| Posted: August 8th, 2013
The challenge that the Obama Administration faces as the president returned to Phoenix this week is in some sense the opposite of that faced when he spoke there four years ago. Then, the challenge was to break a vicious cycle in the housing market that was wreaking havoc on the broader economy. Today, it’s reinforcing a virtuous one that is finally breathing much needed life into the economy.
But this is no small challenge, as the resurgence of the market faces strong headwinds from tight credit and uncertainty over where the mortgage market is headed. If left unchecked, these forces together could bring the recovery to a standstill.
The primary goal of policymakers right now thus must be to find ways to overcome these headwinds, to build the momentum needed to make the recovery sustainable. And while the plan that the Administration laid out this week (found here and here) covers a good deal of ground on everything from immigration to the importance of rental housing, its key components are intended to do precisely that.
Access to credit
To get a mortgage today, you need to have better credit than at any time in recent history. Given what we’ve come through and why, some correction is to be expected and is certainly warranted, but the market has so overcorrected that an enormous share of relatively low-risk borrowers are locked out of the market. This means fewer buyers, less demand, and ultimately a weaker recovery.
What makes this perplexing is that, through the Federal Housing Administration (FHA), Fannie Mae, and Freddie Mac, the government has agreed to cover the risk on these borrowers, leaving one to wonder why a lender wouldn't be willing to make them a loan.
The reason, or an important part of it anyway, is that it is unclear when and why the government guarantor will provide coverage after a borrower defaults. If it determines that the lender has not followed its rules, then the defaulting borrower is the lender’s problem. This of course makes sense, but only if the rules are clear. Here they are not, leaving lenders unsure when they have actually gotten rid of the credit risk on a loan and thus unwilling to make loans to any borrowers without the most pristine credit profiles.
To address the problem, the Administration has committed to working with the FHA (which it controls) and the conservator for Fannie and Freddie, the Federal Housing Finance Agency (which it does not) to clarify these rules so that lenders have the confidence to lend much more broadly. Despite some hyperbole to the contrary, this does not mean a return to subprime lending, but rather expanding lending to a group of borrowers virtually everyone agrees are credit-worthy but who are unable to get a mortgage because of some unintended consequences of agency rule-writing. If successful, it should open the market up to a broader pool of homebuyers, increasing demand and deepening the recovery.
Housing finance reform
Though there is almost universal agreement among policymakers that the current housing finance system is deeply flawed, disagreement about what a new system should look like has frozen the discussion and kept us from moving forward on reform. The resulting uncertainty about what kind of mortgage market we'll see several years down the road has in turn slowed investment in the space, further hindering the prospects for longer-term recovery.
To break the stalemate, the Administration has wisely separated the question of reform into two pieces: shrinking FHA and winding down Fannie and Freddie, over which there is agreement among policymakers; and building a successor system, over which there is not.
On the former, the Administration offered several concrete steps to begin the transition away from a market dominated by the government, designed both to reduce the government footprint and to prepare the country to transition to a new system in which private capital plays a much more central role than it has in the past:
Increase the amount of risk that both Fannie and Freddie push out to the private market each year. This will bring much-needed private capital into the market and reduce taxpayer exposure, but it will also provide market feedback about what kinds of risk syndication work best, which is going to be critical as we look to develop a future system that is much more reliant on the private market to take on credit risk.
Reduce FHA loan limits beginning in 2014. Under the proposal, Congress would let the limits drop back to their pre-crisis level at the beginning of the year and the FHA would reduce them further as market conditions allow, with an ultimate goal of returning the FHA to its traditionally more targeted market share of 10 to 15 percent. As with the prior step, this will help reduce risk to the taxpayer, create more space for private capital to take on credit risk, and give us important information about the tolerance of the private market for credit risk.
Synch up Fannie and Freddie systems in preparation for wind-down. This will become increasingly important as these two entities gradually shift from being two competing, dominant forces in the market to a single set of functionalities that can be transitioned into whatever successor system awaits. The Administration starts with the single security platform, which will no doubt form the backbone for any successor system, but one should expect additional efforts to harmonize the systems of these enterprises.
It is noteworthy that the steps to scale back FHA and the government sponsored entities (GSEs) and those proposed to expand access to credit can all be accomplished without action by Congress. And frankly, none of them should be controversial, as they all push in the direction of two objectives shared by both political parties: reducing regulatory uncertainty and maximizing the amount of private capital flowing through the system.
The second piece of the president’s GSE reform plan, however, is legislative and not without some controversy, in Congress anyway. The Administration had been waiting to weigh in on long-term reform until there appeared to be a plausible legislative path forward. With serious proposals in play in both houses of Congress (see here and here) for the first time since this debate began, the Administration has apparently decided that now is such a moment.
The Administration has stepped into the debate with a position based on a relatively detailed set of principles, covering a wide range of issues important to housing finance reform. But the most interesting of the lot, and the most important (if cryptic), is the following:
“Reform should include a commitment to ensure confidence of long-term investors in mortgage-backed securities to ensure the continuation of the 30-year mortgage in good times and bad.”
This strikes at the heart of the current debate over the role of government in housing finance. The primary argument of those advocating for a broad role is that a deep pool of investors willing to take long-term interest rate risk is needed to maintain broad access to the 30-year fixed-rate mortgage, and a great many of these investors are only willing to invest if the credit risk has been removed through a government guarantee. Thus, broad access to the 30-year depends upon broad government support of the market.
Advocates of a smaller role for the government argue either that broad access to the 30-year is unnecessary or that it does not require these long-term interest-rate investors. By being explicit that they believe the 30-year is both necessary and that having it depends on these long-term interest rate investors, the Administration makes it clear that they side with those who advocate for a broad role for the government.
This and the other principles outlined in the Administration’s plan align it with the bipartisan group of senators in the Banking Committee who are working on a legislative path forward on long-term reform.
It also sets up an interesting question for House Republicans, who recently passed out of the House Financial Services Committee a vision for reform that includes a much narrower role for the government: do they compromise on that vision and clear the way to finally winding down Fannie and Freddie and shrinking the government’s role in the market, or stick to their guns and effectively keep the country in the nationalized mortgage market that we have today? Now that the Administration has weighed in on the debate, clearing the path for the Senate’s likely vision for reform, how the House Republicans answer that question may determine whether we are at long last seeing the light at the end of the tunnel for the era of Fannie and Freddie.
With the president’s return to Phoenix, the Administration has done an admirable job mapping out a plan to address exactly what we most need to address right now: access to credit and the path ahead on housing finance reform. The housing market stands today at an inflection point, from which we can either push ahead into a period of robust, sustained recovery, or stall and risk slipping back into recession. How policymakers handle these two issues will likely determine which path we take.
Neighborhood photo from ShutterstockQuality of Life |Tags: housing, housing finance, Obama, speech, Urban Institute
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