On May 15, the Senate Banking Committee approved a bill to restructure the U.S. housing finance system. The bipartisan proposal, which was drafted by Banking Committee Chairman Sen. Tim Johnson (D-S.D.) and Ranking Member Sen. Mike Crapo (R-Idaho), seeks to repair a broken housing market. That action is long overdue.
Mortgage originations are at their lowest level in 17 years, Millions of school teachers, firefighters, police officers, librarians, military personnel and other qualified moderate-income and low-wealth borrowers are unnecessarily denied access to home loans because lenders have, with overly rigid underwriting practices, overcorrected for their reckless and irresponsible lending leading up to the mortgage crisis.
The three major weaknesses of the U.S. housing finance system that inflated the housing bubble and nearly imploded the entire U.S. financial system were: (1) Inadequate availability and access to safe, affordable, and sustainable conventional mortgage products, creating a market for financially abusive and irresponsible loans; (2) insufficient regulatory oversight that enabled reckless lending and fraudulent practices to flourish; and (3) inadequate capital levels by financial institutions that left taxpayers to pick up the tab for the extraordinary lender losses that resulted.
In response to these problems, Johnson-Crapo proposes to downsize Fannie Mae and Freddie Mac thereby opening the door for private firms to assume most of their business. This transfer would be significant—combined fourth quarter 2013 earnings for Fannie Mae and Freddie Mac were $15 billion.
Yet leading up to the crisis, private capital was in abundant supply. It swelled in the years leading up to the market’s collapse rising from 8 percent to 38 percent of mortgage securitizations between 2003 and 2006. In fact, private capital was the principal reason for the need for taxpayer bailouts; Wall Street funded fully 85 percent of the high-cost, predatory subprime loans that were at the epicenter of the foreclosure crisis. And, ironically, loans securitized by private firms had a failure rate that was six times that for loans securitized by Fannie Mae and Freddie Mac.
Turning Fannie Mae’s and Freddie Mac’s business over to private financial firms in the manner envisioned in Johnson-Crapo will further decrease access to mortgage loans, particularly for young adults, moderate-income families, and people and communities of color.
That outcome would contribute to a further fall in the homeownership rate for young adults that has already dropped from nearly 50 percent before the housing crisis to 42 percent today. And home purchase loans to African Americans and Latinos are down 55 percent and 45 percent respectively relative to 2001-a time before the bloating of the housing market.
Estimates by a range of institutions show that elimination of Fannie Mae and Freddie Mac will result in increased mortgage interest rates from just under half of a percentage point to more than two full percentage points. Ironically, a major concern currently with Fannie Mae and Freddie Mac is that homebuyers now are paying more than they should because, under conservatorship, the firms’ mortgage guarantee fees have been raised to pay for non-housing related federal program spending and other policy purposes.
Johnson-Crapo would also reduce access to mortgages due to additional loan underwriting restrictions and the elimination of requirements for the housing finance system to serve all qualified borrowers.
Having an increased proportion of private capital engaged in the mortgage finance system as an insurance policy against future costly taxpayer bailouts makes sense. And moving Fannie Mae and Freddie Mac out of conservatorship is also long overdue.
But ensuring that loan products are safe, affordable, and sustainable and that adequate capital is held in reserve for future losses by mortgage finance institutions, regardless of their structure, is the best way to avoid future bailouts. There are many ways to accomplish both of those ends.
The Center for Responsible Lending (CRL), for example, has proposed that Fannie Mae and Freddie Mac be replaced by a mortgage finance cooperative that resembles the model of the Federal Home Loan Bank system.
The Federal Home Loan Banks, established in 1932, are not well-known by the public in part because they were the only segment of the housing finance system that neither failed nor required a taxpayer bailout.
CRL’s proposal would bring private firms to the housing finance table as cooperative owners of a new quasi-government institution. The primary mission of that new entity would be the promotion of safe, affordable and sustainable loans to meet the needs of the nation’s diverse population.
There are many other potential models that could deliver safe and affordable mortgage credit to the American public such as a restructuring Fannie Mae and Freddie Mac into a public utility or modifying the current charters of the two companies and releasing them from conservatorship.
Senators Johnson and Crapo are to be commended for working across party lines to create a bill to address the ailing U.S. housing market. But prior to deciding the preferred financing structure for the housing finance system and which companies will financially benefit, their efforts should start with a consensus on the loan products and related services and systems that are needed to ensure broad access to the American Dream of homeownership.
Carr is distinguished scholar with The Opportunity Agenda. He is also a former executive with Fannie Mae, visiting professor at Columbia University, and assistant director for Tax Policy and Federal Credit with the U.S. Senate Budget Committee.