Last week, President Obama gave a speech highlighting his administration’s response to the ongoing crisis in the housing market. The speech material can be broken down into two broad categories: 1) a review of existing government programs (including some modest programmatic tweaks) to boost mortgage modification and refinancing opportunities; and 2) a new refinancing proposal meant to help more struggling, or at-risk, families not currently eligible for the government’s signature programs.
Before diving into these two categories, it’s important to acknowledge the broader economic and political backdrop. The collapse in home values over the past five years helped spark a financial crisis, which then morphed into a broader recession with a historic number of job losses and massive declines in wealth. Today, the U.S. government finds itself either owning or guaranteeing about 72% of all outstanding (first lien) mortgages. The Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac cover roughly 56% of the market by themselves, with the third leg of the government’s housing stool – the Federal Housing Administration – responsible for about 16% (including VA loans). Banks and other private mortgage investors are responsible for remainder. In raw numbers, the government stands behind 40 million first liens, with the private sector covering around 13 million.
Category One: Obama’s “Current” Housing Programs
When Obama took office three years ago, he decided that his Administration would start spending significant taxpayer resources to try and fix the housing market. He tapped TARP and allocated $50 billion to create the Home Affordable Modification Program (HAMP) and Home Affordable Refinance Program (HARP).
HAMP is the government’s main mortgage modification program. It uses taxpayer dollars to pay or incentivize banks, lenders, and servicers to help up to three to four million at-risk homeowners avoid foreclosure. This program is open for all borrowers regardless of whether the mortgage is owned by the government or by a private institution, as long as the borrower meets some basic underwriting requirements. By almost all accounts, HAMP’s record over the past three years has been one of disappointment. The program has helped only a small fraction of its original target, and more than half of those that did receive help are re-defaulting on their HAMP modified mortgage.
The sister program is called HARP and it applies only to those mortgages that Fannie and Freddie own or guarantee. This program is aimed at helping underwater borrowers who are current on their mortgage refinance at lower interest rates. Like with HAMP, this program has also only assisted a small fraction of the 5 million people that it was intended to serve. Importantly, this program is more about helping borrowers reduce their monthly mortgage payments rather than trying to prevent the marginal foreclosure (i.e. turning a delinquent mortgage into a performing one). Therefore, it can be categorized more as economic stimulus, as its main impact is to improve household cash flow, though this in turn has a modest impact in reducing foreclosures.
Late in 2011, the Administration announced programmatic changes to increase the number of refinances in a so-called HARP 2 that would reduce the stringency of the eligibility criteria for a government-guaranteed loan. This rollout was coupled with the announcement of a pilot program to convert vacant government-owned homes into rental properties. Despite the changes to HARP, most analysts are skeptical that even the tweaked program will ever come close to the original target. It’s too early to pass judgment on the rental program, but some red flags are already emerging on this front too. For example, the government’s rental plan aims to sell its vacant properties to private investors, but it looks likely that the government will end up lending or financing the transactions directly (probably through Fannie and Freddie) to help spark investor interest. This amounts to taking money out of one pocket and transferring it to the other. The subsidized loans may boost prices investors are willing to pay, but come at the expense of potential credit losses down the road from the interest rate subsidies. Given the fact that taxpayers have already had to bail out Fannie and Freddie at a cost of more than $150 billion, it’s possible if not likely that fiscal hawks in Congress will balk at the prospect of having the GSEs take on more risk or extend more subsidies even if the underlying project has merits.
Category Two: Obama’s “New” Housing Plan
When Obama spoke last week on housing, he was caught between two of his favorite political narratives: 1) announcing that he is taking administrative action because Congress is dithering; and 2) calling on Congress to act because he can only do so much administratively.
The “new” part of the Obama strategy is to call on Congress to offer a new FHA refinancing opportunity for borrowers with mortgages owned by the private sector – akin to HARP, which again is only available to borrowers with mortgages backed by the GSE. The President’s rationale for this proposal was couched in fairness language. The President is asking Congress to spend new taxpayer dollars to ensure that all homeowners have the same basic refinancing opportunity, especially since most borrowers don’t really even know who technically owns or is responsible for the credit risk on their mortgage.
The irony here, however, is that it was the Obama Administration that created this “fairness” issue when it first launched HARP back in 2009. The new FHA proposal then can perhaps best be understood as the sort of plan that gets announced when an election is approaching. Rather than face the criticism that his current strategy on housing is not comprehensive, why not propose something – even if Congress doesn’t go along – that at least provides the useful talking point that the Administration’s proposals, taken collectively, provide the same solutions to all borrowers regardless of the technical details around who is the lender or owner of the mortgage.
So, why did the President wait until the fourth year of his term to present this type of a proposal? Most likely, it’s because his team has recognized for some time that a large segment of America is weary of more government involvement and spending on housing. Moreover, the fairness issue can easily be flipped around. Large-scale interventions invariably will cost taxpayers a sizeable sum, as there are no free lunches to be had in this area—avoiding foreclosure requires someone writing a check to benefit borrowers and lenders. Spending more to prevent foreclosures raises an important horizontal inequity problem: it’s unfair to spend more to help homeowners who are in houses they can’t afford when there are others out there who were potentially more responsible and are not receiving any assistance. And, what about renters and the effective wealth transfer from them to homeowners? This is the other side of the fairness question and it’s this political challenge or obstacle that leads so many policymakers to talk about doing more to avoid foreclosures but then stopping short of advancing a costly approach that might actually prevent a sizeable number of foreclosures but is politically toxic.
It’s also important to keep in mind that the U.S. is now in its fifth year of what should be a recovery in housing. While government responses could be credibly sold to the American people as temporary in the past, it’s starting to become clear that the cumulative impact of all the efforts is a further consolidation and dependence on government-supplied credit. When consumers or potential homebuyers express frustration that underwriting standards have swung too far in the other direction – now that the bubble has long ago popped – their criticism should be directed towards the government. After all, it’s now the government that is the major decision maker on who and who does not get a loan or a refinancing. Add to that the endless modification programs to postpone eventual sales and it is no surprise housing has yet to recover.
Mortgage lending is by far the largest category of consumer credit. Of the total $13 trillion in consumer debt obligations outstanding, approximately $11 trillion is housing related, compared to another $2 trillion mainly of student loans, auto loans and credit cards. Given the dominant share of mortgages owned by the government versus the private sector today, it should come as no surprise that taxpayers today are effectively on the hook for approximately $6 trillion in total mortgage credit. This amount or share is growing as the government is now also the provider of mortgages for new homeowners, backing roughly 96% of all new purchase mortgages. In time and without any reform, the $ 6 trillion figure could rise to more than $10 trillion over the next decade.
The Re-Emergence of the Federal Housing Administration
Obama’s latest plan for FHA is now to ask Congress to change the rules so the agency can effectively assume or take-over more of the loans left in the private sector. The Administration estimates that this new FHA expansion could cost taxpayers around $10 billion. While both the government and the private sector deserve blame for the housing crisis, the answers or fixes that Obama has offered over the past 3 years have remained consistent. At each turn, the administration has taken incremental steps toward increased government control of housing finance. From President Obama’s vantage point, it’s not hard to see the potential political benefits with a proposal to expand FHA. While taxpayers may have bailout fatigue when they hear the names Fannie and Freddie, FHA is not nearly as well known. Plus, so many of the other crisis programs that have involved FHA have been such failures that most people forgot they were even launched. Hope for Homeowners was supposed to help 400,000 homeowners, but shut its doors toward the end of 2011 having helped less than 1,000 people. FHA Short Refi is another program that didn’t take off.
What Could Really Go Wrong at FHA?
What Obama conveniently omits from his speech and background material on FHA is that the latest actuarial review found the agency has a 50-50 chance of requiring a bailout as soon as this year. His officials at HUD and OMB are no doubt intimately aware of these details. Perhaps they are comforted by the fact that the Treasury Department has independent authority (i.e. Congress doesn’t have to act) to send taxpayer dollars over to FHA to keep the agency solvent (as this would fulfill the government pledge to back FHA loans). Taxpayers would be wise to pay close attention to this agency moving forward.
One of the big lessons from the financial crisis is that the largest financial institutions fell in part because they were way too leveraged and that they miscalculated housing risk. Rather than the historic precedent of being levered 10:1, or 15:1, or in extreme cases 20:1, some of the biggest banks were levered 30 or even 40:1. When their estimates of housing and mortgage risk turned out to be wrong, they failed and we had a crisis.
Now we have a government run housing agency in the FHA, which is levered 300 or 400 to 1 and the Administration is proposing to increase their bets on housing? FHA has only a few billion dollars in reserve against more than $1 trillion of mortgage guarantees that it has outstanding. What could possibly go wrong?
An Alternative Approach for 2012
At this stage in the housing cycle, a more effective approach would be to emphasize two things. In the near term, the best medicine for the housing market is a strong economy and healthy job market – period. Overwhelmingly, people are struggling to pay their mortgages because they don’t have jobs. It’s not because they don’t have another bright and shiny government program to look to for help – especially one that doesn’t address the core issues. Sustained high levels of unemployment (and underemployment) exacerbate the challenges facing both distressed homeowners and potential new homebuyers. For home prices to stabilize and then recover, more jobs need to be created in the private sector and the economy needs to grow. Less unemployment will also boost household formation and lead to more demand for housing.
The second item is that the government should set a clear policy for the future of housing finance in this country. GSE and FHA reform are essential to achieving a sustainable housing market and a full recovery in the long term. The government does not need to be responsible for every mortgage in this country for the dream of homeownership to be kept alive and realized by aspiring families. Private lenders as a class may have performed badly in the bubble years, but that fact doesn’t change the obvious conclusion that they are still the ones that ultimately need to be responsible for the their behavior. In short, the government should get out of the business of underwriting housing risk that should be borne by the private sector. The way Fannie, Freddie, and the FHA work is that private lenders get guarantees from the government. In this sort of system, what incentive to these lenders really have to manage housing risk and be held accountable by consumers? Ultimately, it would be preferable to have private suppliers of capital make decisions about lending standards and take on the incremental risk of new loans—rather than having the government attempt to micromanage the housing finance industry.
Now, some will argue that pursuing this reform agenda now will only disrupt credit availability, since the government is such a dominate player in housing finance today. But this view conflates schedule and speed. The government can establish a framework for returning housing finance to the private sector immediately – with appropriate safeguards for borrowers and restrictions on private lenders. The government can also set a clear and measured transition schedule so that the pace of change doesn’t impact credit availability.
This month marks the one-year anniversary of a white paper that the Obama Administration released outlining three reform strategies for the future of housing finance. The white paper further called for a smaller share for the FHA—a laudable goal flatly contradicted by his latest proposals. It’s disappointing that the President’s recent speech didn’t make system-wide reform the central housing theme for 2012. With real leadership – relying on some of the good principles articulated in his own white paper – the President could have laid out a roadmap that would provide the market with a clear understanding of the rules that will govern the future of housing finance. Home buyers, sellers, and also the current and potential suppliers of credit could then adjust and ready themselves to engage in a true recovery. Americans are right to be skeptical of, if not angry at, many of the big banks, lenders, and mortgage servicers for how they performed before and throughout the crisis period.
Consumers will be best served in the long run by a housing market or system where private incentives drive business decisions rather than having government regulators or political appointees decide on lending standards. Paring back government support and positioning private capital as the foundation of the housing system can drive innovations than benefit borrowers. While the crisis revealed that not all financial innovations are a good thing, it would be foolish to dismiss the private sector and the engine it can be for innovations that lower costs and expand opportunities. If the last five years have made one lesson crystal clear, it’s that the government’s mismanagement of housing policy should leave no one confident that the government will be a better manager of capital or credit allocation in the long term. With new safeguards and consumer protections in place, it’s time to let the private sector lead a recovery in housing.