The 2008 financial crisis was a major missed opportunity. The two giant government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, were at the center of the meltdown and stood in financial ruin.
All Congress had to do was let them die, like any other failed company. Instead, Congress chose to keep them afloat using American taxpayers’ cash. So it goes with all public-private partnerships: narrow special interests won at the expense of the (widely dispersed) general public.
Well-heeled groups – from real estate agent associations to bank trade groups – insisted the GSEs had to be kept around to ensure people could buy homes at affordable rates. Their scary story sounded plausible to many in Congress, and now Fannie and Freddie are more entrenched than ever.
The truth, though, is that Americans don’t need the GSE system or anything remotely similar.
Robust mortgage financing exists in virtually every developed nation of the world without the same degree of government involvement found in the U.S. Yet, the U.S. homeownership rate is about average among developed nations, and Americans pay among the highest mortgage interest rates.
The U.S. is the only major country in the world with the trifecta of a federal mortgage insurer, government guarantees of mortgage securities, and GSEs in housing finance. Comparing the U.S. with 11 other industrialized countries: only two have a government mortgage insurer (Netherlands and Canada), two have government security guarantees (Canada and Japan), and two have GSEs (Japan and Korea).
From 1998 to 2009, which includes the heyday of the GSEs, volatility of home price and home construction in the U.S. was among the highest in the developed world (5th out of 16 countries).
And the U.S. homeownership rate stabilized long before the government became a major player in housing finance. Statistically, the rate is currently no different (64.3 percent) than the rate of63 percent achieved in 1964. Yet, prior to 1968, the year that Fannie Mae was allowed to purchase non-government-insured mortgages, all government-backed mortgages never accounted for more than 6 percent of U.S. mortgages in any given year.
But in the early 1990s, the Clinton administration decided everyone should own a home, and that expanding loans through the GSE system was the way to do it. From 1990 to 2003, Fannie and Freddie went from holding 5 percent of the nation’s mortgages ($136 billion)to more than 20 percent ($1.6 trillion). (George W. Bush continued Clinton’s policies – both Republicans and Democrats are equally to blame.)
Politicians promoted – and still promote – these policies as necessary for making housing more affordable, but their “make loans available to practically anyone” policies have the opposite effect. Homes are less affordable than ever, and the problem is particularly acute for entry-level homebuyers.
Just as bad, the policies have worsened boom and bust cycles in housing. As the GSE footprint expanded, U.S. home prices have seen the largest gains and the largest declines. (In the post WWII era, the largest annual increase in home prices was just over 10 percent, in 2004. The largest annual decline was more than 12 percent, in 2008.)
Simply put, Americans have little to show for U.S. housing policy other than higher debt and less affordable homes. That’s great in the short-run for some financial firms and real estate agents, but it is incredibly myopic and harmful to everyone outside of a relatively small number of special interest groups.
These groups are incredibly powerful in Washington, though, and they have managed to stop Congress from doing virtually anything to upset their status quo. The House and the Senate have remained unable to agree on a way forward, largely because key members of the Financial Services Committee – led by Rep. Hensarling (R-TX) – have consistently pushed for a smaller role for the federal government.
But now, Chairman Hensarling has announced support for a “bipartisan” compromise. When it comes to housing finance, bipartisan equates to fleecing Americans by going along with what the special interests want. In this case, they want more government guarantees. The details are still sparse, but according to Hensarling:
“The compromise plan would permanently repeal the Fannie and Freddie charters, ending the monopoly model. In its place it proposes using Ginnie Mae, the government corporation that explicitly backs the payment of principal and interest to investors in Federal Housing Administration and other government-insured loans. The proposal would direct the corporation to guarantee qualified privately insured mortgage-backed securities.”
This plan is generally consistent with previous Senate bills, and seems similar to House Democrats’ 2014 Partnership to Strengthen Homeownership Act. The plan is also very similar to one proposed by Michael Bright (recently nominated to run Ginnie Mae) and Ed DeMarco (former head of the Federal Housing Finance Agency).
Oddly enough, DeMarco testified in the House last week, the day after Hensarling announced his support for the new plan. At that hearing, DeMarco noted that “there certainly seems to be broad consensus about establishing a single mortgage-backed security that has a catastrophic guarantee from the taxpayer but is backed by substantial private capital in a first loss position.”
DeMarco is right about the consensus: it has always existed among the special interests clamoring for explicit government backing. Until now, though, Hensarling has resisted calls for such guarantees, and has been one of the lone voices in Congress calling for reducing the government’s footprint in housing finance. It appears those days are over, but Hensarling is retiring, he has also reintroduced his (more market-friendly) PATH Act, and there’s virtually no chance the 115thCongress will deliver a housing finance reform bill to President Trump.
The scary thing, though, is that this so-called consensus plan is also very similar to the pre-crisis GSE system, sans the explicit guarantee.
Pre-2008, private mortgage insurance companies provided credit enhancements on mortgages with less than a 20 percent down payment, and the two GSEs guaranteed the payments on the mortgage-backed securities. Implicit in this arrangement was that the government would cover losses on the mortgage securities only if there was a catastrophic failure.
And that is exactly how the scenario played out in 2008.
So it is very difficult to believe there is a broad consensus among Americans to erect that same type of system, only now with explicit government backing from one government agency instead of the implicit backing of the two behemoth GSEs.
If this compromise plan is put into place, it won’t be very long before Ginnie Mae looks almost exactly like the National Flood Insurance Program. Trillions of dollars in financial risk will be housed at one federal agency; the agency will not charge enough to cover that risk, and taxpayers will kick in whatever is needed when there is a disaster.
History clearly demonstrates that Congress will succumb to calls for lower rates, lower capital requirements, and more leverage in the name of making housing more affordable. But these policies clearly make housing less affordable, thus perpetuating the calls for more of the same failed policies. Congress has to break the cycle, and the bipartisan approach will not cut it.
To make housing more affordable, government must get out of the way so that competition among lenders and capital suppliers can create new products and put downward pressure on consumer prices. (Here’s a plan to reform the system without Congress.)
If the status quo remains, with the federal government standing behind virtually all new mortgages and mortgage securities, critics will not be able to blame the private sector the next time housing prices crash. It is sad, but it seems this scenario will be the only way Congress finally does the right thing for Americans.
This piece originally appeared in Forbes https://www.forbes.com/sites/norbertmichel/2018/09/11/nobody-in-congress-is-ready-to-fix-housing-finance/#174b97c857ce