The long-awaited report has been released. I will have extended comments below the fold. Overall, I was disappointed to see that the report is heavily waited toward strategy and tactics, without adequate consideration of objectives. Nobody seems to want to step back and ask fundamental questions about housing policy. In particular, the questions I would want to see asked include the following:
1. What public policy is served by supporting mortgage loans that do not encourage the accumulation of equity in the home by households but instead foster speculation and consumption? These are loans with one or more of the following characteristics: non-owner-occupied homes; low down payments; cash-out refinancing; negative-amortization loans; second mortgages
If the housing market went on a bender earlier in this decade, then these loans were the booze. Staying off the booze is the most critical need for housing policy going forward. That is, the government must make sure that, if it stays in the market at all, it only supports owner-occupied first mortgages for purchase, with significant down payments (I favor 20 percent, but even 10 percent would be much better than the way that the market has evolved) and scheduled amortization of principal. One virtue of the book by Acharya, et al that I just reviewed is that it makes the "stay off the booze" point clearly.
Freddie and Fannie went onto the booze in part because of pressure to meet affordable housing goals mandated by the government and in part as a way to expand the basic model of privatized profits and socialized risk. Going forward, if their regulators were to focus on keeping the GSEs off the booze rather than forcing them to go on it, the GSE model could work. Instead, the report proposes a new form of government guarantee. Without a mandate to stay off the booze, this gives us the worst of all possible worlds: a bubble-prone housing market, a new and untried government-guaranteed institution, with a new and untried regulatory mechanism.
2. The larger question is how much taxpayer risk is justified in order to channel capital into thirty-year fixed-rate mortgages. The report alludes to this issue, but it requires much more attention. It requires fundamental rethinking. Is the thirty-year fixed-rate loan so precious that it is worth risking catastrophic financial crises in order to artificially hold down its cost, rather than allow consumers to shift to something like the five-year rollover mortgage that is prevalent in Canada?
1. The report lists five flaws in the housing finance system, in this order: poor consumer protection; weak and fragmented regulation; the securitization process was opaque; inadequate capital; mortgage servicers who were not equipped to deal with troubled loans
The report says,
Fannie Mae and Freddie Mac's structural design flaws, combined with failures in management, were the primary cause of their collapse. Although some have suggested affordability goals played a major role, the mistakes that led to the failure of Fannie Mae and Freddie Mac - poor underwriting standards, under pricing risk, and insufficient capital with inadequate regulatory or investor oversight - closely mirrored mistakes in the private-label securities (PLS) market where affordability goals were not a factor. In fact, delinquency rates on many PLS securities and other loans held by banks and other private market institutions were far higher than on the loans held by Fannie Mae and Freddie Mac, including loans qualifying for the affordability goals. While Fannie Mae and Freddie Mac's affordability goals were poorly designed and did not effectively serve their purposes (as detailed below), fundamental structural flaws and poor decision-making are the principal reasons these institutions failed.
One thing I like about the report (as well as the Acharya book) is that it deals with the Federal Home Loann Banks. It says,
Reforms to the FHLB system are necessary to restore its important primary role of providing a stable source of mortgage credit for financial institutions of all sizes.
Again, if you shifted out of a tactical focus to ask more fundamental questions, you would come up with a different approach: get rid of the FHLBs. They are like the appendix or the tonsils--unnecessary, but with a potential to become infected and cause great harm.
I liked this sentence:
Any responsible reform effort that addresses the flaws in the pre-crisis housing market will make credit less easily available than before the crisis.
The report also deals with FHA.
In addition to winding down Fannie Mae and Freddie Mac, FHA should
return to its pre-crisis role as a targeted provider of mortgage credit access for low- and moderate-income Americans and first-time homebuyers. (Today, FHA's market share is nearly 30 percent, compared to its historic role of between 10-15 percent.) As Fannie Mae and Freddie Mac's presence in the market shrinks, the Administration will coordinate program changes at FHA to ensure that the private market - not FHA - picks up that new market share.
Here is their Goldilocks argument for keeping government in the housing market:
Complete privatization would limit access to, and increase the cost of, mortgages for most Americans too dramatically and leave the government with very little it can do to ensure liquidity during a crisis. Near-complete nationalization runs too high a risk of crowding out private capital, distorting investment decisions, and putting too much taxpayer money at risk.
They are saying that complete privatization would do what earlier they said "any responsible reform" will do. When you provide a government guarantee to one type of borrower, you subsidize that borrower as opposed to some other borrower. Do we know that the best use of credit is to finance bigger houses? If it were up to me to channel credit, I would prefer to see more of it go to business expansion. But I don't want the job of credit allocation czar, and I don't want the government taking on that role, either.
As to how the government could ensure liquidity in a crisis--well, not having policies that help create a crisis would help. But even so, if banks end up playing a large role in a private mortgage market, does the government not have a means of putting money into banks during a crisis? It seems to me that government was able to keep banks in business this time around quite adequately--too adequately, if you ask me.
The actual Goldilocks proposal is to create an ill-defined mortgage insurance "backstop." Perhaps it is explained in detail elsewhere. In the report itself, all I could find was
One approach would be to price the guarantee fee at a sufficiently high level that it would only be competitive in the absence of private capital. It would thus only expand when needed, and that need would be dictated by the market. An alternative approach would restrict the amount of public insurance sold to the private market in normal times, but allow the amount of insurance offered to ramp up to stabilize the market in times of stress.
With so little detail spelled out, all we are left with is a proposal for the government to take unknown risks in an unknown way with unknown consequences. I assume that more information will be forthcoming.