April 22, 2015

April 22, 2015 | Commentary on Housing, Housing Finance

Status Quo On Housing Finance Keeps Failed System In Place

The status quo. It’s a powerful force in Washington, D.C. No matter how destructive or inefficient an existing program, institution or system may be, it’s always safer for politicians to maintain the status quo rather than meaningfully change direction.

Exhibit A: federal housing finance policy.

Prior to the 2008 financial crisis, the federal government spent decades instituting rules and regulations that ultimately dictated everything banks could do. Regulators even specified capital requirements that supposedly certified financial firms were safe.

On the eve of the crash, the federal government either insured or owned $6 trillion in home mortgages, with essentially zero capital in reserve in case anything went wrong. Nearly one decade later, we’re in an even worse position.

Today, financial institutions have even more rules; there’s a new regulator dedicated to making sure consumers are protected (even more) from paying off their debts, and taxpayers are explicitly on the hook for just about every new mortgage in the U.S.

Billions in taxpayer dollars have been used to prop up the Federal Housing Administration (FHA), an agency that now insures three times the amount of mortgages it did prior to the crisis. And the FHA remains in violation of the law that requires it to maintain an adequate capital reserve against future losses.

Taxpayers were forced to spend $200 billion to prop up Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that provide guarantees on mortgage-backed securities (MBS). Today, the GSEs remain under government control with an agreement that requires their capital reserve to be taken to zero by 2018.

Yet the prospects of Congress fundamentally reforming this system remain as dim as ever, even after the election that gave Republicans control of both chambers of Congress.

Most politicians have clearly revealed their preference for the status quo, and very few are willing to debate the fundamental issue: Should the federal government be involved in housing finance?

Most members of Congress appear to take it for granted that the government should be heavily involved in housing finance. For them, the only remaining question is, “How heavily?”

That’s the wrong question, because we have overwhelming evidence—gathered for decades—that heavy government involvement does little more than increase debt and housing costs, and costs taxpayers billions.

When Republicans were in the minority, they put forth very few real reform proposals. Now that they control both the House and Senate, GOP leaders seem even less willing to do much.

House Financial Services Committee Chairman Jeb Hensarling, R-Texas, deserves credit for introducing a bill back in 2013 that would have eliminated Fannie and Freddie without extending any form of explicit government guarantees.

But even that proposal – deemed radical by the left – included a provision that would have kept the essence of the old system in place.

Hensarling’s bill included a feature called the National Mortgage Market Utility, a nonprofit entity that would have issued MBS and been prohibited from owning them.

This so-called utility – a terribly inappropriate name – would have been nothing more than the standardized MBS platform that the GSEs had already created.

Perhaps at the early stages of the crisis such a provision made sense. But given all the other changes in the mortgage market, creating such an entity now would ensure that virtually all MBS would be issued by one company. Sound familiar?

Worse, under Title VIII of Dodd-Frank, the new company would be labeled a “systemically important” financial market utility, a designation giving it an account at the Federal Reserve. What would happen if there was another mortgage-related crisis?

Somehow, though, Hensarling’s bill was labeled as such a radical departure from the past that many members of Congress were afraid to even vote on it.

But they all seem perfectly willing to vote for something that tweaks the definition of mortgage points and fees, or that allows privately insured credit unions to join the Federal Home Loan Bank system, or to tinker at the margins of what counts as a qualified mortgage.

These little “fixes” are fine for certain groups, but the real problem is that the federal government dictates these things in the first place.

Regulators are in no better position to judge what loans should be made than anyone else, and since they stand ready to swoop in and bail out the companies that screw it up, they’re actually in an even worse position.

Policymakers would do themselves a favor if they dropped their fascination with trying to save everyone who makes a financial mistake. While they’re at it, they should forge a new direction in home financing policy.

Noting the horrible track record of recent government programs, Wharton Professor Joe Gyourko has suggested not a new direction but merely a better way of perpetuating the paternalistic approach to federal housing policy:

Congress created the agency [the FHA], and has continued to authorize it, with the clear purpose of helping first-time buyers and financially constrained households without sizable down payments become successful homeowners. If policymakers still want to pursue that goal, it is time for them to develop different means of doing so.

To be fair, Gyourko prefaced this observation with a hedging “if”—i.e., if policymakers want to pursue that goal. But pursuing that goal is the problem. The evidence clearly indicates that the best thing the feds can do to help is to stop trying to help people take out home mortgages.

In the first place, the FHA simply was not created to help first-time homebuyers and those without sizable down payments. It was created to boost the construction industry. The first FHA loans required 20 percent down.

At best, the FHA has helped people buy homes a few years sooner than they otherwise would have, and done so to the detriment of private lenders.

It’s the very act of subsidizing homeownership that’s the problem. It breeds irresponsible behavior, creates opportunities for cronyism, and spreads financial risks to taxpayers for no demonstrable benefit.

We shouldn’t be arguing about how to best subsidize home loans; we should be arguing how to ensure that the federal government finally stops doing it.

In 1968, the year Fannie became a GSE, the homeownership rate was 64 percent. The other 36 percent of U.S. citizens were not homeless. Exactly the same can be said for the U.S. in 2014.

There’s nothing inherently wrong with aspiring to own a home, but there’s also nothing wrong with renting. Lots of people actually enjoy it.

In fact, many people still want to rent so that they can save their own money and make a sensible choice when they’re ready to buy a home. Lots of potential lenders actually enjoy that.

We don’t need a federal housing policy to make it happen, and evidence suggests we’d be better off without one.

Let the government provide legal protections for property rights and fraud; let people invest and accept their own risks, and let people choose whether to rent or buy. The opposite approach doesn’t work—a fact that should be clear by now.

 - Norbert J. Michel is a research fellow specializing in financial regulation for The Heritage Foundation’s Thomas A. Roe Institute for Economic Policy Studies.

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies

Originally appeared in Forbes