Soon, we may know if House Republicans are planning to break their pledge to start paring back the government’s control of the housing market.
During the 2010 elections, House Republicans published their “Pledge to America.” With regards to housing policy, the National Republican Congressional further clarified here what they committed to do on housing: “Republicans will deliver by ending taxpayer support for Fannie Mae and Freddie Mac, the mortgage giants that triggered the financial crisis.”
First, let me be clear that this is a very worthy, though complicated, objective. Since this pledge was drafted, taxpayers have actually sent $169 billion to Fannie and Freddie to keep them solvent. Today, the government — principally through Fannie, Freddie, and the Federal Housing Administration (FHA) — are responsible for 97 percent of all new mortgages originated today. That’s a staggering share of the market.
It’s important to remember that while the government has been a big player in housing for decades, its share was always a lot lower before the crisis. For example, Fannie and Freddie have historically controlled 30–45 percent of the market dating back to the 1990s. The share for FHA has fluctuated around 10 percent over this period, but dipped below 5 percent during the 2005–2006 period. Today, FHA’s share is around 30 percent of the new-originations market.
As the Republican pledge states, Fannie and Freddie helped trigger the “financial meltdown by giving too many high risk loans to people who couldn’t afford them.” So, what are House Republicans planning to do this week that undermines reform in this area and specifically their commitment to start “end[ing] taxpayer support”?
The House is considering a new law that would keep Fannie, Freddie, and the FHA as the dominant providers of mortgage credit in this country. (This would be accomplished through the appropriations process — specifically negotiations on the minibus that covers housing programs.) The specific policy change has to do with the loan amount, or ceiling, that these three entities are allowed to insure, which is the same thing in this case as a full taxpayer-provided guarantee.
#more#As of October 1 of this year, these three government agencies are no longer allowed to guarantee loans with balances in excess of $625,000. As set most recently by the Obama stimulus in 2009, the ceiling on loans that would qualify for taxpayer support was $729,000, but the elevated level was always set to expire at the end of September.
So, what the House is contemplating now is going back to the $729,000 level.
The importance of this decision in the House can’t really be overstated. If House members conclude that the loan limits should go back to the $729,000 level, they are in effect voting for the Obama ’09 stimulus and undermining their pledge to Americans at the same time.
Put simply, if House Republicans do not trust the private market to set the terms and conditions on mortgage loans for high-income households, how can anybody reasonably believe that they will take subsequent steps — next year, or the year after even — to shrink, if not fully wind-down, taxpayer support for Fannie and Freddie?
It’s important to keep this $729,000 figure in perspective. As the National Association of Realtors notes, the median price of existing homes sold in the middle of 2011 was $171,000.
The reduction in the balance of loans eligible for purchase by Fannie Mae and Freddie Mac affects a small number of housing markets. According to an analysis of the change from Genworth Financial, only 86 of 3,143 U.S. counties (2.7%) had pre-October borrowing limits in excess of $625,000. Those that did were concentrated along the coasts — New York, New Jersey, the San Francisco Bay Area, and Washington, D.C. — and playgrounds for the rich like the ski resort towns of the Colorado, Utah, and Idaho, as well as Honolulu and Key West, Florida. The proponents of an extension of the old loan limits — aside from the obvious special interest groups who depend on government support for homebuilding and mortgage finance — are generally Members of Congress that represent these high cost areas.
Well, what about how a change in the ceiling could impact the price or “affordability” of these large loans? What do analysts think will happen if the government no longer provides a subsidy to what used to be known as jumbo loans?
Initial estimates suggest that absent taxpayer subsidies, a borrower assuming a $700,000 loan for a $800,000 house will face incremental annual interest expense of more than $5,000 and a tripling (or more) of required down payments. An increase in the required down payment from 12.5% to 30% would increase the required down payment in this case by $140,000. This is a huge increase, but most households seeking to buy a $800,000 home are sufficiently liquid to execute this transaction. And if they are not, why is it of any concern to the taxpayers who’d otherwise be asked to backstop this transaction? A mortgage of $700,000 is more than three-times the average unpaid principal balance of the average loan originated in 2010 and, according to FHFA, this average includes $30 billion of purchases of ultra high-balance mortgages during the year.
Perhaps the part of this story that deserves the most attention — and has sadly been ignored by most commentators to date — is what’s going on at the Federal Housing Administration. Before the government took over Fannie and Freddie, FHA was the government’s major direct-support mechanism for housing-related credit (excluding tax benefits, like the mortgage-interest deduction).
Historically, FHA has targeted its mortgage insurance to help low- and moderate-income families become homeowners, with an eye also toward assisting first-time homeowners who may not have the cash for a sizable down payment. One of the most attractive elements of FHA from the borrower perspective is that you can be qualified for a government-insured loan with as little as a 3.5 percent down payment. (Note: this is still the down-payment requirement, if you can believe it.)
Again, over at e21, we presented a useful example:
This means that prior to October 1, a borrower in Los Angeles County with as little as $27,000 in cash would be eligible to buy a $750,000 home through a taxpayer-guaranteed loan. If a private sector lender funded the same loan with discretionary risk capital, a homeowner would be asked to put down roughly $150,000 to $225,000 in equity. This means that the upfront subsidy to the borrower under the government channel is over $123,000. Since California is a non-recourse lending state, smaller down payments make strategic default more attractive since the borrower does not need to worry about losing other assets in the event of foreclosure. What public interest is served by ensuring that a borrower has to commit less upfront cash to buy what amounts to a call option on a $750,000 home?
Here is some more history that policymakers seem to have forgotten about FHA:
The loan limit ceiling for FHA was not always the same as for Fannie and Freddie. Before the financial crisis, the loan-limit ceiling for Fannie and Freddie was $417,000. FHA actually had both a ceiling and a floor — but importantly, the entire range was intentionally set below that of the GSE ceiling. Remember, the GSEs back then were still enterprises that had private shareholders and Fannie and Freddie also didn’t generally allow for down payments as low as 3.5 percent. To partly offset the risk from allowing people to qualify with very low down payments, FHA had a requirement that its mortgage limit, or ceiling, be set at 95 percent of the median home price in that local area. This cap below the median area home price was also consistent with the more narrow pool of potential borrowers that FHA targeted (e.g., low- and moderate-income families and first-time homebuyers, or those that didn’t have the resources for a sizable down payment).
Not to get too far into the weeds, but the law also set a ceiling and floor around the “less than 95 percent” principle that FHA-insured loans should only go to people buying homes under their area’s median home price. In 2007, the ceiling was $359,650, and the floor was $200,160. This meant that the loan limit for an FHA loan was between these two numbers, but also always below 95 percent of whatever the local area’s median home price was.*
The reason this debate is so important is that a reduction in the loan limits almost has to be the place to start phasing out taxpayer support for mortgage finance generally. In my opinion, there is no real rationale today for asking all taxpayers to stand behind large mortgage loans for the affluent.
A vote against reducing loan limits also contradicts the House Republican pledge. The problem is that when we have a system that is subsidizing 97 percent of the mortgage market today, even reform-minded policymakers can lose sight of the fact that subsidizing everyone really means subsidizing no one.
If the government provides credit support to everyone at the same time, then the cost of buying a home will go up for everyone accordingly — canceling out any benefit that’s targeted. It wasn’t always this way in the housing market, but the decision out of Congress this week may signal a full surrender on GSE reform and the broader war to end America’s complete socialization of mortgage-related credit risk.
— Christopher Papagianis is the managing director of Economics21, a nonpartisan policy-research institute, and previously was special assistant for domestic policy to Pres. George W. Bush.
*There is also some technical confusion about when FHA’s 95 percent of median area home price “index” was increased to 115 percent, and then also to 125 percent. While the 2008 ESA adjusted the index, the last law that technically kept the current index value at 125 percent was the Obama ’09 stimulus. It was the 2008 HERA that moved the index to 115 percent. As reviewed in the post, however, the FHA index was 95 percent before the financial crisis. Moving back to an index that’s at 115 percent makes more sense than keeping the elevated 125 percent from the Obama stimulus — but policymakers should really be looking to return FHA to its original target, which was 95 percent of a local area’s median home price.