Leading experts weigh in on current policy issues and challenges

Revisiting Housing Finance: Why a Federal Role?

Almost 10 years into the conservatorship of Fannie Mae and Freddie Mac; a homeownership rate that is stuck in general and continues to fall for African Americans; skyrocketing rents and house prices in places with the greatest job opportunities—not a pretty picture for housing finance in the United States. With tax reform completed, Treasury’s desire to make reform a priority, and major personnel changes on the horizon in Congress and the Federal Housing Finance Agency, there is a new push for legislative action on reform. In this debate, we explore a critically important aspect of the path forward: how the federal government should support housing—both homeownership and rental—for those the market will not.

The Urban Institute is talking with...
Mike Calhoun Mike Calhoun
Laurie Goodman Laurie Goodman
Tim Howard Tim Howard
Shekar Narasimhan Shekar Narasimhan
Ed Pinto Ed Pinto
Rob Randhava Rob Randhava
Lisa Rice Lisa Rice
Mark Zandi Mark Zandi
Barry Zigas Barry Zigas
Ellen Seidman
Moderated by:
Ellen Seidman
Non-Resident Fellow, Urban Institute
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Welcome to our Policy Debate on housing finance reform, with a focus on access and affordability.  Many thanks to all our debaters—a lively group with diverse opinions.

The confluence of a new administration, the announced retirements of major champions of housing finance reform in the House and Senate and the end of Mel Watt’s term as FHFA Director early next year, the drawdown of Fannie’s and Freddie’s capital—and a fairly widespread belief that our housing finance system is not optimally serving the country—have come together in a renewed debate on housing finance reform.  Spurred by a draft Senate bill, many parties, with varying perspectives, have weighed in. As with the Urban Institute Housing Finance Policy Center’s (HFPC) previous Housing Finance Reform Incubator,  this Policy Debate brings together many of those voices.  Unlike the incubator, however, this debate is focused on the critical issues of access and affordability—for both owned and rented housing.

The problems in the current system manifest in multiple ways, as our participants have recognized in their writings over the past several years. HFPC research has set the number of “missing mortgage loans” because of an overly tight credit box at 6.3 million between 2009 and 2015 and HFPC’s February Chartbook shows only limited signs of credit easing.  And the gap in the homeownership rate between black and white households is large and, in most places, growing.  HFPC authors have also noted that high rents in many major metros make it cheaper to own—at the same time that ownership is also expensive. 

For our first question, I’d like debaters to (i) define the federal government’s responsibility to support housing both in terms of the type of support and who should be supported; (ii) highlight the major flaws you see with the current system; and (iii) provide a succinct bottom line description of how you think the system (including if you wish FHA, VA, RHS and the Home Loan Banks) should be reformed to better meet the government’s responsibility as you’ve defined it.  I’d like to hold the pros and cons of the draft Senate bill until the second round if possible.

(i)                  The only plausible reason for government to back the housing market is to help low- or moderate-income (LMI) families buy homes in a sustainable manner that reliably builds wealth. Current policies fail to meet this simple test.

(ii)                Since the early 1990s government housing policies have resulted in higher and more volatile home prices trends, particularly at the entry level.  In a seller’s market, which has predominated, prices rise faster than incomes, so long as marginal buyer, who sets the price for all, has access to higher leverage. The marginal buyer determines not only price level, but also the degree of stability, as price is not necessarily equal to value, especially in a supply constrained market.  Cross-subsidies and expanded access to credit push up demand against a regulation-constrained supply.  In a seller's market, when choice is restricted and the seller virtually dictates sales terms, more liberal credit is likely to be capitalized into higher prices. (Ernest Fisher). 

(iii)               Eliminating the GSEs and greatly reducing government support will slow price growth and homes will become more affordable with greater price stability for first-time LMI buyers.  The FHA should focus on sustainable and wealth-building home purchases by first-time LMI buyers.

I would like to proffer an additional, critically important reason for the federal government to back the housing market - to overcome and undue the effects of previous government-sponsored, de jure discriminatory housing policies.  The federal government created policies, procedures and an infrastructure for institutionalizing residential segregation and redlining in the U.S.  We are still suffering from the impacts of those policies today.  But it is not only low- or moderate- income communities of color that are affected; middle and higher income communities of color are also dealing with the fallout from these discriminatory policies and practices.  In fact, the stark racial wealth gap in America has been primarily caused by harmful policies put in effect decades ago that have never been addressed or cured.  The federal government cannot turn its head from its obligation and responsibility to right this wrong.  The economic viability of our families, communities, and indeed the nation, depend on the government supporting communities that have been under-served the same way it has helped the broader market since our country's inception.

FHA has been rightly criticized for condoning segregation based on race and national origin and enforcing local customs and practices including racial and ethnic covenants through its underwriting practices.  It was wrong to condone long-outdated segregation attitudes and policies.  Yet a total of 1 ¼ pages of its five hundred page Underwriting Manual consisted of references to racial and ethnic customs and practices.  Lost in the redlining criticism was the fact that for the 20-year period ending in 1954, FHA’s sustainable underwriting standards led to the virtual elimination of foreclosures and loss severity was in the single digits.

Racial and ethnic segregation long preceded FHA—at least going back to the 1890s. For level of segregation in early-1930s, before the FHA set up shop, see Hoyt, Homer. 1939, The Structure and Growth of Residential Neighborhoods in American Cities. https://archive.org/details/structuregrowtho00unitrich

Government policies hurting first-time home buyers by unsustainably driving up prices and forcing them to take on more risk. 

Reliable wealth building should be the goal of federal home ownership policy.

I think we do a disservice to consumers and policy by overly emphasizing housing's wealth building character.  People buy homes for a multitude of reasons, and homeownership provides a bundle of values.  Even in FHA's heyday that Ed mentions, when many of our parents bought homes, it was less about a ticket to wealth, and more about an opportunity to escape the uncertainties of renting and to trade crowded city neighborhoods for the suburbs.  Even if people wanted to continue to rent, but in suburban surroundings, they had little option, since the restrictive zoning that Ed has persuasively discussed elsewhere prevented it and still does in many areas.  As Lisa and Ed have pointed out, homeownership also was an opportunity systematically denied to people of color.

Housing does build wealth for most buyers, over time, and we should support sustained access to affordable, responsible credit as broadly as possible.  But the Great Recession and regional housing busts over the last century have made it clear this is not a sure thing. Hyping homeownership primarily for its wealth building potential can create excessive urgency among consumers who fear missing out, overwhelm  other factors consumers should consider, and help fuel the inflation Ed is concerned about.

The federal government’s housing responsibilities should be to (a) devise and implement subsidy programs in support of underserved populations, and (b) foster the development of a housing finance system that will provide the lowest-cost mortgages to the widest range of borrower types, consistent with an agreed-upon standard of taxpayer protection.

The biggest flaws in the current system are that the centerpieces of the secondary mortgage market, Fannie and Freddie, have not yet been given updated, true risk-based capital standards, and that they remain in conservatorship without the ability to retain earnings or raise private capital. During and after the crisis these two companies had by far the lowest default rates of any source of mortgage credit. There is no policy reason to replace them with an untested alternative; they should be allowed to recapitalize to new risk-based standards, be given utility-like return limits and made subject to tighter regulation, and be released from conservatorship.     

For subsidized housing programs, I propose a small (5-10 basis point) fee assessed on all new residential mortgages, not just those financed in the secondary market.

Market participants that benefit from implicit federal government-backing must serve the public interest through enforceable obligations. Compliance with fair lending is required along with affirmative duties on regulators to further fair lending.  The GSEs are required to serve all markets, credit-worthy borrowers, lenders, and must protect taxpayers. The charters of Fannie Mae and Freddie Mac require them to ensure the flow of affordable mortgage credit to undeserved borrowers and communities – in urban and rural areas. They are subject to enforcement provisions, restrictions on business, and penalties to ensure these duties are met.

Despite these mandates, our current system is far from perfect. For instance, despite the cross-subsidy in the current system, lower wealth borrowers are still assessed far too much in fees/insurance with loan level price adjustments and PMIERS. Excessive risked-based pricing has an adverse effect on people of color and leads to under service by conventional lenders. 

FHFA and the GSEs must eliminate excessive risk-based pricing and do more to average price. The 2008 housing crash was caused by systemic failure and working families should not bear the burden of the risk by being forced to pay for the cost of the probability of another financial meltdown.

The federal government should ensure that affordable mortgage credit is widely available to creditworthy borrowers under all economic conditions. This is especially important for lower and middle income households and underserved communities.

This requires that the federal government makes available an explicit government guarantee to parts of the housing finance system. A guarantee that should be paid for by mortgage borrowers.

The current system with Fannie Mae and Freddie Mac in conservatorship is not sustainable long-term. The system will not be able to sufficiently keep up with the nation’s changing demographics and mortgage needs. Moreover, the support provided by the government to the system and the underserved will be variable and uncertain. Private capital can and should also play a bigger part in the system.

The most politically and economically viable approach to ending the GSEs’ current conservatorship is to move to a multiple guarantor system. In this system, several highly-regulated and appropriately capitalized private guarantors compete head-on. The government backstops the system for a fee that fully compensates taxpayers for any risk. To ensure that low and moderate income households are well served, high income households are charged a fee to pay to lower the costs to the underserved of becoming homeowners.

FHA reform should also be part of any housing finance reform, given the importance of the FHA, VA and USDA to promoting responsible homeownership, particularly in the most difficult times.

I agree with Tim's description of the Federal Government's housing responsibilities. And he said it so well, that I will not repeat it.

In executing the goals, the present system has a number of policy objectives for the GSEs: preserving the liquidity of the mortgage market, which reduces the mortgage rate for all borrowers; preserving the 30-year fixed rate mortgage; ensuring equal access to the system for lenders of all sizes; bringing competitive private capital in to bear most of the credit risk; and giving all credit worthy borrowers access to the system. The problem is, the last two of these goals are inconsistent. If you ask the private market to bear the credit risk, they are going to want to price that risk at as granular a level as possible. However, that is going to price some credit-worthy borrowers out of the system.

The current system handles this tension by having the GSEs provide some cross-subsidy through their level guarantee fees and some risk-based pricing through their loan level price adjustments. Not only is this a muddled way of going about it, it’s utterly inefficient, as much of the subsidy is going to those who don’t really need it; they just happen to have poor credit. Moreover, it’s not at all clear how this support for access relates to that provided by the FHA, whose mission it is to play this very role. Any reformed system should clean this up, making the support we provide for access more transparent, more efficient and more effective.

I think it’s important to keep the issues of cross subsidy and direct subsidy distinct. The two are not substitutes; they are complements. That is, our mortgage finance system should be set up so that credit guarantors can do cross-subsidy as effectively and efficiently as possible, and we should complement that with a workable mechanism of direct subsidy. Affordable housing constituents will be best served by such an approach.

I respectfully disagree with Laurie’s statement that, “bringing competitive private capital in to bear most of the credit risk; and giving all credit worthy borrowers access to the system” are “inconsistent.” For the time I was CFO at Fannie Mae (1990 to 2004) I believe we did that extremely well. It was in our best economic interest to do so. The most important determinant of our ability to cross-subsidize was our very low credit guaranty capital requirement (in retrospect, of course, too low). Capital remains the key to effective cross-subsidy, and I believe requiring the credit guarantors of the future—whether Fannie and Freddie or other entities—to hold capital unrelated to the risk of the loans they guarantee, as many reform proposals insist upon, will have significant negative consequences for affordable housing borrowers that are entirely avoidable under a true risk-based capital regime.

Tim is right that capital (and expected rate of return on it and modeled losses) will drive mortgage pricing and that requiring too much capital will drive prices higher than necessary.  Conversely, as Tim notes, insufficient capital levels can lead to guarantee fees that are too low to compensate for the risk.  This is an especially good reason for Congress to leave decisions about capital levels to a well resourced regulator that can change them as market circumstances change, and not try to legislate levels.  

But it's also important not to wax too nostalgic about the breadth of GSE lending before the crisis.  First, robust housing goals and a 1992 charter mandate to pursue LMI lending even at lower returns than non-targeted business pushed Fannie and Freddie much further into lending to more diverse (in every respect) borrowers than either would have done on their own.  It's also worth remembering that both companies in the past could cross subsidize the credit guarantee business with the portfolio investment business (and vice versa), something no longer available to them or likely to be available to any successor guarantors.  Finally, both companies cross subsidized lenders by negotiating guarantee fees to gain and keep market share, sometimes but often not at all connected to the delivery of goals to underserved borrowers.  

All in all, the cross subsidy picture for the pre-crisis GSEs is hard to fully parse.  What's not debatable is that a system relying wholly on private capital without the benefits Tim mentions and with no constraints on that capital's returns is unlikely to be able to extend credit as affordably in the future as it may have done in the past.  

I would like to add another element to the tete-a-tete between Laurie and Tim and that is the need for laser-focused attention on a particular segment of under-served consumers, namely, borrowers of color and other consumers, ie. persons with disabilities, etc., who have been ill-served by the financial markets.  I think Laurie hit the nail on the head.  There is an unresolved clash between extending credit access to borrowers that the traditional market has deemed to be more risky from a credit standpoint and pricing consumers who are in that bucket. 

For the entirety of our nation's history, this tension has meant precisely what Laurie suggested - some credit-worthy borrowers are priced right out of the system.  That is because it is the non-traditional credit market that provides credit access for many under-served consumers.  And those credit providers have practices that artificially deflate the credit scores of the consumers they serve.  For example, many non-traditional credit providers do not report timely credit payments to any credit repository and this means borrowers lose the benefit they might have gleaned from their timely payments had they been able to access credit in the financial mainstream.

What this has meant is that the GSEs have never had a representative market share when it comes to their investments in communities of color.  I can remember - each year - generating GSE market penetration maps for the city of Toledo - my home town.  Those maps often revealed that the GSEs had not purchased one single loan in Toledo's African-American and Latino neighborhoods.  Now,  I was creating those maps in the 1990s and 2000s but I am afraid this is still the case in today's market.  GSE market penetration is abysmally low in these areas and that simply means that the Enterprises are not providing liquidity for mortgage credit in communities of color - something that, as Mike Calhoun pointed out - flies directly in the face of the GSEs' charters and fair lending obligations.

The secondary housing finance system must operate in a way that does not price (or underwrite) under-served groups out of the system, better affixes pricing for borrowers who have been under-served - including low-wealth borrowers, and provides meaningful and effective cross-subsidies.

I think it's important to clarify what the point of cross subsidies in a broad insurance pool is.  It's not necessarily to deliver subsidy to a specific income group. It is to level out the pricing of risk in the pool so those with lower risk profiles can support the expected higher costs of higher risk profiles, with an average price that evens out these differences.  This is more a matter of equity as in equitable treatment of like profiles than subsidy of certain groups regardless of their profile.  The 1992 and 2008 legislative mandates that the GSEs serve the broadest market possible through the use of housing goals and a directive to accept lower returns for some business did not mandate subsidies. They directed the GSEs to incorporate the cost of extending credit to higher risk borrowers in their overall business model. 

There has been a broad bipartisan consensus about the government’s roles in housing since its first interventions during the New Deal and this is broadly reflected in the other comments.  These are support for affordable rental housing through direct subsidies and tax preferences, and support for a broad national mortgage market that assures consumers of access to responsible mortgage credit across a broad range of down payment and credit profiles throughout business cycles. 

The current system fails miserably at the first objective. Securing a significant, dependable revenue source for affordable rental housing as part of mortgage finance reform through a fee as proposed in numerous models is essential.  Given the outsized support homeowners receive through tax subsidies, rental assistance should get the lion’s share of that fee.

The current system and most future models also fail to capitalize on the interrelated roles of FHA and other government mortgage insurance programs like VA and RHS to support the second objective.  The current system fosters contradictory policy initiatives and can lead to them working at cross purposes.  The tension between the political desire to see private capital bear more risk without subsidy and the imperative to assure broad access to credit is inescapable, as Laurie points out.  FHA, et al., are designed to provide broad cross subsidies and level risk pricing.  By design they offer cost advantages private insurance cannot and can serve consumers when private capital will not offer a competitive price.  These features should be fully used in designing any new system. 

It looks like there is a good deal of agreement that if companies enjoy public protections – and I recognize that Ed questions the wisdom of that in this context – then they should be required to serve the public in return. Fannie and Freddie currently do this in a number of ways, including the affordable housing goals, compliance with civil rights laws, the trust fund, the duty to serve rule, and other policies. These policies have been helpful, and they should be preserved if not improved.

But we should clarify what we mean by “the current system.” This summer will mark a decade since the enactment of HERA and since the GSEs were put in conservatorship, eight years since the passage of Dodd-Frank, and six years since GSE profits were eliminated and their capital reserves – something we usually think of as a cornerstone of sound financial regulation – were set on a course to zero. While FHFA Director Mel Watt wisely restored a buffer, it was a limited move and the GSEs still operate in a state of excessive restraint.

While I’m open to proposals that preserve or improve on the goals and other access & affordability policies, I agree with Tim that we should end the conservatorship in the short term. This isn’t in order to go back to the system we had before the crisis, as some have claimed, but because we no longer operate under the same system - and a decade later it might be wise to assess how the new one works in a “real world” setting before wiping out a multi-trillion dollar industry and starting from scratch. If we’re still keeping the GSEs in conservatorship after ten years largely because so-called “recap and release” would undermine the momentum for reform, then perhaps we need a better case for it.

Thank you all for your meaningful (and succinct!) responses to the first question, as well as for some serious interaction among you. 

I think there’s general agreement that there is a federal role in housing finance, and that it revolves around ensuring that there is decent affordable housing—including homeownership opportunities—for those the market would not serve on its own.  And there also seems to be agreement that the current system—and Rob is right that we need to be careful about what we mean by “current system”—is not producing this result.  But there are significant disagreements about mechanisms and, in particular, the role of entities beyond those that are wholly government owned (FHA, VA, RHS).

The draft Senate bill is one of many plans and proposals for how to get from the current, sub-optimal system to one that aligns with the goals you’ve articulated.  But it is the plan currently in play.  For the second question, please discuss why and how you think the Senate draft does or does not align with the goals you’ve set out for access and affordability.  Please consider issues beyond dollars—both because we’re dealing with a system, not just a series of transactions, and because the Senate bill touches on these issues (whether by commission or omission).  What of housing goals, duty to serve, business judgment, fair lending, enforcement mechanisms? Suggestions as well as critiques are welcome; this debate can be the source of constructive improvements to the bill.

For those of you who think the FHA needs to be a critical element in a future housing finance system, please provide your thoughts about how the FHA can effectively overcome not only its redlining past, but also more recent issues involving ancient technology and spotty oversight of both lenders and servicers.  Are the VA and RHS different, and could some of their experiences help guide a revitalized FHA?

The leaked draft Senate bill falls short on fair lending and fair housing protections.  It appears that the drafters of the bill were of the assumption that current fair housing protections are primarily contained in the federal Fair Housing Act.  That is not the case.  The existing legal framework, requiring the housing finance system to be free from discrimination and to promote the nation’s fair housing goals, is comprised of a bevy of laws.  Those laws are designed to provide fair access to credit, particularly for under-served consumers, and to eliminate discriminatory practices from the system.

The Senate bill eliminates important language that is contained in several of these pieces of legislation.  It also includes language regarding the right of newly formed entities to exercise their business judgment without threat of liability.  This is dangerous and I believe deliberate.  This language threatens legal precedent and the Supreme Court’s 2015 ruling that disparate impact is cognizable under the Fair Housing Act.  The Senate’s draft language regarding business judgment would weaken the ability of civil rights organizations to address systemic policies and practices that unfairly restrict access to quality, sustainable credit.

Any new GSE Reform legislation must strengthen fair housing and fair lending protections already in place and address a fundamental problem that has thwarted our ability to achieve fair lending in America.  Our fair housing and fair lending laws and regulations have never been fully enforced and housing finance players, including the GSEs, have not done all they could to implement fair housing practices.  New legislation must ensure fair access to quality credit – particularly for underserved consumers, incorporate clear statements of the non-discrimination obligations of entities that form the system, guarantee strong and effective enforcement and regulatory oversight, and provide transparency that serves the needs of borrowers, lenders, investors and the public.

The leaked Senate bill makes the cross subsidization explicit. If you are going to have private bearing most of the credit risk, you need to either somehow force those bearing credit risk to provide the cross subsidy, as we do today, or have the government do it. The leaked Senate bill does the latter. This allows the subsidy to be much more clearly and effectively targeted to those who need it in ways they can use it. By introducing a 10 bps explicit charge to pay for the Housing Trust Fund, the Capital Magnet Fund and the a mortgage access fund (MAF) that supports LMI borrowers through a few specific uses, the bill manages to generate more subsidy that we have today, better target who gets it and how it’s used. The subsidy is still largely moving from some who use the system to others who use the system: it’s just done more effectively.

Of course, the devil is always in the details. The leaked bill provides for five different kinds of subsidies: interest rate reduction, down payment assistance, money deposited into a savings account to cover housing related activities in time of economic distress, housing counseling, subsidizing the cost of servicing delinquent loans, without a specific distribution plan. In a recent paper, Jim Parrott and I discuss the importance of each of these forms of support and talk through the mix of design issues they raise.

We concluded that a quarterly subsidy sheet in which qualifying borrowers can choose how they receive a prescribed amount of assistance—interest rate reduction, down payment assistance, or money deposited into a saving account—would be the most effective way to provide these forms of support, and that housing counseling can be readily allocated through a fund. We struggled with how to provide support for delinquent servicing in an effective way, concluding that it was best left out of the regime altogether. But the bottom line is that the regime as a whole is a more rational way to allocate subsidy than the opaque and inefficient way we do it today.   

For over 60 years, “Affordable Housing” initiatives have eased credit, promoted price Instability, made housing less affordable, and led to many millions of needless foreclosures.  

•       1950s: introduction of 30-year and minimal down payment loans for FHA
•       1960s: expands FHA to lower-income families unable to meet normal FHA credit requirements
•       1977, 1995: Community Reinvestment Act requires use of innovative and flexible lending practices to address LMI buyers
•       1992: GSE affordable housing goals
•       2008: GSE affordable housing goals tightened, addition of duty-to-serve
The Senate draft is no different--to promote and ensure access to affordable mortgage credit and affordable housing, including to underserved borrowers and concepts such as the “Market Access Fund”, “Market Access Plan”, “Market Access Agreement”.  

All such mandates seek a “free lunch”, but ignore the fact that the marginal buyer determines not only price levels, but also their degree of stability, because price does not necessarily equal value. 

Today, FHA’s pro-cyclical underwriting policies are fueling a home price boom which occurs during extended periods of a seller’s market.  FHA, as the largest provider of credit to highly leveraged buyers, has a responsibility to take counter-cyclical action now.  It should eliminate the riskiest portions of the FHA credit box, crowd out the 30-year mortgage, and crowd in the 20 year mortgage. Eliminating Fannie Mae and Freddie Mac without legislation 

 

Most of you are aware that I am not an economist.  But I know that there are several in the Policy Debate group.  Ed's argument about sellers' markets and affordability subsidies being priced into house prices is interesting.  Any comments from the economists?  

Ed's argument that the affordability subsidies result in higher house prices, washing out any benefit to the underserved presupposes that there is no housing supply response to the increase in housing demand. That may or may not be the case in the short-run in some communities, but it isn't the case in the longer-run.  And specifically with regard to the affordable goals, it isn't clear they are effective in supporting housing demand, and thus likely have had little impact on house prices even in the short-run.  Ed's concern that the FHA is currently promoting a "housing price boom" appears overdone.  House prices are consistent with  household incomes and rents in most communities; the exception being in markets impacted by strong global investor demand in global gateway cities.

 

Federal housing policy promotes homeownership by subsidizing mortgage debt for many households with few assets and low credit scores. Empirical work by AEI's Housing Center exploited the Federal Housing Administration’s (FHA’s) surprise 50 basis point cut to its annual mortgage insurance premium in January 2015 to study the impact of federal housing policy and interest rates on housing demand for a population of households likely to be influenced by changes to policy. The premium cut, which reduced monthly payments the same amount as a three-quarter percentage point drop in the mortgage rate, increased the purchasing power of the typical FHA borrower by 6 percent. Our analysis suggests FHA borrowers increased the value of the housing they purchased by 2.5 percentage points relative to a control group of borrowers in areas with minimal FHA presence. The rise in spending reflected an increase in constant-quality home prices, with no significant change in the quality of housing purchased by FHA buyers. We also estimate that the premium cut induced approximately 17,000 households to become first-time homebuyers in the initial year after the cut, an increase that fell far short of the FHA’s projection. Because the rise in constant-quality house prices affected both FHA and other buyers in areas with substantial FHA lending, non-FHA first-time buyers as a group incurred a cost of $180,000 for each of the 17,000 new first-time FHA buyers. The big winners were the Realtors, which had lobbied hard for the premium cut--some $400 million/year in additional commissions.  Not bad for maybe a couple of million spent on lobbying for the cut. The Impact of Federal Housing Policy on Housing Demand and Homeownership: Evidence from a Quasi-Experiment

My framework for government involvement in housing has two components: an effective direct subsidy program, and a mortgage credit guaranty system whose structure and operation facilitate cross-subsidies that hold down guaranty fees for affordable housing borrowers.

The Senate draft bill misses badly on both. Its proposed reform of the secondary market credit guaranty system is almost completely devoid of details, making it impossible to assess how guaranty fees would be affected under the bill. The draft is silent on credit guarantor capital requirements—the most important determinant of guaranty fees—and leaves nearly all of the difficult challenges of replacing the existing system based on Fannie and Freddie with a new multi-guarantor system to be figured out by the regulator after the bill has passed. That is extremely risky.

The Senate draft compounds this error by pretending that having an effective direct subsidy program is conditional upon secondary market reform. It is not. To the contrary, the “market access fee” proposed in the Senate bill would collect much more revenue, and provide support for many more affordable housing programs, if were levied on all newly originated mortgages, not just those financed by secondary market credit guarantors.       

Speaking from a multifamily perspective. The simplest reason for government engagement in rental housing is that it is where most lower-income Americans live and we must ensure safe, decent and sanitary housing for all Americans. The leaked Senate bill has 5 important elements for the multifamily sector: 1.  Ensures liquidity at all times with the government back-stop- critical given balloon mortgages and the need for regular property upgrading.  2. Does not interrupt the flow of capital as it utilizes current systems to create the new one (Fannie & Freddie MF businesses are spun-out) and Ginnie Mae becomes government back-stop. 3. Puts private capital at risk first and removes any back-stop for the corporate entity. 4. Keeps GSE multifamily lending in the affordability fairway  with requirement that at least 60% of all units financed must serve 80% of area median income and 5.  Encourages  serving under-served markets through the market access fee and risk-taking with credit enhancement. All-in-all, an improvement on the current system with clearer rules of the road.

The really problematic issue with access and affordability in the single family market  that neither the current system nor the leaked Senate bill solves for is the fact that lender often avoid making loans to LMI borrowers, because of the lower profits both at the point of origination and for on-going servicing. Lenders tend to charge the same percentage for originating and servicing all the loans they handle. Yet on average LMI borrower take out smaller loans and are move likely to go into default, making them less profitable to originate and service. While I believe paying lenders for servicing these loans, is proposed in the Senate bill would likely take up the lion’s share of the borrower subsidy, with no direct borrower benefit, the bill does make an attempt to address this issue.    

Laurie's hit on an important point -- the secondary market doesn't originate loans.  It can make certain loans more attractive for primary market lenders through concessionary pricing, underwriting approaches or other features.  Conversely, it can chill the market for responsible innovation to reach more borrowers by declining to provide a liquidity outlet for such loans.  If there isn't coordination in carrots and sticks in both the primary and secondary markets access will suffer.  The Community Reinvestment Act has spurred such innovation in the past.  But its "sticks" are weak, and more and more of the mortgage industry falls outside of its coverage.  

 

The leaked Senate draft recognizes the quandary of its basic design – by relying on privately capitalized guarantors with no constraints on return, no requirement to accept lower returns for some credit risk as part of a broadly cross subsidized book, and no enforceable obligation to fully meet credit needs in the market, it would leave assurance of broad service to goodwill and chance, an unpalatable option.  The drafters attempt to remedy this by redirecting the revenues from a 10 basis point strip on guaranteed securities to a system of direct subsidies to LMI borrowers as a discounted guarantee fee or cash assistance for down payments. 

I’ve written here about why this approach falls short, and here and here on how FHA and other government mortgage credit insurance offers a means to provide full spectrum lending across risk profiles. The Center for Responsible Lending and National Urban League have published an extensive critique of the draft that raises significant additional issues.

Recent work from the Terner Center at UC Berkeley, whose recommendations echo those in the 2002 Millennial Housing Commission report, recommends comprehensive FHA changes.  But FHA (and other similar programs) will continue to play a major role no matter what successor model is adopted, from recap and release to something like the leaked draft.  Full scale reform and reorganization might be a long-game objective for FHA. But it can’t be suspended or frozen while we wait; for now Congress and the Administration should focus on more immediate issues, particularly in resolving lenders' concerns about False Claim Act prosecutions,  providing significant separate funding for infrastructure upgrades and support, and confirming an FHA Commissioner. 

The Senate draft offers a weak tea substitute for the robust affordable housing infrastructure in the current system.  It rids the system of its public interest mandate and is built on a set of overly optimistic assumptions.  It focuses on a proposed $4 billion direct subsidy that lacks the enforceability of current duty-to-serve obligations, including affordable housing goals.  It weakens fair lending with business judgment protection for the guarantors’ market access plans.  The proposal is not only a blow to affordable housing, it harms the overall housing market.

The proposed system will increase costs by: providing less cross-subsidy to underserved borrowers than the current system; increasing G-fees, after correcting assumptions about the current and proposed system; and increasing, not decreasing, the average mortgage interest rate.

Congress has already taken on bipartisan reform with the Housing and Economic Recovery Act of 2008 (HERA).  Now, we should shift focus to ensuring that the system meets its access and affordability requirements.

A more robust discussion of our views can be found in a report that we co-authored with Marc Morial, president of the National Urban League and Mike Molesky, a senior financial economist and leading expert on mortgage default risk and insurance regulation. 

 

The future housing finance system envisaged in the Senate draft legislation would at the very least maintain the GSEs’ current credit box, and more effectively target support to low and moderate income households.

It does this through a market access fee charged on all single and multifamily mortgages insured by the multiple guarantors in the future system. Assuming a 10 basis point fee, this would translate into over $5 billion in funds per annum to finance cross-subsidization in the system. This compares to cross-subsidization in the current system of closer to $4 billion per annum.

The cross-subsidization in the future system would be targeted at low and moderate income households, instead of the high-risk borrowers receiving a cross-subsidy in the current system. These aren’t necessarily the same groups, and indeed in the current system some high-income, but high-risk borrowers receive a cross-subsidy.

It is important to note that this can be accomplished at the same time as providing taxpayers with more protection and allowing the future guarantors to risk-based price.

Having said this, the Senate draft legislation could be improved with regard to access and affordability by requiring that all of the future guarantors in the system have a national footprint. That is, they must serve the entire market in all market conditions. A somewhat higher market access fee is also possible, to generate more revenue for even more cross-subsidization without reducing the market share of the future guarantor system.

This paper provides a detailed description of how the cross-subsidization to assure access and affordability in the future system envisaged in the Senate draft legislation would work.

 

Thanks, Debaters, for your thoughtful responses, and your interactions with each other. 

For our final question, please consider what could and likely will happen over the next 3-5 years (go out to 10 if you dare), first, if there is no legislation and second, if legislation similar to the Senate draft bill is enacted.  In your responses, consider (i) what the Treasury and FHFA have the authority to do, alone or together; (ii) the likely impact of any decision and/or settlement of the shareholder litigation; and (iii) likely budgetary action by Congress relating to HUD and the FHA.  Remember that the focus of this debate is on access and affordability—in a world in which the vast majority of new households will be headed by non-whites.

There are many things about the future of reform that we don’t know, and one very big thing that we know for certain.  The things we don’t know include whether any legislation can emerge from either side of Congress, let alone both; what features or impact any potential legislation that makes it through that gauntlet might have; how capital markets and lenders would react to a new system whose details remain sketchy, as Tim as written; and whether even the unsatisfactory provisions for assuring guarantors fulfill an obligation to broadly serve the market in a new system included in the Senate draft will have much impact.  I’m skeptical that anything will emerge from Congress in this term.

Even if it did, I don’t foresee immediate consequences for consumer access and affordability because there would be significant ramping up of administrative and regulatory structures and procedures, and the runway for “turning on” its proposed new system is long. 

The thing we know for certain is that FHFA Director Mel Watt’s term will end in January 2019.  Even if a nominee can secure Senate confirmation, I don’t share some apocalyptic predictions that s/he will lay waste to the current housing finance system.  He/she might well try to further constrain the housing goals, but their latitude is constrained by legislation and required administrative procedures.  The GSEs’ duty to serve plans are already being executed and are unlikely to be much affected, though renewals could be handled very differently by a new regime.  The current assessment for the Housing Trusts Fund and Capital Magnet Fund is mandated by law; with the companies profitable and allowed to retain some capital its cancellation by a new director seems unlikely.

A new director probably would try to shrink the GSE footprint and “crowd in” private investment by increasing guarantee fees and reducing loan limits, no matter how dubious that outcome is. This would lead to higher consumer costs and likely push more borrowers out of the GSE market and into the FHA and other government insurance alternatives.  Regardless, the consensus that interest rates are going to rise over the next few years signals further stress on both renters and aspiring owners.

But there is no political appetite in the run-up to a Presidential election to take radical steps that could adversely affect homebuilding and homebuying.  It is too big a part of the economy, and too much of a direct pocketbook issue for voters. This is a stabilizing certainty that I think constrains any legislative or regulatory initiatives.

Fannie Mae and Freddie Mac will likely remain in conservatorship for the foreseeable future, as finding consensus for legislative GSE reform remains vexed. That doesn’t mean the GSEs will stand still, particularly with a Trump appointee running the FHFA.

The credit risk transfer process will continue to evolve and expand. The CRTs began nearly 5 years ago, and are now transferring more than half of the credit risk taken on by the GSEs. The process will surely be tested by recession and financial market volatility, but it will successfully adapt to these challenges.

The common securitization platform will come to full fruition. Despite some handwringing, it too has made significant progress. The CSP and a single security are important to any future housing finance system.

It is also likely that the size of the GSEs’ credit box will be reduced. Lower loan limits seem a likely approach to reduce the GSEs’ footprint to allow private portfolio lenders to take on more credit risk. The cross-subsidy in the current system may also be reduced.

The longer the GSEs remain in conservatorship, the harder it will be to get them out. That they will likely soon be scored by the CBO as providing a negative subsidy and thus providing revenues to the Treasury for other government needs will make it doubly hard politically to change the status quo.

This is unfortunate, as the GSEs in conservatorship will not be able to keep up with the changing demographic and technological needs of the nation’s underserved mortgage borrowers.

I have been a critic of credit risk transfer (CRT) securities as a substitute for equity capital in a reformed secondary market credit guaranty system, because I strongly believe that programmatic CRT issuance will make guarantors less able to absorb the credit losses they retain.

My argument is a simple one. Investors price CRT securities with the objective of earning a competitive risk-adjusted return (that is, so that the interest income and principal repayments they receive will comfortably exceed expected credit loss transfers). If they believe there is a significant chance of losing money on a CRT investment, they either will raise their yield requirement or (more likely) decline to purchase new CRT issues. The inevitable result of this entirely predictable behavior by CRT buyers is that the issuer will end up paying more (and likely far more) in interest on the CRTs it issues than it receives in credit loss transfers, weakening its ability to bear losses itself during times of stress.

In the spirit of debate, I would like to ask supporters of programmatic CRT issuance: “Am I getting anything wrong in my analysis, and if not, what is the counter-argument for supporting a ‘reform’ element that is bad both for the stability of the housing finance system and for homebuyers, who will have to bear the cost of this program?”

This paper presents the case for the capital market CRTs in the current and future housing finance system.

Legislatively reforming or eliminating the GSEs and decreasing the risk of taxpayer-funded bailouts will be difficult. Policy disagreements in the Senate, and between the Senate and the House, make it unlikely to accomplish in 2018.

An administrative solution to eliminate the GSEs and reform the FHA could be implemented over 5+ years (Eliminating Fannie Mae and Freddie Mac without legislation).  This would create a stable housing finance market by turning the government-dominated US housing finance system into a predominantly private-sector system based on free market principles, get the taxpayers off the hook, help Treasury reduce the debt by billions of dollars annually, and slow home price growth thereby making homes more affordable for first-time LMI buyers.

Make reliable wealth building the goal of federal homeownership policy:

•       Focus FHA exclusively on first-time, LMI homebuyers by crowding out the risky 30-year loans and crowding in 20-year wealth building loans by administrative action.

•       Congress could create the Low-Income, First-Time Homebuyer (LIFT Home) Tax Credit, a transparent, targeted, on-budget, upfront tax-credit more replacing today’s system using opaque subsidies on high risk lending to marginal buyers.

•       Over 10 years, 4 million buyers placed on the path to wealth building, with a 50% reduction in default risk, and freeing up an estimated 1.2 million low-income rentals, allowing the expensive LIHTC program to be phased out.

I don’t believe there is any way to predict what will happen if the Senate bill passes, since it’s virtually devoid of operational details. It is analogous to having a group of auto critics design a car as it’s being built on the assembly line; it’s anybody’s guess as to what it will look like when it rolls off, let alone whether it will run.

A non-legislative outcome is far more likely in any case, due to the complexity of the problem and the dysfunction in Congress. Even here, however, prediction is very difficult. It’s more a case of what’s most probable, and here is my assessment of that:

- Fannie and Freddie will remain in conservatorship until some triggering event—most likely an adverse ruling in one of the court cases challenging the net worth sweep—occurs to prod (or force) administrative action by Treasury.

- Treasury’s reform initiative will follow the model put forth by Moelis & Company last June. This is a “turnkey” solution, with support of the investment bankers who will need to raise the capital for it, and it also will yield upwards of $100 billion for Treasury through conversion of warrants for Fannie and Freddie common stock.  

- Affordable housing groups will succeed in getting legislation, not tied to secondary mortgage market reform, that imposes a small fee on all new mortgage originations, with the proceeds used for targeted subsidy programs.    

 

 

I believe the Senate bill would be good for access and affordability by better targeting the benefits and making the cross- subsidization transparent. Moreover, these cross-subsidization features would become legislative, rather than dependent on the goodwill of the head of the FHFA. That said, I am very pessimistic about the likelihood of legislative GSE reform in the next 5 years. I don’t think the political will is there: there is no consensus as to what the new system should look like, and the present system seems to most of be working well enough.

So where does that leave us? As Mark Zandi put it so well, we continue down the path of administrative reforms. GSE credit risk transfer expands, the Common Securitization Platform and the Single Security become a reality next year, the GSE portfolios reach their target size and stabilize. The wildcards here are the GSE footprint and the access and affordability features. Mel Watt’s 5-year term as head of the FHFA expires in January of 2019. His successor could choose to substantially curtail the GSE footprint by decreasing loan limits or raising guarantee fees (which are already higher than the risk of the book of business plus the administrative costs of running the GSEs require). His successor could also choose to substantially weaken the access and affordability features in the present system. That is, the cross-subsidization in the current pricing structure could be reduced, the housing goals could be weakened or eliminated, and the new guard could fail to enforce the duty to serve mandate.

 

September 7, 2018 will mark the 10th anniversary of conservatorship. Easiest prediction is that the current state continues indefinitely- there really are a lot of people who like it and are benefiting from it! Most lenders- for- and non-profit and also non-banks are having banner years. Minor details in my view- it is not stable and is not fully serving the market.  But change is inevitable-Jan  2019  Mel Watt, Jeb Hensarling and Bob Corker are no longer in their current seats. Therefore, an administrative solution in 2019 would be my prediction with real congressional reform in 2022. The administrative solution would be to move to receivership and then start selling "assets" to redeem the subordinated debt and possibly preferred stock. That would leave a shrunken and likely much less effective system by the time Congress gets to it in 2022.  Or a miracle happens and the leaked Senate bill sees the light of day and reform is a compromise- like everything else in life!

Dramatic housing finance reform has already been implemented over the past ten years, and it is ongoing and should continue through the administrative process. The Housing and Economic Recovery Act of 2008 provided a blueprint on access and affordability issues in our housing finance system. These statutory requirements should make us less concerned about the replacement of the FHFA director next year. Furthermore, our view is the Senate draft would do much more harm than good, and we should not rush to legislate simply because there will be new leadership at FHFA. The Senate draft, if it became law, would have negative ramifications baked into statute, making the policies extremely difficult to change.

A necessary change within the power of FHFA is for the GSEs to stop the excessive risk-based pricing that occurs in LLPAs and PMIERs. This would bring in many of the potential homeowners that Urban Institute reports are locked out. 

Homeownership is the way that most Americans build wealth over time. The future of the market is now. Most new household formation is families of color and new homebuyers are increasingly families of color. The market depends on ensuring that millennials and people of color are well served. This also benefits existing homeowners, especially older Americans, who will need buyers when they want to sell, when new families will need access to affordable mortgage credit to buy their homes.

As Lisa stated, the federal government has facilitated discrimination in the mortgage market and now has an obligation to correct those wrongs. Black homeownership is where it started at passage of the Fair Housing Act in 1968. The exclusion of Blacks, Latinos, and other people of color must be addressed to achieve a well-functioning system.

Testimony we delivered before the House Financial Services Committee last year highlights the federal government's role in fostering the racial wealth gap and the steps the government can take to remediate the system toward access and affordability.

For the reasons that Mike, Lisa, and Tim have stated here and elsewhere, I don't see how we get to a legislative consensus in the foreseeable future. 

Mark may be right that the GSEs remain in conservatorship indefinitely, and that the longer they remain, the harder it will be to get them out. But the longer they remain, if the only reason for keeping them there is a strategic one, the more doubts there will be about the merits for a comprehensive overhaul. As far as what happens with administrative reform, I'm curious to see what Larry Kudlow does in light of the position he has taken, but ultimately it's hard to speculate until we know who is in charge of the Senate confirmation process after this November. 

Housing finance reform is the open business from the housing and financial crises of 10 years ago.  While conservatorship has brought stability, and even some innovation, as our Debaters have pointed out, we continue to face a housing finance system that does not fully serve all. At the same time, political, personnel and (probably) economic and budgetary changes have brought us to a point where some significant change to the status quo is likely.  And that change will likely implicate, if not directly involve, not just the GSEs, but also the other government entities involved in housing, especially FHA, VA, RHS and the Home Loan Banks.  Our Debaters have considered how the critical issues of access and affordability should be handled as this process plays out.  They have expressed multiple perspectives, but agreement on the broad goal of federal involvement in housing finance: ensuring that there is decent affordable housing—including homeownership opportunities—for those the market would not serve on its own.

As we close this debate, thanks to the Urban comms team, especially Nicole Levins and Sheryl Pardo.  And thank you to all the Debaters, and those who worked with them.  We urge you to keep the conversation going.