Financing a mortgage has never been riskier in U.S. history.

• Houses are overvalued
• Prices have been declining for years for the first time since The Great Depression
• Foreclosures are at a record high
• The housing market has never been more levered (equity near all-time low)
• Unemployment is elevated and persistent (an indicator of future foreclosures)
• Low-down payment Government mortgages have established the conditions necessary to fuel future foreclosure-driven price declines
• Highly visible and inevitable ARM resets will continue through 2012 contributing more foreclosures, which force prices lower, to already high inventories of distressed transactions

So why are mortgage rates at a record low?

Broadly interest rates in the U.S. are low for two reasons. 

• The Federal Reserve have set lending rates at near zero in a futile attempt to stimulate the economy
• A global flight to quality has increased demand for relatively safe stores of value like U.S. Government bonds

This demand for quality has pushed mortgage rates to 4.58% despite the Federal Reserve's recent elimination of its $1.25 trillion subsidy.  But how can mortgages, which have never been more risky, qualify as a safe institutional investment?

The answer is the biggest housing market subsidy of all.  The Federal Government has functionally nationalized the U.S. mortgage industry, representing 96.5% of transactions in the first quarter, and has "guaranteed" those mortgages against default underwritten by taxpayers.  Bizarrely, the failure of Fannie Mae and Freddie Mac, which has led to an explicit guarantee of their mortgages, has actually lowered mortgage rates and further increased the size of Government subsidization.

Taxpayers are being pilfered like never before.  The Government:

• Is offering incentives to get people to overpay for houses that are falling in value
• Is issuing low-down payment mortgages that will default as prices fall
• Has put taxpayers on the hook for losses from inevitable defaults making institutional investments in mortgage assets "risk free"
• Is charging/subsidizing the lowest interest rates on record to finance the highest risk mortgages in history

Imagine what the unsubsidized private sector would require to finance a mortgage in today's environment.  A material down payment would be required to lower the chance of default and protect against capital losses from foreclosure.  The private sector would also charge a mortgage rate reflective of risk.  How much farther would housing prices fall if 10% down payments and 8% mortgage rates were the norm?  What about 20% and 10%?

By transferring the risk of financing mortgages and the costs of default to taxpayers, the Government has employed the Biggest Housing Subsidy of All.

The net result will be that housing prices, which need to fall in order for economic stability to return, are doing so more slowly.  Tax payers will be on the hook for future mortgage guarantee losses that have the potential to make losses to-date appear quaint.  Those losses are being magnified exponentially by the low-down payment and low-mortgage rate environment mandated by a policy decision to nationalize the home lending industry.