Treasury’s Take on Housing Finance Reform

Treasury Secretary Mnuchin Being Sworn In

The Department of the Treasury released its Strategic Plan for 2018-2022. One of its 17 Strategic Objectives is to promote housing finance reform:

Support housing finance reform to resolve Government-Sponsored Enterprise (GSE) conservatorships and prevent taxpayer bailouts of public and private mortgage finance entities, while promoting consumer choice within the mortgage market.

Desired Outcomes

Increased share of mortgage credit supported by private capital; Resolution of GSE conservatorships; Appropriate level of sustainable homeownership.

Why Does This Matter?

Fannie Mae and Freddie Mac have been in federal conservatorship for nine years. Taxpayers continue to stand behind their obligations through capital support agreements while there is no clear path for the resolution of their conservatorship. The GSEs, combined with federal housing programs such as those at the Federal Housing Administration and the Department of Veterans Affairs, support more than 70 percent of new mortgage originations. Changes should encourage the entry of greater private capital in the U.S. housing finance system. Resolution of the GSE conservatorships and right-sizing of federal housing programs is necessary to support a more sustainable U.S. housing finance system. (16)

The Plan states that Treasury’s strategies to achieve these objectives are to engage “stakeholders to develop housing finance reform recommendations.” (17) These stakeholders include Congress, the FHFA, Fed, SEC, CFPB, FDIC, HUD (including the FHA), VA, Fannie Mae, Freddie Mac, the Association of State Banking Regulators as well as “The Public.” Treasury further intends to disseminate “principles and recommendations for housing finance reform” and plan “for the resolution of current GSE conservatorships.” (Id.)

This is all to the good of course, but it is at such a high level of generality that it tells us next to nothing. In this regard, Trump’s Treasury is not all that different from Obama and George W. Bush’s. Treasury has not taken a lead on housing finance reform since the financial crisis began. While there is nothing wrong with letting Congress take the lead on this issue, it would move things forward if Treasury created an environment in which housing finance reform was clearly identified as a priority in Washington. Nothing good will come from letting Fannie and Freddie limp along in conservatorship for a decade or more.

Tips for First-Time Homebuyers

dphoto by Alachua County

Cheapism quoted me in 21 Tips for First-Time Homebuyers. It opens,

GETTING YOUR FOOT IN THE DOOR

Buying your first home is a high-pressure endeavor. The number of homes for sale in America has been steadily declining for years. According to Zillow, inventory has been on a year-over-year downward spiral every single month since February 2015. That means competition for homes is fierce, particularly for starter homes. There’s also a great deal to learn as a first-time home buyer, ranging from understanding mortgages to knowing what to look for when touring properties and which markets are the best. Cheapism has asked real estate experts to share their top tips for those making their first foray into the market. Here’s what the professionals want all first-time homebuyers to know when they start hunting for their dream home.

WORK WITH AN EXPERIENCED REAL ESTATE AGENT

There are many ways a real estate agent can make the home-buying process less stressful, says Tracy Ouellette, a regional sales manager with CLV Group, a full-service real estate brokerage. “Quite often first-time buyers try to do it themselves in order to save a bit of money,” said Ouellette. “However, there are many of aspects of the home-buying experience that greatly benefit from using a realtor. They know the market and are able to negotiate a fair price, which ends up saving you more money in the end. They also ensure that your contract will protect you and your house, if any issues arise in the future.”

GET EDUCATED ABOUT MORTGAGES

Mortgages are complicated financial products, so spend some time educating yourself about them, said David Reiss, a law professor at Brooklyn Law School. “If you understand them, you can choose the right one for your circumstances,” said Reiss. “Most people think they should get a 30-year-fixed rate mortgage. But those usually have a higher interest rate than adjustable rate mortgages.” For those buying a starter home, an adjustable rate mortgage (ARM) may be worth considering in order to keep the monthly mortgage payment lower initially.

The Little-Known Escalation Clause

The Wall Street Journal quoted me in Escalation Clauses: A Little-Known Bidding-War Strategy. It opens,

For home buyers locked in a heated bidding war, there is one weapon that may help ensure victory: an escalation clause.

It’s an addendum to a real-estate contract, typically when the offer is made, in which a prospective buyer says, “I will pay X dollars for this house, but if another buyer submits a verifiable bid that’s higher, I will raise my offer in increments of Y dollars to a maximum price of Z.”

These clauses are particularly useful in a competitive real-estate market where homes typically get multiple bids. If a bidding war erupts on a home, the escalation clause will automatically raise the buyer’s offer on the house by the predetermined increment, up to the maximum amount the buyer authorizes. It eliminates the back and forth of offer and counteroffer and helps the buyer avoid paying too much for a house by getting caught up in the frenzy of a bidding war. But they can be risky for buyers who use them.

“A buyer can think of an escalation clause as a ‘have your cake and eat it, too’ clause,” says David Reiss, a Brooklyn Law School professor who specializes in real estate. “But in real estate, as with cake, it is hard to have it all.”

One concern is that the buyer is tipping his hand to the seller by using an escalation clause, Prof. Reiss says.

By indicating the maximum amount he will pay for the house, a buyer is revealing important information—that he’s willing to pay more. For example: Seller lists the house for $1 million. The buyer bids $950,000 with an escalation up to $975,000. The seller can counteroffer at $975,000, knowing that the buyer can both afford it at that price and is willing to pay it.

“Sellers get more money than they ever thought they would have,” says Carrie DeBuys, a real-estate agent with Realogics Sotheby’s Realty in Seattle. In her market, it isn’t uncommon for a seller to receive “10, 15 or 20 offers on a property.”

On the flip side, an escalation clause may not be in the seller’s best interest, explains Prof. Reiss.

Say a house is listed for $1 million, and there are three bidders. Buyer A offers $950,000. Buyer B offers $975,000 with an escalation clause that could go up to $1 million in $5,000 increments. Buyer C offers $980,000. In this scenario, the seller would get $985,000 from Buyer B after the initial offer escalates over Buyer C’s offer. But, had the seller not relied on the escalation clause and instead asked the bidders for their best and final offer, he might have sold the house for $1 million. “We know that the buyer was willing and able to go up that high,” Mr. Reiss says. “Thus, the seller is likely getting $15,000 less in the escalation-clause scenario.”

The “Humbled” Consumer Financial Protection Bureau

photo by Lilla Frerichs

The Consumer Financial Protection Bureau is changing directions in a big way under the leadership of Mick Mulvaney as seen in its Strategic Plan for FY 2018-2022. In his opening message to the Plan, Mulvaney writes that the Plan

presents an opportunity to explain to the public how the Bureau intends to fulfill its statutory duties consistent with the strategic vision of its new leadership. In reviewing the draft Strategic Plan released by the Bureau in October 2017, it became clear to me that the Bureau needed a more coherent strategic direction. If there is one way to summarize the strategic changes occurring at the Bureau, it is this: we have committed to fulfill the Bureau’s statutory responsibilities, but go no further. Indeed, this should be an ironclad promise for any federal agency; pushing the envelope in pursuit of other objectives ignores the will of the American people, as established in law by their representatives in Congress and the White House. Pushing the envelope also risks trampling upon the liberties of our citizens, or interfering with the sovereignty or autonomy of the states or Indian tribes. I have resolved that this will not happen at the Bureau.

So how do we refocus the Bureau’s efforts to better protect consumers? How do we succinctly define the Bureau’s unique mission, goals, and objectives? Fortunately, the necessary tools are already set forth in statute. We have drawn the strategic plan’s mission statement directly from Sections 1011 and 1013 of the Dodd-Frank Act: “to regulate the offering and provision of consumer financial products or services under the Federal consumer financial laws” and “to educate and empower consumers to make better informed financial decisions.” We have similarly drawn the strategic plan’s first two strategic goals and its five strategic objectives from Section 1021 of the Dodd-Frank Act. By hewing to the statute, this Strategic Plan provides the Bureau a ready roadmap, a touchstone with a fixed meaning that should serve as a bulwark against the misuse of our unparalleled powers. Just as important, it provides clarity and certainty to market participants. (2)

The subtext of this change in direction is not that “sub” at all. The Trump Administration wants to rein in the Bureau after it aggressively pursued financial services companies for violating a broad range of consumer protection statutes.

The Plan says that the Bureau will now act “with humility and moderation.” What that means is that the it will now be cutting financial services firms a lot of slack. Let’s see how a humbled Bureau works out for consumers.

Trump’s War on HUD

Shots Across The Bow

President Trump’s budget for fiscal year 2019 offers these highlights for the Department of Housing and Urban Development:

  • The Budget reflects the President’s commitment to fiscal responsibility by reforming programs to encourage the dignity of work and self-sufficiency while supporting critical functions that provide assistance to vulnerable households. The Budget recognizes a greater role for State and local governments and the private sector to address community and economic development needs and affordable housing production.
  • The Budget requests $39.2 billion in gross discretionary funding for HUD, an $8.8 billion or 18.3-percent decrease from the 2017 enacted level. (63)

The specifics are somewhat unbelievable. For instance, the budget

  • “eliminates programs that are duplicative or have failed to demonstrate effectiveness, such as the Community Development Block Grant (CDBG) program . . .” (Id.) and
  • does not request funding for the Public Housing Capital Fund, as the provision of affordable housing should be a responsibility more fully shared with State and local governments. (64)

Similar to other Trump documents, the budget veers toward incoherence when it states that

The Budget proposes legislative reforms to encourage work and self-sufficiency across its core rental assistance programs, consistent with broader Administration goals. Currently, tenants generally pay 30 percent of their adjusted income toward rent. The Administration’s reforms require able-bodied individuals to shoulder more of their housing costs and provide an incentive to increase their earnings. (Id.)

Decreasing the housing subsidy will decrease, not increase, the incentive to work. All other things being equal, increasing a household’s rent the more they work will discourage additional work.

It is hard to know what to do with a budget like this. Already, the Administration is backtracking on some of the cuts, including some of those targeting HUD. It seems highly unlikely that Congressional Republicans will wipe out the CDBG program because those funds are spread across their districts as well. But this sally in the budget wars is more than a shot across HUD’s bow. Rather, it reflects a strategy of weakening the safety net for those most in need.

Redefault Risk After the Mortgage Crisis

 

A tower filled with shredded U.S. currency in the lobby of the Federal Reserve Bank of Philadelphia.

Paul Calem et al. of the Phillie Fed posted Redefault Risk in the Aftermath of the Mortgage Crisis: Why Did Modifications Improve More Than Self-Cures? The abstract reads,

This paper examines the redefault rate of mortgages that were selected for modification during 2008–2011, compared with that of similarly situated self-cured mortgages during the same period. We find that while the performance of both modified and self-cured loans improved dramatically over this period, the decline in the redefault rate for modified loans was substantially larger, and we attribute this difference to a few key factors. First, the repayment terms provided by modifications became increasingly generous, including the more frequent offering of principal reduction, resulting in greater financial relief to borrowers. Second, the later modifications also benefited from improving economic conditions — modification became more effective as unemployment rates declined and home prices recovered. Third, we find that the difference in redefault rate improvement between modified loans and self-cured loans is not fully explained by observable risk and economic variables. We attribute this residual difference to the servicers’ learning process — so-called learning by doing. Early in the mortgage crisis, many servicers had limited experience selecting the best borrowers for modification. As modification activity increased, lenders became more adept at screening borrowers for modification eligibility and in selecting appropriate modification terms.

The big question, of course, is what does this all tell us about preparing for the next crisis? That crisis, no doubt, won’t be a repeat of the last one. But it will likely rhyme with it enough — falling home prices, increasing defaults — that we can draw some lessons. One is that we did not use principal reductions fast enough to make a big difference in how the crisis played out. There were a lot of reason for this, some legit and some not. But if it is good public policy overall, we should set up mechanisms to deploy principal reduction early in the next crisis so that we do not need to navigate all of the arguments about moral hazard while knee deep in it.

Micro Apartments and The Housing Crisis

photo by BalazsGlodi

The NYU Furman Center has posted 21st Century SROs: Can Small Housing Units Help Meet the Need for Affordable Housing in New York City? The policy brief opens,

Throughout much of the last century, single-room occupancy (SRO) housing was a commonly available type of low-rent housing in New York City, providing housing to people newly arrived in the city, low-income single New Yorkers, and people needing somewhere to live during life transitions. SRO units typically consisted of a private room with access to full bathroom and kitchen facilities that a renter shared with other building occupants. As the city fell onto hard times, so did SRO housing. During the second half of the last century, many SROs came to serve as housing of last resort, and policymakers enacted laws limiting their construction and discouraging the operation of SRO units. Many SROs were converted to other forms of housing, resulting in the loss of thousands of low-rent units in the city.

New research and analysis from the NYU Furman Center addresses the question of whether small housing units (self-contained micro units and efficiency units with shared facilities) can and should help meet the housing need previously served by SROs. In this policy brief, we present a summary of the paper, 21st Century SROs: Can Small Housing Units Help Meet the Need for Affordable Housing in New York City? We provide an overview of the potential demand for smaller, cheaper units, discuss the economics of building small units, analyze the main barriers to the creation of small units that exist in New York City, and suggest possible reforms that New York City can make to address these barriers. (1)

The policy brief makes a series of recommendations, including

  • reducing density limitations for micro units near transit hubs
  • permitting mixed-income and market-rate efficiency units
  • creating a government small unit program to promote the construction of micro apartments

There is no doubt that the lack of supply is a key driver of the affordable housing crisis across the country. Small units should be part of the response to that crisis, not just in New York City but in all high-cost cities.