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Eleven years into the conservatorship of the government-sponsored enterprises and yet, another report — this one by the Trump administration — has come out with a plan for housing finance reform.
But this one promises to be different, since many of the recommendations may be done administratively.
In the week following Treasury report’s release, Federal Housing Finance Agency Director Mark Calabria has already started implementing one of the key recommendations — reining in Fannie Mae and Freddie Mac’s exploding multifamily businesses.
The GSEs were up to their old tricks, using taxpayer advantages to crowd out the private sector and procyclically grow an already burgeoning multifamily debt market. This was the result of loopholes put in place by Calabria’s predecessor. From 2015 to 2017, the GSEs’ volume grew three times faster than the overall market.
This prompt action bodes well for others to follow, as Calabria accomplished it by amending the GSEs conservatorship scorecard, an expeditious and effective method.
Yet, most of the media reports have focused on the legislative proposals to reform Fannie Mae and Freddie Mac, legislation that is unlikely to be enacted anytime soon. Ignored are the many recommendations for prompt administrative action to reduce crowding-out by leveling the playing field between the GSEs and the private sector; and shrinking the GSEs’ footprint.
The Treasury report, along with a companion one by the Department of Housing and Urban Development, have given Calabria and FHA Commissioner Brian Montgomery the green light to take administrative action and do so quickly. This is all the more feasible, since today’s lower rates and strong market demand would minimize the impact, a practical consideration with a presidential election looming.
Shrinking the GSEs’ massive single-family footprint is also called for. Today, the taxpayers are on the hook for over $5 trillion in GSE debt. Yet, the only plausible reason for the government to back the housing market is to help low or moderate income families buy homes.
An evaluation of the GSEs’ 2018 business shows that they fail to meet this simple test — less than 25% goes to those buying a primary residence costing less than $250,000. Once again, the GSEs have used their numerous advantages to crowd out the private sector and operate in a dangerous pro-cyclical fashion.
The Treasury report endorses the Consumer Financial Protection Bureau’s decision to allow a so-called patch to sunset for its Qualified Mortgage rule. The QM rule was established in response to the housing crisis by setting an ability-to-repay standard for underwriting mortgages. But it also allowed a temporary patch for any GSE-backed mortgage to qualify under the rule, which greatly advantaged the GSEs. This would be a huge step in leveling the playing field between the GSEs and the private sector.
Independent of changes made by the CFPB, the FHFA should examine which single-family mortgage loans under a revised ability-to-pay requirement should be eligible for acquisition by the GSEs, as the Treasury report recommends. Next, the FHFA should implement GSE capital requirements that require sufficient capital to remain viable during a severe economic downturn, while also ensuring shareholders bear potential losses instead of taxpayers.
The Treasury report is also correct in suggesting that the FHFA, in consultation with the other federal financial regulators, should “harmonize the regulatory requirements” for the GSEs and other housing finance participants.
A key recommendation calls for the FHFA to reduce the GSEs’ footprint by “tailor[ing] support for cash-out refinancings, investor loans, vacation home loans, higher principal balance loans, or other subsets of GSE-acquired mortgage loans.” This would reduce crowding out, shrink the GSEs’ footprint and have little or no impact on the home purchase market.
Finally, in order to end the competition between the GSEs and FHA, Calabria and Montgomery need to clarify the appropriate roles and overlap between the GSEs and the FHA, as the report recommends. They should address the GSE’s acquisitions of high loan-to-value and debt-to-income loans. They should also address the FHA’s underwriting of cash-out refinances, conventional-to-FHA refinances and loans to FHA repeat borrowers.
This is necessary to end the unseemly taxpayer-supported competition for high-risk loans between these agencies and the increasing risk of FHA’s insurance portfolio.
With entry-level home prices still rising rapidly and the supply of homes constrained, taking these steps now would slow unsustainable house price appreciation. This would be good news for first-time homebuyers, who tend to be of lower income and minorities. These same borrowers tend to take out the loans with the greatest risk of default with the most risk layering.
This would be a win-win for the first-time buyers and the taxpayers.
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