The infrastructure of U.S. housing finance is “the great unfinished business of post-financial crisis reform,” Federal Reserve Board Gov. Jerome Powell said in a recent speech. He warned that that unfinished business should be finished while housing continues to enjoy its regained health, to avoid ultimately trying to solve the issues in a fresh crisis atmosphere.
Most of the big issues of the crisis period have been addressed, including many consumer protection aspects of the mortgage process, Powell said. But he said that long-term structural issues—notably the future role of Fannie Mae and Freddie Mac—have not been addressed, though they have been much debated since the crisis. Fannie and Freddie were placed into federal conservatorship in 2008, nearly a decade ago, and have remained there.
Powell said it was ironic that the housing finance system has not seen fundamental reform.
“The housing bubble of the early 2000s was, after all, an essential proximate cause of the crisis,” he pointed out. He said that while markets have come back, and consumer mortgage rules tightened, borrowers with lower credit scores now find it harder to get home loans. He suggested the current system may be too rigid, and that “a lack of innovation and product choice has limited mortgage credit availability to some creditworthy households.”
“As memories of the crisis fade,” said Powell, “the next few years may present our last best chance to finish these critical reforms. Failure to do so would risk repeating the mistakes of the past.”
Major matters long on hold
Early on since the conservatorship, plans began emerging to revamp the plumbing of the housing finance system and the structure of the secondary markets. Nothing came of these proposals during the Obama Administration.
Powell said that the conservatorship had been characterized as a “time out” by the Bush Administration Treasury Secretary, Hank Paulson. The idea was to stabilize the two mortgage giants to allow evaluation of their future role.
“Almost nine years into this time out,” said Powell, “the federal government’s domination of the housing sector has grown and is actually greater than it was before the crisis.”
Powell said the government accounts for 80% of the purchase mortgage market today. This includes the participation of Fannie, Freddie, the Federal Housing Administration, and the Department of Veterans Affairs. The remaining 20% is held by private financial institutions.
“After reaching nearly 30% of the market before the crisis, private-label securitization has dwindled to almost nothing today,” Powell added.
Powell said pulling more private capital into housing finance would be “the most obvious and direct step forward.”
Sources would include setting up multiple private guarantors who would insure a portion of mortgage credit risk. As the system stands right now, he said, Fannie and Freddie resemble the equivalent of a banking system dominated by two large insured banks. That “insurance” represents a huge potential taxpayer burden should housing hit trouble again.
5 principles for reform
Powell acknowledged early in his speech that the Fed is not a housing agency, but that a “robust, well-capitalized, well-regulated housing finance system” is part of a sound financial system—a key Fed responsibility.
He outlined five elements for reform:
1. Make the possibility of future housing bailouts as remote as possible.
2. If Congress chooses a proposal that includes government guarantees against catastrophe—after private capital is wiped out—then that guarantee should be explicit and transparent.
He said that guarantee should cover mortgage-related securities, not institutions.
3. There should be greater competition.
“The economics of securitization do not require a duopoly [such as Fannie and Freddie],” said Powell. “Greater competition would help to reduce the systemic importance of the GSEs, and spur more innovation.”
4. Consider simple approaches to restructuring.
“We know that housing reform is difficult,” said Powell. “Completely redrawing the system may not be necessary and could complicate the search for a solution.”
5. Find and build on areas of bipartisan agreement.
“At this late stage we should not be holding out for the perfect answer,” said Powell.
Where things stand in Congress
Powell gave his speech on July 6. The week before, the Senate Banking Committee, at a hearing on housing reform, Chairman Mike Crapo (R.-Idaho) identified the issue as one of his key priorities for the current Congress.
“I have repeatedly stated that the status quo is not a viable option,” said Crapo. He noted that three years earlier, a bipartisan reform package made it out of Senate Banking.
Among his views, recapped in an opening statement at the hearing, is taxpayer protection:
“We need multiple levels of taxpayer protection standing in front of any government guarantee, including downpayments, loan-level private insurance, and substantial, robust, loss-absorbing private capital at guarantors comparable to the amount of capital maintained by global systemically important banks.”
Among hearing witnesses was Edward DeMarco, president of the Financial Services Roundtable’s Housing Policy Council. DeMarco noted that progress has been made on development of reform concepts. The basic principles he outlined were much in sync with those outlined by Powell.
One key issue DeMarco treated with was the issue of federal guarantees.
“Why any federal guarantee at all?” he said. “The simple answer is that an explicit, federal guarantee to cover catastrophic credit risk is needed to ensure a steady flow of mortgage credit in all economic cycles.” He then went into depth on the issue beyond the simple concept.
The House Financial Services Committee has not held hearings on these matters in this Congress. The Financial Choice Act, passed by the House in June, does not deal with these issues.
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