our producers sent us the story about Denmark's home buying market and what they do differently.
And it's a business insider article that I would suggest folks read because it's a little complicated what they do, but they basically removed the disincentive for people with low interest rates to kind of stay in their homes when interest rates go up by letting them profit off of the difference. Yes. It's really interesting, really interesting article. But I had to read the paragraph like three times to understand how it works, which may explain partly why we haven't adopted it.
Yeah. This is why I didn't even try to explain in great detail just now. I was like read the article. It's a business insider piece. I actually have a friend who recently assumed a mortgage and it was a family member's mortgage that she was able to assume and it's saving them so much money. And yeah, it's not available to everybody, but a good deal if you can get it. Yeah. And there you go. You have to know somebody. Well, I just wanted to say one last thing about the lock-in effect.
I'm working on a story right now for a marketplace about first time home buyers and just how hard it is to get in the market with all these people who are holding on to their mortgages. And the FHFA, the Federal Housing Finance Agency, estimates that that effect prevented 1.3 million home sales between the middle of 2022 and the end of 2023, which is just kind of staggering. It's like a fifth of usual transactions. So it really is gumming up the works in, I think, kind of an unprecedented way.
So I'll be very interested in the next couple of years to see the kind of, uh, lag effect, sort of the knock on effect of all of these Airbnb bands that cities have implemented. Because most of those kicked in in the last year or two, I think, is best I can tell.
And I wonder how long before those folks, because I imagine many of those folks, once they realize they, if they weren't able to get around the band, are probably doing longer-term rentals, but eventually we'll get tired of being, you know, landlords that way. And will that free up more places on the market as well? Yeah, that's a great point. It'll be interesting to watch. Yeah. Well, anyway, we want to know what you all think about some of the potential fixes to the way that we do housing.
If you think you have an idea that might ease this up, or if you just have a follow-on thought to what we just talked about, let us know where 508-827-6278, also known as 508-UB Smart, and we will be right back. The weight is over. Dell Technologies, Black Friday, and July deals are live. Check out incredible savings on select laptops and more, like the XPS-15 powered by Intel Core processors. The XPS-15 brings you the perfect balance of power and portability.
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Hey, everyone. It's Rima Grace. Most of this is uncomfortable. Here to let you all know about our Summer Book Club. Every other week, we're going to recommend a book that our team loves that gets at some uncomfortable topic around money, class, our relationship to work. We'll feature a wide range of wrecks, including classics, like EM4sters, a passage to India, page turning novels like Naomi Alderman's The Future, and Personal Finance Books, like Paco D'Lion's Finance for the People.
Join this is Uncomfortable's Book Club by signing up for our newsletter. Be sure to sign up today at Marketplace.org slash book club. Okay, time for some news. And I guess I'll go first because mine is sort of related to the conversation we were just having. It's about interest rates. So Fed Chairman Jerome Powell testified before the Senate Banking Committee today. Use his semi-annual monetary policy report.
And he basically reiterated that the Fed doesn't have the confidence yet to start cutting interest rates. It's going to take a little more certainty that inflation is getting closer to the 2% target to feel comfortable doing that. The next Fed meeting is at the end of this month, July 30th and 31st.
And Powell said in his prepared testimony, quote, the Fed has stated that we do not expect it will be appropriate to reduce the target rate for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward 2%. This is me now, not Powell, the last PCE, Personal Consumption Expenditures, Price Index, was up 2.6% in June, which was down from 2.7% in May. So definitely moving in the right direction, but not there yet.
So if you are one of those people on the sidelines wanting to buy a home, we're probably not going to see much relief on mortgage rates yet. But the market is predicting rate cuts later this year, the first in September. So we'll see. You know, I was doing some reporting a while back on the mortgage interest deduction, and I was talking to some real estate agents.
The mortgage interest deduction is something that overwhelmingly benefits wealthier people in general, people with more expensive houses and who itemize their taxes, which most people don't, like only 11% of people itemize their taxes. But itemize their deductions, I should say.
But the real estate agent who I interviewed for the story pointed out that with interest rates being so much higher than in the past and home prices being so high, it's kind of means more people are able to use the mortgage interest deduction because they're paying so much more in interest that it kicks them over the limit of the standard deductions and they actually start itemizing and getting that mortgage interest deduction.
You're paying more for your house and more for interest, but that might kick you into the tax situation where you can write more of that interest off. That's so interesting. You still wonder, do you come out ahead in the end or not because the prices are that much higher? Yeah, that's more math than I can do. Yeah, that would take some calculating. For sure, for sure.
The news that I have is from the Federal Trade Commission, they just came out with the 71-page report on pharmacy benefit managers. The only benefit managers are these companies that are hired by employers and government health insurance programs and the idea is they're supposed to negotiate prices with drug makers, pay the pharmacies and help kind of decide what drugs should be available at what pharmacies and four different health plans and at what price.
The only idea is that this is supposed to save everybody money by these pharmacy benefit managers negotiating rather than every single employee sponsored health plan negotiating. But according to this report from the Federal Trade Commission, pharmacy benefit managers are often ramping up prices, like increasing prices. I'm reading from the New York Times here.
In a statement on Tuesday, Ms. Con Lina Khan, the head of the FTC, said the agencies in Query had shown how dominant pharmacy benefit managers can hike the cost of drugs, including overcharging patients for cancer drugs. She went on to say that the agency found evidence of how PBMs can squeeze independent pharmacies that many Americans, especially those in rural communities, depend on for essential care.
The New York Times also had an investigation last month that found that these PBMs often act in their own interests, often at the expense of patients and employers and in the case of the government run programs taxpayers. There's only like six companies that control most of this market. There's a ton of consolidation.
Most of it actually, with just the top three, that CVS is health care marks, signals, express scripts, and United Health's OptumRx, and they process roughly 80% of prescriptions in the United States. If you've had a prescription filled, you've probably dealt with one of these companies, and it can have a big impact on how much you're paying for your drugs. The FTC is usually when they issue one of these reports, it's in advance of trying to do some rulemaking or encouraging Congress to act.
Hold your breath for either of those happening in this current political environment, but because I want to give people solutions these days, there are a lot of states working on this.
In the show notes, I've got a link to this group called the National Academy for State Health Policy, which is tracking state level legislation on pharmacy benefit managers, because there are quite a few states that are trying to regulate these companies to make them work more benefit, pharmacy benefit managers, to better benefit customers, and the employers who are hiring them.
The government accountability office also has a report they put out in April of this year looking at different states that had plans that seemed to be working well. It said, we've studied five states that have laws to regulate these companies. We found, for example, that all states regulated the company's drug pricing and pharmacy payments, including by limiting companies' use of manufacturer rebates and their ability to pay pharmacies less than health plans are charged.
There are some solutions that are already out there that improve the way, at least according to the people who want it to work this way, improve how efficient these companies run and make them operate in better ways with individual people and customers and things like that. If this is the thing you want to latch on to, we've got some resources there for you. Nice. I like that. Having solutions, we don't just talk about the problems. Exactly. Exactly. All right, that's it for the news.
Let's do the mailbag. Hi, Kine Kimberley. This is Godfrey from San Francisco. Jesse from Charleston, South Carolina. And I have a follow up question. It has to be thinking and feeling a lot of things. All right. In the same line of what we were just talking about last week, Kine, I were talking about how we can all play a role in maintaining the health of our democracy. You're just full of fun. I know. I make Nancy Marshall Gensert proud for the rest of folks listening.
Nancy Marshall Gensert, one of our Washington correspondents is our resident pun expert. And she lives for them. God bless her. Anyway, we can all play a role in maintaining the health of the democracy, even when we are feeling hopeless. And we got this message from Kathy and Virginia Beach. I am one of those that has been feeling fairly hopeless over the last couple of weeks, which is the Supreme Court decisions that run so against the grain of everything I stand for.
But your last statement where you said, don't lose hope. Stay on top of things. I'm trying. I wrote a letter to the Supreme Court expressing my displeasure. I call my Congress people. I call other Congress people and senators. I just feel very helpless, but I just wanted to let you know, I appreciate your words. Well, thank you Kathy. And thank you for choosing to do something because we all can do something. And I think we live in a world of instant gratification.
And it feels like when we don't see the immediate results of something, it doesn't matter. But that's not true. I think it does matter. And I did a story years ago about a constituent male and constituent communication with members of Congress. And I interviewed some of the staffers whose job it is to sort through the messages that members of Congress get from their constituents. And they pay a lot of attention to what they hear. And they log it.
They have special software that logs comments that come in from people. And what side of an issue they're on. And they pay attention because they want to get reelected. So your notes and your calls are probably hopefully not going unheard. And also, honestly, I just think it feels better sometimes to do something, even if you're not sure how much difference it's going to make. It just for me, it helps me deal with my anxiety to just feel like I'm doing something.
And I think that's worth something too. It reminds me of in the 2020 election, we were in the pandemic and a lot of states expanded male invoting or early voting and things like that, but got a lot of pushback. And so in Missouri, and I was visiting home, they said, fine, you can do male invoting, but you have to have it notarized. And that was an additional obstacle for a lot of people.
So this group of volunteers got together, got themselves all notarized, made themselves all notaries, and started setting up pop-ups all over the state and put themselves in an online database so that anybody who couldn't get to a notary, they would literally drive to your house to notarize your mail-in ballot for you. And they organized that amongst themselves.
And it was something kind of random, just if you're a notary or if you could get to be a notary and get your certification, and then they just put themselves in a spreadsheet and made themselves available and started showing up at farmers markets and coffee shops. And it was such a beautiful thing, I thought, and they didn't care what party you were voting for or who you were going to support or anything.
They were just like, if you need a notary because you want to have better access to vote, we will help you out. And they just did it on their own. And I think that's great. And those skills probably paid off later in life too. You never know when you might need something notarized. Exactly. Before we go, we're going to leave you with this week's answer to the Make Me Smart question, which is what something you thought you knew, but later found out you were wrong about summer travel edition.
This week's answer comes from Emily Thompson, an editor at the travel site, The Points Guy. I thought that I didn't need an air tag in my luggage because I always do carry on only when I travel. And then I was actually leaving on a trip to London and I had to gate check my bag. And so I handed over my bag, knowing there was no air tag in it. And I was just terrified that it wouldn't make it to London with me and I couldn't track it down. I got really lucky. My bag made it with me.
But ever since then, I ordered an Apple air tag as soon as I got home. And that is always in my bag, whether I plan on carrying on or checking just in case. Yeah. In my horrific trip to Los Angeles last week, I had an air tag in my bag. And I think my bag made it to Los Angeles about six hours before I did. Maybe seven. And you knew that was the air tag. Am I the only person who doesn't do this? I've never put an air tag in or on anything. I guess I'm behind the times.
I am a rather absent-minded person. I have an air tag like on my keys. I have an air tag on my wallet. I have an air tag in my bags when I travel. Yeah, I lived that life. Because I lose many things. Anyway, we want to know what something you thought you knew, but later found out you were wrong about when it comes to summer travel or anything else. Leave us a voice message at 508-827-6278. Also known as 508-UB Smart.
Me Smart is produced by Courtney Bergseeker, Ellen Ralfes writes our newsletter. Today's program was engineered by Jay Seabold with Mixing by Jess and Dooler. Ben Talde and Daniel Ramirez composed our theme music. Our senior producers, Marissa Cabrera, Bridget Baudner is the director of podcast, Francesca Levy is the executive director of Digital and Marketplace's Vice President and General Manager is Neil Scarborough.
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