Changing The Formula
Such a challenging time for the housing market would not represent the safest testing ground for Congress or the federal agencies to experiment with sweeping changes to how the market operates.
California, New York, and New Jersey all have active bills that would alter foreclosure rules in their states. While legislation that would discourage institutional or out-of-state investors from purchasing foreclosed properties may help keep homes and commercial buildings in the hands of residents, the bills still represent economic protectionism. Investment that may revitalize communities will be directed elsewhere, driving up competition and prices where it is directed.
The Office for Management and Budget (OMB) recently directed federal agencies to ignore existing medical debt to the fullest extent possible when making lending decisions. This of course will include the FHFA and is likely to apply to the GSEs at the very least by association (although not originators of loans themselves, the GSEs effectively set market standards for loan originators by determining which loans they will buy, with which characteristics, and under which circumstances). Reducing the amount of data available to lenders decreases the quality of lending decisions the agencies make and will not by itself improve consumer creditworthiness; in fact, it far more likely to do the opposite as it may cause Americans to end up even further in debt due to purposefully withheld information.
The FHFA is past due for a decision on its review of alternative credit scoring models. The vast majority of the industry (and federal agencies) has used the FICO Classic scoring model for the last 20 years. Any change to this approach would be costly to the GSEs and private lenders, and those costs would quickly be passed on to consumers.
Increasing Housing Risk
The United States does not have a functioning private secondary mortgage market and has a wildly distorted primary market because of Fannie Mae and Freddie Mac. If Congress seeks a healthy and functioning housing market that benefits all participants, then it must continue its efforts to reform the GSEs. But the Biden Administration has reversed these gains, decreasing the amount of capital the GSEs are required to hold and once again allowing them to purchase the riskiest mortgages.
GSE reform is absolutely necessary for the long-term health of the housing market, but the process will be slow, costly, and likely involve a temporary increase in housing prices. Short of the reform the market needs, however, Congress and the FHFA must commit to not increasing the footprint of the GSEs in the housing market.
The FHFA has repeatedly and consistently engaged in mission creep via the mechanism of new pilot programs. These pilots expand the products offered and decrease underwriting standards at the GSEs. While this gets more people into houses, it does nothing to expand housing inventory, and thereby acts as another demand-side subsidy, increasing the costs of housing for everyone.
In July, 10 members of the House wrote to FHFA Director Sandra Thompson, noting “The Enterprises have a history of venturing into new activities and product offerings that go well beyond their congressionally approved roles in the secondary market. The FHFA must do more to ensure there is appropriate transparency regarding any new products or activities that the Enterprises undertake and that these activities do not displace private firms or crowd out private capital.”
The FHFA must undertake to finalize the long-overdue rulemaking on Prior Approval of Enterprise Products, a requirement of the Housing and Economic Recovery Act of 2008 that still has not been brought into law nearly 15 years later.
Fourteen years after the GSEs were brought into conservatorship, they remain undercapitalized. The GSEs enjoy all the opportunities of both private entities and government agencies without the regulation or supervision of either. Former FHFA Director Mark Calabria took a series of extremely important steps along the path to GSE reform, not least of which was halving the GSEs’ combined leverage ratio (down to a still mind-boggling 500-1). These efforts not been continued, and what’s more, this administration’s FHFA has made the baffling decision to return risk to the GSEs by allowing them to make more toxic loans and hold less capital against that risk.
The Federal Housing Administration (FHA) has significantly expanded its role since the financial crisis and, with the GSEs, guarantees over $7 trillion in mortgage-related debt to the borrowers least able to repay. The FHA’s book of mortgages is considered so toxic that even Ginnie Mae, the Government National Mortgage Association, has proposed a 250% risk weight on gross mortgage service rights (MSRs) that make up the majority of the FHA’s business. Former FHFA Director Calabria has warned that the FHA is setting the market up for failure with its poor underwriting standards, the risk of which could topple the housing market.
Even in the best of times it can be difficult to parse the wide variety of economic indicators. Depending on interpretation, the housing market is either boiling or has already collapsed. The economy writ large is either strong or in a recession. Against this backdrop, the Fed is attempting to engineer a “soft landing,” decreasing inflation without triggering significant economic collapse.
Part of this effort necessarily involves intentionally making the housing market more hostile for a time, as noted by Fed Chair Jerome Powell. While there is little Congress and the federal agencies can do to improve housing supply in the short term, they could do much in haste and good intentions that would further muddy the economic waters. At worst, further demand-side subsidies would undo the Fed’s efforts, increasing the pain of inflation, the risks of recession, and the length of economic recovery.