ALG Editor’s Note: In the following featured column from the National Law Journal, David Oedel and Edward Pinto remind the American people of the unfortunate role played by government in contributing to the credit crisis:
Oedel and Pinto: Denationalize housing finance
By David Oedel and Edward Pinto
Financial firms have properly been pilloried for their role in bringing on the financial tsunami, but at least they’re getting a re-regulatory look. Lurking beneath the financial, legal and media surface is another ongoing saga: government pouring torrents of money into our effectively nationalized housing markets.
Most politicians don’t want to highlight the dangers of housing finance because their own votes helped cause the problem and now legally entrench a dysfunctional system. Moreover, many of the most immediate targets of the government’s apparent largesse are not fat-cat bankers, but low-income Americans. Nobody wants to pick on the poor. Stunning fiscal irresponsibility afflicts the lower-end housing sectors, though, much as legal laissez faire has corrupted fancy financial boardrooms.
In the 1990s, federal law spurred “affordable” housing finance and fostered “flexible,” “innovative” underwriting standards. In 1992, Congress passed the misleadingly named Federal Housing Enterprises Financial Safety and Soundness Act, which imposed affordable housing goals on Fannie Mae and Freddie Mac. In 1994, the U.S. Department of Housing and Urban Development (HUD) began making “Fair Lending Best Practices Agreements” with lenders across the country, spreading affordability cheer wider.
HUD POLICY STARTED IN 1995
The Community Reinvestment Act was juiced in 1995 to apply to all banks, while further raising expectations about “affordable” lending. HUD’s 1995 rollout of the national home ownership policy, nominally for lower-income families, introduced “flexible” and “innovative” underwriting standards that leaked into the rest of the mortgage market. Risk-based capital requirements then brewed up a wicked storm, encouraging subprime lenders to offload their toxic mortgages into securities. Three-quarters of subprime mortgages were being securitized by 2006. Meaningful reckoning was postponed in 2008 when the Federal Reserve, relying on a Treasury guaranty, began buying most of Fannie and Freddie’s issuances of mortgage securities on a scale eclipsing the Troubled Asset Relief Program. But TARP gets the headlines, while housing finance remains a back-story.
The alarm is ringing. Mortgages based on phony housing finance standards, stitched together with legal patchwork and floating on a high tide of public money, threaten to sink most housing markets. Whether we will see a wave of “strategic default” makes little difference. Either way, housing is now the government’s largest public works project.
But it’s steady ahead on the Titanic. Fannie and Freddie, after their effective failures and formal nationalization in 2008, no longer lead in making marginal subprime housing loans, though the Federal Housing Administration (FHA) is helping fill that gap with congressional encouragements like the $8,000 first-time-homebuyer tax credit. Congress extended that credit until April 30, and included phaseout provisions reserving those incentives for those who can least afford to buy a home.
As a result of federal adjustments to the traditional benchmarks for who can really afford to buy homes, the FHA now accounts for more than 25% of new lending, up from 2% in 2006. The FHA has insured a whopping $400 billion in mortgages since Fannie and Freddie were nationalized in 2008. In 2006, the FHA underwrote only $55 billion in mortgages and has since grown sevenfold. To the extent the FHA can’t cover the tab, other public backing waits. On Christmas Eve, Fannie and Freddie were quietly given an unlimited new ceiling on their debt.
Home loans with the lowest levels of borrower equity (loans with the highest “loan-to-value ratios”) accounted for 23% of all mortgage originations in 2009, compared with only 17% in 2006. Many high-risk loans in 2006 were packaged into securities that later were deemed toxic or contributed to the tanking of Fannie and Freddie. What will flow from the latest wave of high-risk lending? Perhaps another bailout, this time of the FHA, which in November belatedly revealed that it has a slender half-percent in reserve — a dangerously thin cushion. But it’s a nationalized industry, so who cares?
With unemployment high, government remains intent on floating the housing markets longer, hoping the housing bubble was just a passing swell. By keeping the housing markets awash with cash (the argument goes), all boats will be buoyed.
The deep costs of flooding the mortgage markets with public money, however, far exceed a possible FHA rescue. Since the formal nationalization of Fannie and Freddie, more than $2 trillion has been committed to stimulate the housing market, atop $4 trillion in prior subsidies by Fannie, Freddie, FHA, the Fed and others. The opportunity costs of those commitments are staggering.
The housing markets need to find their own bearings for everyone’s sake, including the poor and the underemployed, who will continue to experience record rates of foreclosure as the latest waves of lousy loans crash. Government funding, and the elaborate legal regime enabling it, is the problem in housing finance, not the solution. That’s true for all Americans, rich or poor. Although many properties are vacant, inflated values make homes hard for low-income Americans to afford. Better to have devoted those funds toward jobs, education, infrastructure, innovation, energy independence or anything other than big debts, zero equity and the disturbing threat of foreclosure for millions of American families.
Americans love their homes, but what has traditionally made home ownership so culturally special is that it represents a consummation of the American dream of self-reliance and stability. By keeping housing prices artificially high, especially at the lower regions of the housing market, through the surging nationalization of housing finance, the government has turned this classic equation on its head. Now home “ownership” for many Americans amounts to reliance on the dole. Record rates of foreclosure challenge classic notions of stability.
How about returning to the concepts of thrift, personal responsibility, and market pricing in home ownership and lending? Although everyone wants a robust housing market, the paradox is that government can best restore home ownership as a blessing, not a curse, only by cutting the huge subsidies and repealing the laws that make housing finance the biggest public-works project of all. The Third Amendment, which prohibits billeting soldiers in homes, made sense because homes were all private. Today, though, many Americans can fairly call Uncle Sam lender and landlord. The process may be tough, but it’s high time to denationalize housing finance and home ownership.
David Oedel is professor of law at Mercer University Law School. Edward Pinto, who has testified repeatedly on this subject before Congress since late in 2008, was Fannie Mae’s chief credit officer in the late 1980s, and is an expert on affordable housing.
