March 16, 2018
John Campbell et al. have posted Structuring Mortgages for Macroeconomic Stability to SSRN. They are not the first to propose a mortgage product that is designed to lessen its burden when times are hard, but that does not make their proposal any the less intriguing. The authors write,
Events in the last decade have shown that adjustable-rate mortgages (ARMs) have advantages over fixed-rate mortgages (FRMs) in stabilizing the economy, at least when the central bank has monetary independence and can lower the short-term interest rate in a recession. A lower short rate provides automatic budget relief for ARM borrowers and helps to support their spending. It can also provide some relief to FRM borrowers, but this requires both a decline in the long-term mortgage rate and refinancing, which may be constrained by declining house prices and tightening credit standards. Barriers to FRM refinancing in the aftermath of the Great Recession were an important concern of US policymakers and motivated the introduction of the Home Affordable Refinance Program. (1, citations omitted)
The authors are certainly right that mortgages were a big drag on households during the Great Recession and many of them (but not all) would have benefited from lower monthly payments. To address this, the authors
study mortgage design features aimed at stabilizing the macroeconomy. Using a calibrated life-cycle model with competitive risk-averse lenders, we consider an adjustable-rate mortgage (ARM) with an option that during recessions allows borrowers to pay only interest on their loan and extend its maturity. We find that this option has several advantages: it stabilizes consumption growth over the business cycle, shifts defaults to expansions, and lowers the equilibrium mortgage rate by stabilizing cash flows to lenders. These advantages are magnified in a low and stable real interest rate environment where the standard ARM delivers less budget relief in a recession.
While there have been some pilot programs that introduce countercyclical mortgage products, nothing has really taken off so far. Hopefully, papers like this will push lenders and regulators to keep looking for solutions to our next housing crisis, before it actually hits.
March 15, 2018
Researchers at the NY Fed have posted The Role of Technology in Mortgage Lending. There is no doubt that tech can disrupt the mortgage lending business much as it has done with others. The abstract reads,
Technology-based (“FinTech”) lenders increased their market share of U.S. mortgage lending from 2 percent to 8 percent from 2010 to 2016. Using market-wide, loan-level data on U.S. mortgage applications and originations, we show that FinTech lenders process mortgage applications about 20 percent faster than other lenders, even when controlling for detailed loan, borrower, and geographic observables. Faster processing does not come at the cost of higher defaults. FinTech lenders adjust supply more elastically than other lenders in response to exogenous mortgage demand shocks, thereby alleviating capacity constraints associated with traditional mortgage lending. In areas with more FinTech lending, borrowers refinance more, especially when it is in their interest to do so. We find no evidence that FinTech lenders target marginal borrowers. Our results suggest that technological innovation has improved the efficiency of financial intermediation in the U.S. mortgage market.
The report documents the significant extent to which FinTech firms have already disrupted the primary mortgage market. They also predict a whole lot more disruption coming down the pike:
Going forward, we expect that other lenders will seek to replicate the “FinTech model” characterized by electronic application processes with centralized, semi-automated underwriting operations. However, it is unclear whether traditional lenders or small institutions will all be able to adopt these practices as these innovations require significant reorganization and sizable investments. The end result could be a more concentrated mortgage market dominated by those firms that can afford to innovate. From a consumer perspective, we believe our results shed light on how mortgage credit supply is likely to evolve in the future. Specifically, technology will allow the origination process to be faster and to more easily accommodate changes in interest rates, leading to greater transmission of monetary policy to households via the mortgage market. Our findings also imply that technological diffusion may reduce inefficiencies in refinancing decisions, with significant benefits to U.S. households.
Our results have to be considered in the prevailing institutional context of the U.S. mortgage market. Specifically, at the time of our study FinTech lenders are non-banks that securitize their mortgages and do not take deposits. It remains to be seen whether we find the same benefits of FinTech lending as the model spreads to deposit-taking banks and their borrowers. Changes in banking regulation or the housing finance system may affect FinTech lenders going forward. Also, the benefits we document stem from innovations that rely on hard information; as these innovations spread, they may affect access to credit for those borrowers with applications that require soft information or borrowers that require direct communication with a loan officer. (37-38)
I think that the author’s predictions are right on target.
March 14, 2018
Senate Bill 2155 is looking like it will be enacted and reduce the amount of data collected pursuant to the Home Mortgage Disclosure Act. The Federal Reserve Bulletin includes a report that demonstrates just how useful that data is, Residential Mortgage Lending in 2016: Evidence from the Home Mortgage Disclosure Act Data. Key findings of the report include,
1. The number of mortgage originations in 2016 rose 13 percent, to 8.4 million from 7.4 million in 2015. For loans secured by one- to four-family properties, growth was strong in both home-purchase originations—which increased to 4.0 million from 3.7 million in 2015—and refinance originations—which increased to 3.8 million from 3.2 million in 2015.
2. Black and Hispanic white borrowers increased their share of home-purchase loans for one- to four-family, owner-occupied, site-built properties in 2016, the third consecutive annual rise for both groups. The HMDA data indicate that 6.0 percent of such loans went to black borrowers, up from 5.5 percent in 2015, while 8.8 percent went to Hispanic white borrowers, up from 8.3 percent in 2015. The share of home-purchase loans to low- or moderate-income (LMI) borrowers decreased to 26 percent in 2016 from 28 percent in 2015.
3. The average value of home-purchase loans rose 3.2 percent in 2016, to $257,000, with similar increases for loans made to borrowers of different racial and ethnic groups. The average value of home-purchase loans to Hispanic white borrowers remained well below the 2006 peak, while the averages for Asian, black, and non-Hispanic white borrowers were all above their 2006–07 peaks.
4. Black and Hispanic white borrowers continued to be much more likely to use nonconventional loans (that is, loans with mortgage insurance from the Federal Housing Administration (FHA) or guarantees from the Department of Veterans Affairs (VA), the Farm Service Agency (FSA), or the Rural Housing Service (RHS)) than conventional loans compared with other racial and ethnic groups. In 2016, among home-purchase borrowers, 69 percent of blacks and 60 percent of Hispanic whites took out a no-conventional loan, whereas about 35 percent of non-Hispanic whites and just 16 percent of Asians did so.
5. The share of mortgages originated by non-depository, independent mortgage companies has increased sharply in recent years. In 2016, this group of lenders accounted for 53 percent of first-lien owner-occupant home-purchase loans, up from 50 percent in 2015. Independent mortgage companies also originated 52 percent of first-lien owner–occupant refinance loans, an increase from 48 percent in 2015. For the first time since at least 1995, non-depository, independent mortgage companies accounted for a majority of each of these types of loans. (2-3)
It is important that HMDA data continue to provide a reliable overview of the mortgage market so that changes in the market can be identified and policies can be modified to respond to them. It remains to be seen just how much Senate Bill 2155 will reduce the usefulness of HMDA data. Time will tell.
March 13, 2018
The National Low Income Housing Coalition has posted The Gap: A Shortage of Affordable Homes. The report opens,
One of the biggest barriers to economic stability for families in the United States struggling to make ends meet is the severe shortage of affordable rental homes. The housing crisis is most severe for extremely low income renters, whose household incomes are at or below the poverty level or 30% of their area median income (see Box 1). Facing a shortage of more than 7.2 million affordable and available rental homes, extremely low income households account for nearly 73% of the nation’s severely cost-burdened renters, who spend more than half of their income on housing.
Even with these housing challenges, three out of four low income households in need of housing assistance are denied federal help with their housing due to chronic underfunding. Over half a million people were homeless on a single night in 2017 and many more millions of families without assistance face difficult choices between spending their limited incomes on rent or taking care of other necessities like food and medical care. Despite the serious lack of affordable housing, President Trump proposes further reducing federal housing assistance for the lowest income households through budget cuts, increased rents and work requirements.
Based on the American Community Survey (ACS), this report presents data on the affordable housing supply, housing cost burdens, and the demographics of severely impacted renters. The data clearly illustrate a chronic and severe shortage of affordable homes for the lowest income renters who would be harmed even more by budget cuts and other restrictions in federal housing programs. (2, citations omitted)
The report’s key findings include,
- The nation’s 11.2 million extremely low income renter households account for 25.7% of all renter households and 9.5% of all households in the United States.
- The U.S. has a shortage of more than 7.2 million rental homes affordable and available to extremely low income renter households. Only 35 affordable and available rental homes exist for every 100 extremely low income renter households.
- Seventy-one percent of extremely low income renter households are severely cost-burdened, spending more than half of their incomes on rent and utilities. They account for 72.7% of all severely cost-burdened renter households in the United States.
- Thirty-two percent of very low income, 8% of low income, and 2.3% of middle income renter households are severely cost-burdened.
- Of the eight million severely cost-burdened extremely low income renter households, 84% are seniors, persons with disabilities, or are in the labor force. Many others are enrolled in school or are single adults caring for a young child or a person with a disability. (2, citations omitted)
While the report does show how wrongheaded the Trump Administration’s proposed cuts to housing subsidies are, I was surprised that it did not address at all the impact of local zoning policies on housing affordability. There is no way that we are going to address the chronic shortage in affordable housing by subsidies alone.
The federal government will need to disincentivize local governments from implementing land use policies that keep affordable housing from being built in communities that have too little housing. These rules make single family homes too expensive by requiring large lots and make it too difficult to build multifamily housing. We cannot seriously tackle the affordability problem without addressing restrictive local land use policies.
March 12, 2018
Researchers at the Fed and UC Berkeley have posted Liquidity Crises in the Mortgage Markets. The authors conclusions are particularly troubling:
The nonbank mortgage sector has boomed in recent years. The combination of low interest rates, well-functioning GSE and Ginnie Mae securitization markets, and streamlined FHA and VA programs have created ample opportunities for nonbanks to generate revenue by refinancing mortgages. Commercial banks have been happy to supply warehouse lines of credit to nonbanks at favorable rates. Delinquency rates have been low, and so nonbanks have not needed to finance servicing advances.
In this paper, we ask “What happens next?” What happens if interest rates rise and nonbank revenue drops? What happens if commercial banks or other financial institutions lose their taste for extending credit to nonbanks? What happens if delinquency rates rise and servicers have to advance payments to investors—advances that, in the case of Ginnie Mae pools, the servicer cannot finance, and on which they might take a sizable capital loss?
We cannot provide reassuring answers to any of these questions. The typical nonbank has few resources with which to weather these shocks. Nonbanks with servicing portfolios concentrated in Ginnie Mae pools are exposed to a higher risk of borrower default and higher potential losses in the event of such a default, and yet, as far as we can tell from our limited data, have even less liquidity on hand than other nonbanks. Failure of these nonbanks in particular would have a disproportionate effect on lower-income and minority borrowers.
In the event of the failure of a nonbank, the government (through Ginnie Mae and the GSEs) will probably bear the majority of the increased credit and operational losses that will follow. In the aftermath of the financial crisis, the government shared some mortgage credit losses with the banking system through putbacks and False Claims Act prosecutions. Now, however, the banks have largely retreated from lending to borrowers with lower credit scores and instead lend to nonbanks through warehouse lines of credit, which provide banks with numerous protections in the event of nonbank failure.
Although the monitoring of nonbanks on the part of the GSEs, Ginnie Mae, and the state regulators has increased substantially over the past few years, the prudential regulatory minimums, available data, and staff resources still seem somewhat lacking relative to the risks. Meanwhile, researchers and analysts without access to regulatory data have almost no way to assess the risks. In addition, although various regulators are engaged in micro-prudential supervision of individual nonbanks, less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it, and a history, at least during the financial crisis, of going out of business. We write this paper with the hope of elevating this question in the national mortgage debate. (52-53)
As with last week’s paper on Mortgage Insurers and The Next Housing Crisis, this paper is a wake-up call to mortgage-market policymakers to pay attention to where the seeds of the next mortgage crisis may be hibernating, awaiting just the right conditions to sprout up.
March 9, 2018
David Finkelstein, Andreas Strzodka and James Vickery of the NY Fed have posted Credit Risk Transfer and De Facto GSE Reform. It opens,
Nearly a decade into the conservatorships of Fannie Mae and Freddie Mac, no legislation has yet been passed to reform the housing finance system and resolve the long-term future of these two government-sponsored enterprises (GSEs). The GSEs have, however, implemented significant changes to their operations and practices over this period, even in the absence of legislation. The goal of this paper is to summarize and evaluate one of the most important of these initiatives – the use of credit risk transfer (CRT) instruments to shift mortgage credit risk from the GSEs to the private sector.
Fannie Mae and Freddie Mac have significant mortgage credit risk exposure, largely because they provide a credit guarantee to investors on the agency mortgage-backed securities (MBS) they issue. Since the CRT programs began in 2013, Fannie Mae and Freddie Mac have transferred to the private sector a portion of the credit risk on approximately $1.8 trillion in single-family mortgages (as of December 2017; source: Fannie Mae, 2017, Freddie Mac, 2017). The GSEs have experimented with a range of different risk transfer instruments, including reinsurance, senior-subordinate securitizations, and transactions involving explicit lender risk sharing. The bulk of CRT, however, has occurred via the issuance of structured debt securities whose principal payments are tied to the credit performance of a reference pool of securitized mortgages. A period of elevated mortgage defaults and losses will trigger automatic principal write-downs on these CRT bonds, partially offsetting credit losses experienced by the GSEs.
Our thesis is that the CRT initiative has improved the stability of the housing finance system and advanced a number of important objectives of GSE reform. In particular the CRT programs have meaningfully reduced the exposure of the Federal government to mortgage credit risk without disrupting the liquidity or stability of secondary mortgage markets. In the process, the CRT programs have created a new financial market for pricing and trading mortgage credit risk, which has grown in size and liquidity over time. Given diminished private-label securitization activity in recent years, these CRT securities are one of the primary ways for private-sector capital market investors to gain exposure to residential mortgage credit risk.
An important reason for this success is that the credit risk transfer programs do not disrupt the operation of the agency MBS market or affect the risks facing agency MBS investors. Because agency MBS carry a GSE credit guarantee, agency MBS investors assume that they are exposed to interest rate risk and prepayment risk, but not credit risk. This reduces the set of parameters on which pass-through MBS pools differ from one another, improving the standardization of the securities underlying the liquid to-be-announced (TBA) market where agency MBS mainly trade. Even though the GSEs now use CRT structures to transfer credit risk to a variety of private sector investors, these arrangements do not affect agency MBS investors, since the agency MBS credit guarantee is still being provided only by the GSE. In other words, the GSE stands in between the agency MBS investors and private-sector CRT investors, acting in a role akin to a central counterparty.
Ensuring that Fannie Mae and Freddie Mac’s credit risk sharing efforts occur independently of the agency MBS market is important for both market functioning and financial stability. The agency MBS market, which remains one of the most liquid fixed income markets in the world, proved to be quite resilient during the 2007-2009 financial crisis, helping to support the supply of mortgage credit during that period. The agency market financed $2.89 trillion of mortgage originations during 2008 and 2009, experiencing little drop in secondary market trading volume during that period. In contrast, the non-agency MBS market, where MBS investors are exposed directly to credit risk, proved to be much less stable; Issuance in this market essentially froze in the second half of 2007, and has remained at low levels since that time.4 (1-2, citations and footnotes omitted)
One open question, of course, is whether the risk transfer has been properly priced. We won’t be able to fully answer that question until the next crisis tests these CRT securities. But in the meantime, we can contemplate the authors’ conclusion:
the CRT program represents a valuable step forward towards GSE
reform, as well as a basis for future reform. Many proposals have been put forward for long-term reform of mortgage market since the GSE conservatorships began in 2008. Although the details of these proposals vary, they generally share in common the goals of
(1) ensuring that mortgage credit risk is borne by the private sector (probably with some form of government backstop and/or tail insurance to insure catastrophic risk and stabilize the market during periods of stress), while
(2) maintaining the current securitization infrastructure as well as the standardization and liquidity of agency MBS markets.
The credit risk transfer program, now into its fifth year, represents an effective mechanism for achieving these twin goals. (21, footnote omitted)
March 8, 2018
Donghoon Lee and Joseph Tracy of the NY Fed have posted a staff report, Long-Term Outcomes of FHA First-Time Homebuyers. It opens,
The Commissioner of the Federal Housing Administration (FHA), David Stevens, in remarks delivered on December 12, 2009, defined the purpose of the FHA as follows. “As a mission-driven organization, FHA’s goal is to provide sustainable homeownership options for qualified borrowers.” These remarks followed a remarkable increase in the scope of the FHA mortgage insurance program in response to the financial crisis and housing bust. This comment by Commissioner Stevens is important in that it clarifies a goal of the FHA program. However, this clarity was not followed up by the FHA with a definition of “sustainable homeownership.” Nor was there any documented attempt by the FHA to develop metrics to track their progress toward this objective, or a commitment by the FHA to make this information available to the public in the future.
Program evaluation is an integral part of any effective program—government or private. We illustrate in this paper that advances in data availability offer the opportunity for the FHA to both define what it means by sustainable homeownership and to measure its progress against this definition. We believe that it would be beneficial for the FHA to be transparent in this effort and to report on not only its definition and metrics, but also on its progress on an annual basis. Improved tracking of long-term outcomes of FHA borrowers will better help inform the FHA on program design. This should lead to improved outcomes over time and enhanced public support.
We focus our analysis on first-time homebuyers who are an important market segment for the FHA. The mission of sustainable homeownership is particularly relevant for these new homeowners. The benefits of a government mortgage insurance program that helps to facilitate the transition from renting to owning rests importantly on the success of these new borrowers in remaining homeowners in the future. However, to date, the FHA has not systematically tracked the progress of its first-time homebuyers after they pay off their credit risk to the FHA. We use the New York Fed’s Consumer Credit Panel (CCP) data to do this analysis starting with the 2002 cohort of FHA first-time homebuyers. (1, footnotes omitted)
This is inarguably right. The FHA should set forth performance metrics and provide annual progress reports for them. For too long, the FHA has cherry-picked metrics without providing a holistic perspective on its performance. The authors conclude,
A stated mission of the FHA mortgage insurance program is to support sustainable homeownership. An examination of the history of the FHA program illustrates a strong initial focus on sustainability, but legislated changes in the 1950s and early 1960s shifted the focus to affordability. If sustainability remains an important goal for the FHA, then it would be desirable for the FHA to define what they mean by sustainability and to track their performance over time. Only by being transparent and holding themselves accountable can the FHA improve on this objective over time. (14)
Amen to that.