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The Senate Banking Committee is making progress toward drafting legislation to overhaul the mortgage finance market, but one of the biggest unresolved issues is how much skin in the game private market participants must have in return for a government guarantee.
November 27 -
Another big law like Dodd-Frank could be harmful to the mortgage market, but an incremental approach to housing finance reform might be the perfect solution.
October 31
Sometimes it seems as though no one debating housing finance reform was alive before 2008.
How the housing finance system operated then, and why it all went wrong, tells us a lot about the "reforms" that are in prospect.
For example, what can we learn from the fact that before the 2008 crash there was a "jumbo" market for loans bigger than the conforming limit? That was a fully private market, accounting for about 15% of all mortgages, which regularly priced mortgages at 25 to 40 basis points over the rate for Fannie Mae and Freddie Mac loans. There were
Yet now we hear from housing pundits that a fully private marketparticularly the one that would be created by the House Republicans' bill would result in a spread of
Another example is the debate about the 10% private capital requirement in the Corker-Warner Senate proposal. Here, the history of the housing finance market has suddenly taken on an importance that it did not have when the issue was how a fully private market would behave. Some participants in the debate argue that the GSEs' losses did not exceed 4%, so the 10% capital requirement in Corker-Warner is
However, what happened in the past on this question is of little value in determining what will happen in the future. The reason is simply that when the government controls a marketas it would under the Corker-Warner planit creates the future that it wants.
Even now, we are seeing the future that the Government Mortgage Complex wants. It includes a "
There are two corollaries to the duty to serve"opening the credit box" and low-cost mortgages. Opening the credit boxa concept that is incomprehensible to anyone unfamiliar with housing market jargonmeans reducing the underwriting standards to the point where borrowers who would normally be ineligible for mortgage credit will now be eligible. These borrowers are frequently describedrecently in testimony by the Center for American Progressas "
If a borrower is truly creditworthy, the credit will be available, barring discrimination of some kind. If there is discrimination, it should be punished, but that does not tell us why a creditworthy borrower cannot get mortgage credit. The problem is clearly a difference of opinion between a lender and a borrower about who is creditworthy. The Qualified Mortgage devised by the Consumer Financial Protection Bureau defines a creditworthy borrower as anyone who can repay a mortgage at the time it is agreed, irrespective of the borrower's record of doing so in the past, or stake in the property (since neither credit scores nor down payments are considered necessary). The Government Mortgage Complex (GMC) is happy with that definition, and all the government's relevant financial regulators have signed off, even though they admit that mortgages meeting this testhad they been originated between 2005 and 2008would have resulted in a mortgage default rate of 23%.
The other corollary of "duty to serve" is a low-cost mortgage, and government can certainly see to that. It would not be much of a reform, of coursenor would the duty to serve be achievedif mortgage rates were so high that many would-be homeowners could not afford them.
The Corker-Warner proposal can accommodate this. Whether the private sector capital is 5% or 10% doesn't really matter. The amount of private sector risk will depend on the underlying mortgages. If the projected default rate is 23%, as it is likely to be under the prospective QM (and companion Qualified Residential Mortgage) rule, the return to the private sector will have to be extremely high. That will raise the costs of the underlying mortgages, probably far above the amount low-income borrowers could afford.
But government can and will fix that, too. The government will find a way to subsidize those mortgages, first by eliminating any payment to the proposed Federal Mortgage Insurance Corp., and later perhaps by "temporary" subsidies to the FMIC so it remains solvent, or an FMIC guarantee extended to the private sector participants, assuring them a "reasonable" return on their risk-taking that does not cause the cost of mortgages to rise excessively. A final expedient might be giving the FMIC the right to borrow with government backingjust "implicit," of course, because the debt is already too high.
In the end, we will once again have a system that looks suspiciously like Fannie Mae and Freddie Mac redux, with a housing bubble, a mortgage meltdown and a financial crisis. This is reform, GMC-style.
Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute.