PROJECTHousing Finance Reform Incubator

John Taylor: Improving Our Mortgage Finance System Shouldn’t Require a Total Reinvention
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June 1, 2016

Let’s consider what’s at stake in the housing finance reform debate. It’s a big deal. It will have enormous consequences for Main Street. If we get it wrong, many hardworking, creditworthy families will be shut out of homeownership, and their efforts to climb the economic ladder will be stymied. Much of the conversation on Capitol Hill and among policy thinkers has pushed affordability and access to the back burner. We need to bring it to the forefront of the conversation. The shape and quality of housing finance reform will have repercussions in every neighborhood and community and for our national economy.

Homeownership is the best vehicle for low- and moderate-income families and people of color to build wealth and enter the middle class. African American and Hispanic families hold most of their wealth in the form of home equity (Kochhar, Fry, and Taylor 2011).1 This is also true for working-class whites. A home purchased using the leverage of a responsible mortgage beats any other investment option in terms of return on investment. Homeownership is a mechanism that is unmatched in providing economic opportunity to working families.

Homeownership also offers community, economic, and social benefits, including better health outcomes, less crime, and better academic achievement (National Association of Realtors 2012). Homeownership also drives economic growth, benefiting the whole economy. For decades, a strong network of US policies supported responsible homeownership and the creation of affordable and safe mortgages, which had vast benefits for our economy and bolstered the growth the middle class. Fannie Mae and Freddie Mac are a cornerstone of this success, providing a deep, liquid market for US mortgage debt. The shift toward securitization by Fannie Mae and Freddie Mac signaled the start of a long, stable, and gradual rise in homeownership and home values. This ended with the rise of the private-label securities market in the early 2000s, and we see a sharp rise in prices that coincides with the growth of private-label securities market share.

In the 1990s, affordable housing goals were put into effect for the government-sponsored enterprises (GSEs). The housing goals offered regulators a method to ensure that Fannie Mae and Freddie Mac led the market, increasing credit access for blue-collar, working-class Americans in underserved communities, while ensuring the long-term stability of the GSEs. Decades of lending discrimination and redlining left these communities with severe financial disparities. Without laws and rules such as the Community Reinvestment Act and the affordable housing goals, underserved communities could be blocked altogether from affordable credit.

Almost all authors on this forum have acknowledged how large a role Fannie Mae and Freddie Mac have played since the 2008 financial crisis and the preeminence of agency mortgage securitization as a source for mortgage capital since the savings and loan crisis in the 1980s. But the major proposals considered by Congress to reform housing finance have eliminated Fannie Mae and Freddie Mac and eliminated their affordable housing goals. And there is scant evidence that any of the alternative models that have been postulated would do as good a job as Fannie Mae and Freddie Mac did for most of their history. So why reinvent the wheel?

Market Uncertainty and Insufficient Private Capital in Alternative Models

There may not be enough private capital to replace the $5 trillion in mortgage credit made possible by the GSEs’ role in the secondary market. All the reform models proposed to date have significant flaws regarding this issue and whether they could provide stable financing in all markets at all times. It’s unclear whether guarantors could raise sufficient capital to support reform models that require a 10 percent capitalization like the one proposed by Alex Pollock, not to mention whether that type of capitalization requirement and the guarantee fees it implies would simply price many low- and moderate-income borrowers out of the conventional market altogether.

Other proposals, such as those proposed by Mark Zandi as well as Gary Acosta, Jim Park, and Joe Murin rely heavily on transferring far more credit risk and GSE revenue into the private market (e.g., private mortgage insurers, capital markets, reinsurers, and lenders). They seem to require a much greater shift in the focus and resources of the GSEs away from their primary role of ensuring liquidity, stability, and affordability in the housing market for new mortgage credit to much more of a credit risk–sharing mechanism. Based on Fannie Mae and Freddie Mac deal documents, the first-loss securities sold by the GSEs under Fannie’s Connecticut Avenue Securities (CAS) and Freddie’s Structured Agency Credit Risk (STACR) is still under $1 billion. And overall, private capital has been sharing first-loss and mezzanine risk on mortgage pools that had the most pristine credit, with average FICO scores of 758.2

In reviewing the housing finance reform legislation by US senators Tim Johnson and Mike Crapo, Freddie Mac approximated that to attract enough private capital to insure only the top 10 percent of the GSEs’ $5 trillion mortgage credit book of business, the industry would need to attract close to $500 billion of capital—16 times what the entire mortgage insurance companies and financial guarantors had. The combined capital for the three largest banks (JP Morgan, Bank of America, and Citi) was approximately $650 billion at the end of 2013.

The Johnson-Crapo model suffered from both flaws: requiring substantial capital for guarantors while permitting the sale of credit risk into the securities market. Legitimate questions have been raised about whether the coexistence of such securities- and guarantor-based models can provide stable financing. It seems implausible that these reform proposals will yield enough private capital, mitigate taxpayer risk, and facilitate financing at comparable or better levels of affordable housing for low- and moderate-income borrowers.

Most reform proposals rely on private-label securitization and portfolio lending to provide most of the nation’s credit needs. There is little evidence that the private-label securities market and balance sheet lending, for example, can step up to the GSEs’ mortgage credit book of business, and most acknowledge that the private sector lacks the willingness or capacity to take risks in an economic downturn. Based on history, the sufficiency-of-private-capital question is a reasonable one to ask before we upend the current system in favor of a new one. Many proposals appear to imply reforming to a much smaller mortgage market with less available and more expensive credit. As a result, many creditworthy borrowers of modest means in working-class communities will get squeezed out of a market that offers fewer options. A smaller market will also negatively affect older Americans seeking to downsize and sell their homes.

The Necessity of a Strong Affirmative Obligation and Measurable Affordable Housing Goals

None of the legislation that has gained serious consideration so far has included affordable housing goals. This omission is highly problematic. The GSEs’ affordable housing goals—loan purchase targets that have provided conventional mortgage credit to low- and moderate-income borrowers and traditionally underserved—must be included in any new model. A stronger version of the existing goals should be the objective. The affordable housing goals have increased access to responsible mortgage credit in underserved communities.

Unfortunately, some experts have persisted in repeating negative falsehoods about the affordable housing goals, blaming them for the crisis. These claims are without merit. The US Financial Crisis Inquiry Commission examined the housing bubble and found that neither the Community Reinvestment Act nor the affordable housing goals was a significant factor in the financial crisis. Other researchers have reached the same conclusion, including economists at the Federal Reserve Bank of St. Louis, Federal Reserve economist Neil Bhutta, and researchers at the Center for American Progress.

The major housing finance reform proposals considered by Congress did not re-create Fannie and Freddie’s statutory “affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families…at a reasonable economic return” or include affordable housing goals. Instead, they have included a nebulous “duty to serve” and a weak financial incentive model. None of these measures are a satisfactory replacement for a strong affirmative obligation in statute and measurable affordable housing goals setting clear benchmarks. Two contributors to this forum, Marc Morial and Tim Howard, have joined the National Community Reinvestment Coalition’s clarion call for strong affordable housing goals that “lead the market” and are enforceable. Blue-collar Americans are served by the affirmative obligation in Fannie and Freddie’s statutes and the affordable housing goals that apply to both entities. The affirmative obligation and the affordable housing goals are current law, giving those working up the economic ladder a fair chance at owning a home via a responsible and sustainable loan. Most Americans got a loan precisely through this mechanism, in which Fannie, Freddie, the Federal Housing Administration, the US Department of Veterans Affairs, or the Rural Housing Service guaranteed or securitized their loan. Any future law must match and exceed these measures in strength.

The Virtues of Preserving the Existing System

Despite the efforts to contrive a new model for housing finance, it is unnecessary to dismantle Fannie Mae and Freddie Mac and replace them with an untested new system. The US banking system—and the housing finance system within it—is far more safe and sound today than it was before the financial crisis. Global banking regulators, Congress, and the nation’s new and existing regulators have enacted reforms in response to the 2007 financial crisis that have strengthened the requirements for regulated financial institutions with regard to capital adequacy, liquidity, disclosure, risk retention, and consumer protections. The nation could simply build upon the regulation, transparency, and capital provisions enacted for the GSEs by the Housing and Economic Recovery Act of 2008 and improve the accountability of the enterprises. Fannie Mae and Freddie Mac should be put back to work doing the job they have done well for most of their existence.

Much of the resistance to this course of action originates from entities who have long been clamoring for Fannie and Freddie’s business: Wall Street banks and insurance companies. Not coincidentally, these institutions are the primary beneficiaries of some of the alternate models that have been put forth.

Political and Policy Uncertainty Create the Need for Immediate Action

As this housing forum demonstrates, there are a lot of ideas about how to reform the secondary mortgage market. But comprehensive housing finance reform is at an impasse in Congress, with no legislative consensus on the horizon. Various piecemeal legislative and administrative approaches to a new housing finance system continue to take shape while the future of Fannie Mae and Freddie Mac hangs in the balance as their capital buffers dwindle to zero and their investment portfolios decline.

The Federal Housing Finance Agency inspector general has found that the future profitability of the GSEs is not assured. Recent statements by Director Mel Watt on the impacts of a protracted conservatorship and declining capital, the earnings volatility and net income losses at Freddie Mac in the third quarter of 2015 and the first quarter of 2016, and recent tepid profitability at Fannie Mae are all bringing into sharper focus the stakes for the nation’s mortgage market. Yet Fannie Mae and Freddie Mac have paid the US Treasury over $50 billion more than they withdrew on their line of credit with Treasury. It appears that efforts by the Obama administration to continually sweep profits from the GSEs may be to keep them in a precarious financial state and prevent them from ever coming out of conservatorship, thereby making a comprehensive reform bill necessary.

In addition, there is the political uncertainty about the policy approaches the next president and his or her appointees will take on the GSEs, their conservatorship, and their affirmative obligation and affordable housing mandates, including the affordable housing goals, the forthcoming duty-to-serve rule, and the National Housing Trust Fund and Capital Magnet Fund.

Because of the important role Fannie Mae and Freddie Mac continue to play in providing access to all creditworthy borrowers, including those in low- and moderate-income, minority, rural and other traditionally underserved markets, the National Community Reinvestment Coalition has urged that it is time to recapitalize the GSEs, institute a capital restoration plan, end the conservatorship, and build on the reforms of strong supervision, oversight, and increased transparency started as part of the Housing and Economic Recovery Act of 2008. Recapitalizing the enterprises does not mean that reforms to governance stop. Building the capital reserves that the GSEs have already calculated into their guarantee fees and charging the market to build is a responsible and prudent step that protects taxpayers and the GSEs’ affordability mission.

Holding these enterprises in conservatorship has not been beneficial for working-class Americans. While in conservatorship, Fannie and Freddie have reduced securitization of low- and moderate-income loans to a near 10-year low. And for most of the time in conservatorship, they have essentially securitized loans for people with high down payments and extremely high credit scores. What’s the point of Veterans Affairs loans, Rural Housing, the Federal Housing Administration, Fannie Mae, Freddie Mac, or any government guarantee if not to assist those whom the market chooses to ignore?

Everyone talks about the growing wealth inequality in the United States, but there are scant offerings on how to narrow that wealth gap. The working poor are already paying rent. Having that portion of their income go toward a mortgage is the greatest tool used by working people to build wealth. But the bar has been raised for homeownership disproportionately for working-class whites, African Americans, Hispanics, Asian Americans, and others. Let’s get back to what builds economic opportunities and strengthens the middle class: responsible homeownership opportunities for all creditworthy borrowers. Let’s ensure that homeownership does not fall victim to political shenanigans and market greed.

Notes

  1. Editorial Board, “Homeownership and Wealth Creation,” New York Times, November 29, 2014, http://www.nytimes.com/2014/11/30/opinion/sunday/homeownership-and-wealth-creation.html?_r=1.

  2. Ben Lane, “Fitch: Fannie, Freddie risk-sharing deals will become more common,” HousingWire, July 15, 2015, http://www.housingwire.com/articles/34488-fitch-fannie-freddie-risk-sharing-deals-will-become-more-common.

References

Kochhar, Rakesh, Richard Fry, and Paul Taylor. 2011. Wealth Gaps Rise to Record Highs between Whites, Blacks, and Hispanics. Washington, DC: Pew Research Center.

National Association of Realtors Research Division. 2012. “Social Benefits of Homeownership and Stable Housing.” Washington, DC: National Association of Realtors.


John Taylor is president and CEO of the National Community Reinvestment Coalition. Raised in the housing projects of Boston and trained as an attorney, he has dedicated his life to economic justice.  With over 25 years in the field, he has received numerous local, state, and national awards, including the Martin Luther King Jr. Peace Award, two United States Congressional Citation Awards, the State of Massachusetts Award for Excellence in Community Economic Development, and a presidential appointment to the Community Development Financial Institutions Fund.

He has served on many national boards, including the Consumer Advisory Council of the Federal Reserve Board, the Fannie Mae Housing Impact Division, the Freddie Mac Housing Advisory Board, and the boards of the Rainbow/PUSH Coalition and the Leadership Conference on Civil Rights.

He has appeared on ABC's Nightline, CBS, Fox News, CNN, C-SPAN, in the New York Times, Washington Post, Chicago Tribune, and hundreds of other print, television, and radio media. Taylor has testified before numerous congressional committees in the US Senate and the House of Representatives.

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A photo of Laurie Goodman. Dark hair, glasses, bright smile.
"It is time for an open-minded look at the housing finance system and what role, if any, today’s government-sponsored enterprises might play in the future."
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Tim Howard
"When invented narrative is replaced with verifiable fact, Fannie and Freddie cease to be a 'failed business model' that must be wound down and replaced; they instead become valuable resources that must be built upon and improved."
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A photo of Jim Millstein. White hair, slight smile, suit and tie.
"To address the conflict between their affordability mission and shareholder returns, the mortgage guaranty businesses should be subjected to utility-like regulation, with strict activity, leverage, and return on equity limitations."
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A photo of Alex Pollock. Slight smile, suit and tie.
"At the 10% Moment, Congress should declare the senior preferred stock fully retired, as in financial substance it will have been. Simultaneously, Congress should formally designate Fannie and Freddie as systematically important financial institutions.
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A photo of Mark Zandi. Slight smile, suit, brown hair.
"A group of us has put forward a reform proposal that addresses the system's structural problems and keeps what works."
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A photo of James Carr. Severe smile, suit, dark hair.
"The basic pillars of America’s housing finance system were enacted 80 years ago. Since then, major reconfigurations in our economy, demographic composition, and household locational preferences demand a bolder vision for housing finance in the 21st century."
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A photo of Andrew Davidson. Slgiht smile, greying hair, glasses.
"A realistic approach to GSE reform is to strip the GSEs down to the functions that promote standardization, liquidity, and access to credit, and adopt the best governance structures for those functions. This can be achieved in four steps: streamline, share risk, wrap, and mutualize."
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A photo of Mark Calabria. Slight smile, suit, dark hair, glasses.
“Mortgages, under any system, have to rest on someone’s balance sheet. Like water running downhill, the risk has flowed to the most leveraged sectors of our financial system. This is a recipe for instability.”
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A photo of Patricia Mosser. Dark hair, glasses, bright smile.
“The characteristics of mutuals that may be seen as disadvantages for some types of financial companies are in fact advantages for our financial market utility proposal because they align the utility’s incentives with other actors in the securitization chain.”
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A photo of Marc Morial. Big smile, suit, dark hair.
“In the aftermath of the Great Recession, the tragic loss of wealth, and the bailout of the big banks, our national government must continue to play a central role in the housing market to right previous wrongs, ensure access to all qualified borrowers, and keep the housing finance system afloat ...
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A photo of Laurie Goodman. Dark hair, glasses, bright smile.
"Between now and 2030, this country will face an unprecedented surge in rental housing demand. Already, rents are skyrocketing out of the reach for many families, especially in places with job opportunities. New multifamily housing construction is at its highest level since the 1986 Tax Refo...
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A photo of three individuals. All three are smiling, have suits, ties, and dark hair.
"There will be nuanced demands coming from the high concentration of household formation in African American, Asian, and Hispanic communities. Ginnie Mae 2.0 looks to be the safest way to build a sustainable platform to bring proven market stability to meet the needs of a materially changing demo...
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A photo of two individuals. Both are smiling, have suits, ties, and glasses.
“The most critical need for multifamily is simply that policymakers pay attention to it early and plan ahead.
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A photo of two individuals. Both are smiling, have suits, ties, and glasses.
We propose a spinoff of the multifamily business units of the GSEs and the formation of other new guarantors to increase access to affordable multifamily financing.
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A photo of two individuals. Both are smiling, have suits, and ties.
"Consensus exists that a reformed housing finance system must protect taxpayers, emphasize the private markets, support a broad variety of housing options and remain liquid throughout an economic cycle. Surprisingly, few recognize that a proven model already exists that meets those objectives-and...
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A photo of Jim Millstein outside. Dark hair, big smile, suit and tie, glasses.
"Mortgage finance reform discussions have failed to generate consensus assuring the widest possible access to sustainable mortgage credit at the lowest practical cost. We can resolve this impasse if we integrate all federal supports for mortgage finance into one cohesive whole."
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A photo of Pinto. White hair, glasses, slight smile, suit.
"Today’s government-centric housing finance system is an “economics free zone” indifferent to supply and demand. Composed of an alphabet soup of agencies, this system has fostered a massive liberalization of mortgage terms and provided countless trillions of dollars in lending. Yet housing has be...
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A photo of Taylor. White hair, suit.
"Much of the conversation on Capitol Hill and among policy thinkers has pushed affordability and access to the back burner. We need to bring it to the forefront of the conversation. The shape and quality of housing finance reform will have repercussions in every neighborhood and community and for...
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Mike Calhoun and Sarah Wolff
"Average price estimates obscure significant variation. To assess access and affordability, we need to look closely at differential prices, not just overall prices or prices for low–credit risk profiles."
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Rodrigo Lopez and Debra Still
"We believe that all housing needs, from the most directly-subsidized, affordable rental housing to the prime jumbo single-family lending market, lie along a single continuum. This housing continuum can be best served only by addressing single-family and multifamily, rental and homeownership, gov...
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Janet Murguía
"By 2020 half of all first-time homebuyers will be Latino. Without affordable access to credit for these prospective buyers, the housing market will decline, with harmful consequences on the larger economy."
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Jim Parrott
"Coming out of the crisis, there was thus almost universal agreement that we should reduce our reliance on this duopoly and shift more risk into a competitive private market."
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row of houses rendering
Research Areas Housing finance
Policy Centers Housing Finance Policy Center