After a long and wrenching plunge, the housing sector has finally bottomed out and seems to be recovering. According to the latest S&P/Case-Shiller index, home prices rose in nearly every metropolitan area during 2012 and turned in a solid gain of 7 percent nationally. Celebration would be premature, however. The human cost of the housing crash has been fearful. Trillions of dollars of household wealth have evaporated, 5 million people have lost their homes, and 22 percent of the remaining homeowners still have mortgages exceeding the value of their properties. With housing prices still 30 percent below their (admittedly unrealistic) 2006 peak, it will take average homeowners many years to rebuild the savings that their home equity once represented.
Even worse, the federal government’s response to the housing crisis is now becoming part of the problem. When the sector crashed, destroying the balance sheets of Fannie Mae and Freddie Mac, the government had no choice but to take them over, at a net cost to the taxpayer (so far) of $141 billion—by far the costliest bailout in the Great Recession. And the end is nowhere in sight, because the federal government has actually expanded the role of Fannie and Freddie mortgage-backed securities since the crash. Mortgage-backed securities—bundles of mortgages sold to investors—are the principal source of capital for the housing sector. By 2011, securities backed by government agencies—Fannie Mae, Freddie Mac, and Ginnie Mae—accounted for a stunning 97 percent of the MBS market. As for individual mortgages, government agencies accounted for 88 percent of loan originations in 2010, compared to only 47 percent in 2007 and 35 percent in 2006. Without the federal government, it seems safe to say, there wouldn’t be a functioning housing market today at all.
This is no one’s idea of a long-term fix, however. Unfortunately, the Obama administration has otherwise been AWOL on housing. Not only did it do little to assist distressed homeowners, it has not pushed for the fundamental reforms that are needed to prevent future housing meltdowns and to restore the appropriate role of the private sector in housing finance.
Enter the Bipartisan Policy Center with a far-reaching report, “Housing America’s Future.” The BPC report covered a wide range of housing issues beyond single-family homes, including affordable rentals, rural housing, and so-called Naturally Occurring Retirement Communities (NORCS) that allow Americans to age in the neighborhoods where they raised their children.
While all the commission’s recommendations deserve serious consideration, I want to focus on the heart of the matter—its proposals to reform our system of housing finance. The key objective is to ratchet down the involvement of the federal government while bringing the private sector back in. To do this, the commission offers two key proposals.
First, restore the original purpose of the Federal Housing Authority. During the housing crisis, all government agencies dramatically increased the limits on the size of the loans they were prepared to make. The FHA, whose original mission was to assist moderate income and first-time buyers, ended up extending mortgages for as much as $729,750 in high-cost areas. Fannie Mae and Freddie Mac did much the same thing. The commission suggests that these maximum loan limits should be gradually reduced, enabling housing officials to gauge the private sector’s willingness to accept unsupported mortgage credit risk for higher-income borrowers. The government could then refocus its programs—especially the FHA—on bolstering homeownership for credit-worthy borrowers of moderate means.
Second, phase out Fannie Mae and Freddie. As critics had long contended, the ambiguous role of Fannie Mae and Freddie Mac—private entities that enjoyed implicit government backing—led first to distortions of the housing market and then to ruinous losses the burdens of which fell on taxpayers. The BPC commission bites the bullet and recommends their phased elimination.
That does not mean that the federal government would have no role in the mortgage market. The commission recommends establishing a “Public Guarantor” that would cover the kinds of catastrophic mortgage losses that so many lenders experienced during the Great Recession. Borrowers would pay standardized fees into a pool from which the Public Guarantor would draw once both the borrowers and lenders reach the limits of their ability to pay.
The point of this approach is to eliminate—or at least reduce to the absolute minimum—the need for an open-ended draw on taxpayers. To accomplish that goal, the guarantee fees would have to be set at a rate that reflects real risks to lenders, and it would have to be adjusted in light of experience, as is the case with federal insurance for bank deposits. Determining the appropriate fees and monitoring the performance of the guarantee fund would be one of the Public Guarantor’s most important tasks.
But hardly the only one: the new agency would also take on important regulatory functions. For example, it would ensure that private sector participants in the housing finance system are adequately capitalized. It would establish uniform pooling and servicing standards to govern the distribution of mortgage proceeds and losses to investors. It would serve as a gatekeeper for private institutions who seek to serve as issuers, servicers, and private credit enhancers of MBS. And it would establish criteria for mortgages that could be included in MBS and specify standards for mortgage data and disclosures.
No doubt this proposal will come under fire from more than one direction. Many liberals believe that without Fannie and Freddie, mortgage interest rates would be much higher and that many middle-income families wouldn’t be able to afford to own a home. For their part, many conservatives think that federal involvement in the housing market has produced distortions and bubbles and that it’s time to pull the plug entirely. The report won’t please either extreme, because it charts a middle course, retaining a regulatory and catastrophic insurance role for the federal government while eliminating the institutions whose excesses have done so much damage.
While there are no unflawed or uncontroversial housing reforms, the BPC report is the most comprehensive in years, and one of the few designed to achieve agreement across party lines. There are indications that it could spur, at long last, some serious proposals from the Obama administration. The administration reportedly is monitoring the response to the report for signs of an emerging consensus. If the response is broadly positive, the Treasury could unveil its own ideas.
If Jack Lew is looking for a lasting legacy as Treasury Secretary, attacking the unresolved structural issues that Fannie and Freddie pose for the entire financial system would be a good place to start. One thing is clear: if the federal government doesn't reform its involvement in the housing market, the current housing crisis could be a prelude to the next one.