Today was a big one for housing finance. Treasury kicked things off with its much awaited report to Congress on “Reforming America’s Housing Finance Market.” And then the Brookings Institution hosted a full day conference on “Reforming the U.S. Mortgage Market.”
Both Treasury’s report and the conference showed that there’s still important debate about the potential merits and demerits of a continued government backstop in the prime mortgage market. Treasury’s three options, for example, run the gamut from no guarantee to a backstop guarantee that kicks in during bad times to a permanent, broad-based guarantee. I’ll have more to say on these options in the future.
For now, I’d like to highlight several other aspects of the Treasury report and the discussion at Brookings that I found encouraging. Based on what I heard (and what I read between the lines of the Treasury report), there appears to be near-consensus on five important issues:
- The multi-trillion dollar investment portfolios of Fannie Mae and Freddie Mac were a mistake. As the Treasury report puts it: “Fannie Mae and Freddie Mac were allowed to behave like government-backed hedge funds, managing large investment portfolios for the profit of their shareholders with the risk ultimately falling largely on taxpayers.” Such government-backed portfolios have no place in our future mortgage finance system.
- Any future government assistance must be better targeted. For example, the conforming loan limit (and its FHA counterpart) need to come down.
- If there are any future government guarantees for prime mortgages, they must be protected by greater private capital.
- If there are any future government guarantees for prime mortgages, they must be explicit, and financial firms must pay at least actuarially fair rates to purchase them.
- Affordable housing programs should be transparent and on budget, rather than embedded in regulatory requirements on Fannie Mae, Freddie Mac, or any successors.
Each of these would be a substantial improvement from the old GSE system.
Ok as far as it goes but..
(BTW: we should all remember that these GSE entities were originally government owned and were later “privatized” in the name of efficiency)
1. At stake is the future of the fixed rate 30 year pre-pay without penalty home mortgage. Even though most people pay off their mortgages well before 30 years, this has been the key ingredient to the entire post WWII housing boom and the vehicle that made over 65% of households homeowners. I think the 30 year mortgage will die without government backing – or at least become much more costly.
However, there are a number of arguments to be made as to why this is no longer a good idea (if it ever was):
a. It promoted flight – especially white flight – from our cities (in a very rapid way without markets able to adjust)
b. Large suburban single family houses on large lots are wasteful of energy resources
c. We live in a much more mobile society and fewer and fewer people even expect to be in their homes for 10 years – let alone 30.
d. The private mortgage market should be happy to provide 10 year loans in great abundance (I predict they will offer two versions in the future – one at a lower rate with a prepayment penalty and one at a higher rate without a prepayment penalty).
2. But we need to remember how the entire post WWII mmortgage market evolved. It was the creation of the FHA that facilitated the development of the private mortgage market which up until that time had been limited to short term lending from local banks. The FHA did two critical things that led to the private mortgage market: (1) it created a standard underwriting template that all borrowers had to pass through in order to qualify for a loan (minimum ratios of income to housing debt and income to total debt, minimum down payment, minimum credit thresholds (I don’t think they had credit scores then), employment verification, pay stub verification, bank statement proof of assets, etc.) and (2) this resulted in a statistically verifiable data set of borrowers that enabled lenders to understand how borrowers passing through this template will perform over time – a predictable baseline of the likelihood of default. After enough time had passed private lenders and mortgage insurers were prepared to offer financing based on this experience. Fannie Mae essentially did the same thing with a different class of purchasers. Indeed, this process is a textbook example of how the public and private sectors should interact. The public sector took the initial step of taking the risk and setting the parameters until it put itself out of business (FHA loans had declined to a very low percentage of home mortgages). Why go through the government bureaucracy when you could get the same terms from private lenders?
NOTE: One of the primary reasons for the recent home mortgage debacle was that no one who should have noticed – the rating agencies, the underwriters of securitizations, the lenders – realized that the “template” had changed – option ARMS, no doc loans, limited doc loans, – but they just assumed likely default outcomes without having a data base to use based on these altered templates.
Therefore, if FANNIE and FHA are getting out of the home mortgage business – except for those families of modest means purchasing relatively low cost homes – there needs to be some replacement entity that will set the standardized template for private mortgage lending. If different lenders start using different templates there will be too much “noise” and inefficiency in the market which will result in a smaller pool of lenders and higher interest rates. Maybe this could be done by some type of clearinghouse created by all secondary mortgage underwriters and lenders?