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House of Doubt

by Christopher Papagianis
The case for providing clear mortgage rules now, not later

The ongoing struggles of the housing market are contributing to the softness of our overall economic recovery. Over the last couple of weeks, the Obama administration has restarted debate about further government action to prevent foreclosures and stave off home-price declines — all with an eye toward improving the outlook for a market that has traditionally been a key driver of the broader economy.

The backdrop for these closed-door meetings is that the U.S. government will soon be the country’s largest source of domestic home-mortgage and consumer-credit loans. In reviewing the latest Fed data, Investor’s Business Daily noticed that the total amount of government-financed consumer credit (the vast majority of which is mortgages) stood at $6.3 trillion, just slightly below the private sector’s total, $6.5 trillion. As recently as 2006, the private sector far outpaced the government: $8.5 trillion to $4.4 trillion.

And how is the Obama administration approaching housing policy today? Is it trying to shrink the government’s footprint on the consumer-credit space? No — quite the opposite. Already, the administration has announced an expansion of one of its programs at the Federal Housing Administration, changing the rules so that unemployed borrowers may miss mortgage payments for a full year.

Proceeding with caution is certainly wise — in the wake of a financial crisis, the transition back to private-sector dominance needs to be slow and measured, in order to keep credit flowing through the economy — but the administration is moving the market in the wrong direction entirely.

Currently, the government provides massive financial assistance to homeowners through tax deductions for mortgage interest and property taxes, the ongoing bailouts of Fannie Mae and Freddie Mac (more than $160 billion and counting), the Federal Housing Administration (which still accepts down payments of 3.5 percent), and a host of other housing-support programs. Over the last few years, the government’s share of new home loans in this country has grown to more than nine out of ten, if you include loans backed by government-sponsored enterprises (GSEs) such as Fannie and Freddie. It used to be approximately half that.

These interventions, many launched during the crisis or nascent recovery, can be broadly placed in two categories: policies designed to boost the demand for housing by supporting sales and prices; and policies designed to control the supply of housing by keeping distressed homeowners out of foreclosure (thus keeping their houses off the market). The first category includes policies such as the homebuyer tax credit; the second includes the Home Affordable Modification Program (HAMP), the Home Affordable Unemployment Program (HAUP), the Home Affordable Foreclosure Alternatives Program (HAFA), and the Home Affordable Refinance Program (HARP).

The administration’s signature housing program is probably HAMP, which seeks to help borrowers avoid foreclosure by reducing their mortgage payments to a manageable level. Since the program was announced in 2009, HAMP has led to roughly 700,000 permanent mortgage modifications, far short of the administration’s goal of 3–4 million.

As the depth of the housing decline demonstrates, these types of policies — pursued by both Republican and Democratic administrations — have failed to stem large-scale losses. In large part, this failure reflects the magnitude of the housing problem; tens of millions of American families bought homes they could not afford. It also reflects a basic political obstacle to large-scale interventions of this kind: the intrinsic unfairness of helping people who bought houses they could not afford at the expense of people who were more prudent.

It seems that even the Obama administration no longer views HAMP as a plan to keep millions of struggling borrowers in their homes permanently. For instance, in a meeting with prominent financial bloggers, Treasury officials stressed the importance of HAMP in preventing a rash of foreclosures at an inopportune time. Even if many aid recipients re-default and lose their homes anyway, the administration will likely declare success, claiming HAMP reduced stress on the banking system during a critical period.

This narrative is plausible, but it is based on the questionable assumption that more foreclosures would have destroyed the system, as opposed to speeding along a needed transition in the real-estate market. Further, this shift in rationale doesn’t make the program any more popular: Taxpayers have balked at the prospect of spending tens of billions of dollars to assist banks and drag out the foreclosure crisis.

A more cynical narrative is that the Obama administration was trapped — having criticized the Bush administration, the new president had to “do more” to avoid foreclosures, but he couldn’t afford the political cost of bailing out so many irresponsible borrowers. This left the administration with HAMP, which gave the appearance of bold action but achieved only modest results.

Just as expectations of rising prices helped inflate the housing bubble, restricting the supply of houses for sale has created expectations of future price declines, which has further damaged market confidence. Despite the various mortgage-modification programs, there are still too many homes for sale, and not enough willing buyers. In this climate, when the government makes short-term efforts to keep houses off the market, potential buyers stay away, expecting that prices will fall even farther when the government programs end and those houses — what analysts call the “shadow inventory” — finally become available.

Rather than continue to play small ball with the housing market, the administration and Congress should pursue a bold restructuring of our housing-finance system. The new system should rely on private capital, not taxpayer resources, and private entities — not quasi-government enterprises such as Fannie and Freddie — should bear the burden of mortgage-related losses.

Some analysts argue that the fragile state of the housing market and the risk it poses to a sustained economic recovery mean that broad-scale reform of the housing-finance system should happen slowly. But the speed of the actual transition is a separate matter from the legislative schedule for developing — and, more important, committing to — a new system. As Brookings Institution scholars including Karen Dynan and Ted Gayer have argued, the fact that there is no new legal regime on the horizon for housing finance is a source of real uncertainty for businesses and families trying to make informed decisions. How can we expect private-sector lenders to commit large amounts of discretionary capital to housing unless there are clear rules about how the market will be governed? Even if a new system did not go into effect for several years, the alleviation of this uncertainty would have an immense positive impact.

The GSEs were taken over by the government in 2008. It’s now 2011, and the Obama administration and Congress plan to wait until 2013 to even start debating plans for the future. But the time to act is now. Passing a law that clearly establishes how our mortgage-financing system will work should be the top legislative priority this summer after the budget talks wrap up. It is the best and most direct way to get the housing market back on track.

– Mr. 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.

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