Author Archives: David Reiss

The FHA’s Ailing Reverse Mortgage Program

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photo by aag.com

The Fiscal Year 2017 Independent Actuarial Review of the Mutual Mortgage Insurance Fund: Cash Flow Net Present Value from Home Equity Conversion Mortgage Insurance in Force has been released. It has some bad news:

FHA provides reverse mortgage insurance through the HECM program. HECMs enable senior homeowners to access the value of their homes. The program began as a pilot program in 1989 and became permanent in 1998. Between 2003 and 2008, the number of HECM endorsements grew because of increasingly widespread product awareness, lower interest rates, higher home values and higher FHA mortgage limits. Prior to fiscal year 2009, the HECM program was part of the General Insurance (GI) Fund. The FHA Modernization Act within the Housing and Economic Recovery Act of 2008 (HERA) moved all new HECM program endorsements into the MMIF effective October 1, 2008.

The Cranston-Gonzalez National Affordable Housing Act (NAHA), enacted in 1990, introduced a minimum capital requirement for MMIF. By 1992, the capital ratio was to be at least 1.25%, and by 2000 the capital ratio was to be no less than 2.0%. The capital ratio is defined by NAHA as the ratio of capital plus Cash Flow NPV to unamortized insurance‐in-force (IIF). NAHA also implemented the requirement that an independent actuarial study of the MMIF be completed annually. HERA also amended 12 USC 1708(a)(4) to include the requirement for the annual actuarial study. Accordingly, an actuarial review must be conducted on HECM mortgages within the MMIF. In this report, we analyze the HECM portion of the MMIF, which is mortgages endorsed in fiscal year 2009 and later.

Pinnacle projects that, as of the end of fiscal year 2017, the HECM Cash Flow NPV is negative $14.2 billion. (4, citation omitted, emphasis in the original)

With the housing market on the mend, Congress should ensure that essential infrastructure of the housing finance market is on solid footing. The HECM program should not have a negative cash flow (net present value) while the housing market is healthy as that will compound the bad news when the market takes a turn for the worse.

The Future of Public Housing

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The Terner Center for Housing Innovation at UC Berkeley has posted Lessons for the Future of Public Housing: Assessing the Early Implementation of the Rental Assistance Demonstration Program. Housing policy analysts have bemoaned the chronic underfunding of public housing for decades to little effect. This study looks at a relatively new initiative, the Rental Assistance Demonstration program and evaluates how local public housing authorities have played the hand that they have been dealt by Congress, as weak as it may be. The study opens,

In its 2018 budget, the Trump Administration is proposing to slash public housing funding by $1.8 billion, a 29 percent decline from 2017. This is on top of nearly a decade of continued cuts to public housing, for both capital improvements and operations. The consequences of these perpetual funding shortfalls are dire for the 2.2 million residents who live in public housing, exposing them to significant health and safety hazards from the lack of maintenance, including exposure to mold and lead paint, rodent infestations, and outdated electrical and sewage systems.

While the Senate markup of the appropriations bill reverses some of the more drastic funding cuts proposed by the administration, the amount of funds allocated to the public housing operating and capital funds remains well below need. Nearly half (44%) of the nation’s public housing stock was built before 1970, resulting in significant need for maintenance and rehabilitation. However, federal funding for capital investments in public housing dropped by 50 percent between 2000 and 2015, generating a $26 billion backlog of capital repairs. The lack of maintenance is directly tied to the loss of public housing units: approximately 300,000 units— more than 20 percent of the total public housing stock—have been demolished over the past 20 years due exclusively to units being uninhabitable.

At the same time, the Senate markup lifts the current 225,000 unit cap on public housing conversions under the Rental Assistance Demonstration (RAD) program, signaling its support for the program. Congress passed RAD in 2012 to address the chronic underinvestment in public housing. Through the RAD program, public housing authorities (PHAs) can convert their portfolio of HUD-funded units to project-based Section 8 contracts, and in doing so, be positioned to tap into private sources of funding for real estate, including debt and equity. These funds can be leveraged to rehabilitate older buildings and protect units from obsolescence.

Though RAD may seem novel, most affordable housing built today is financed with multiple sources of funding. For example, the Low Income Housing Tax Credit (LIHTC) program, which helped finance 2.78 million units of affordable housing built between 1987 and 2014, has long used debt and equity financing to produce and preserve affordable housing. Debt financing is a powerful tool: it is the same principle that allows households to buy a home with only a down payment.

But debt financing also entails risks, including the risk of default. Ensuring that deals are appropriately underwritten—and have adequate gap funding support—is critical for the longterm financial viability of the properties. The introduction of debt financing also requires strong property and asset management skills, which do not always exist at the local level.

And RAD changes the governance and streams of funding for public housing, which has implications for housing authority capacity and sustainability over the long-term. Thus, mechanisms need to be in place for oversight and accountability, especially as it relates to tenants’ rights and well-being.

In this policy brief, we summarize findings from more than 25 interviews with staff at public housing authorities and other organizations across the country who have been engaged in the implementation of RAD at the local level. The goal of this brief is to highlight the challenges that housing authorities have faced in implementing RAD in their markets, and to share best practices that have emerged in RAD implementation. Future research will look at the impact of RAD from the perspective of residents.

The brief covers RAD implementation in a wide range of housing markets, including communities in Arizona, California, New York, North Carolina, Tennessee, and Texas, to highlight RAD’s flexibility and limitations in different market contexts. In San Francisco and New York, for example, RAD is being used as a tool to leverage funds needed to preserve public housing stock in the face of high housing costs and significant concerns over displacement. In Laurinburg, North Carolina, RAD is helping expand the capacity of the housing authority to manage its stock in a region hard-hit by the recession and ensuing job losses. In many of the markets that we studied, PHAs are converting all of their public housing under RAD –known as a “portfolio” conversion—allowing us to explore the implications of a changing institutional landscape for public housing at the local level.

Overall, respondents stressed the benefits of RAD, but also provided insights into how the program could be improved moving forward. Because many PHAs are still undergoing RAD conversion, and there are discussions at the federal level to lift the cap on the number of units that can be converted, these insights are particularly timely. Given political realities and federal budget constraints, RAD may well be the best prospect for preserving public housing going forward. The program could be made even more effective by drawing on the lessons learned on the ground in the first few years of the program. (2-3, citations omitted)

Smarter Housing Tax Breaks

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Matt Rossman has posted a timely article, In Search of Smarter Homeowner Subsidies, to SSRN just as Congress debates the future of the mortgage interest deduction and other tax perks of homeownership. The abstract reads,

Critics have long assailed the federal tax code’s homeowner subsidies as lucrative tax breaks for upper income households that are essentially worthless to lower income households financially constrained from purchasing a home. This article examines the subsidies through a different lens and reveals another serious flaw that has received little attention. It demonstrates how the homeowner subsidies do very little to contain the negative housing externalities that other federal policies seek to abate and, worse yet, probably undermine these policies by subsidizing behavior that exacerbates the externalities. These policies are wide-ranging and include: (i) combating blight, deterioration and public health risks in disinvested housing markets, (ii) decreasing economic and racial housing segregation, and (iii) lessening environmental degradation that results from housing choices, while reducing the vulnerability of those who reside in environmental hotspots.

This article provides several explanations for this disconnect. Among these is an idealization of homeownership, reflected in the tax code, which sees only its positive externalities. Accordingly, the tax code subsidies reward homeowner decisions at large and without regard to the negative externalities that often follow from homeowner location and form decisions. This serves as the basis for this article’s contention that the current subsidies are not “smart.”

This article then explores whether and how the homeowner subsidies might be made smarter. Applying public finance research on the track record of more targeted, development subsidies at the state and local levels, the article identifies three conceptual legal models for smarter subsidies. It also identifies a host of accompanying challenges, many related to trying to tackle multiple housing externalities that vary across and within thousands of different localized housing markets. The article calls attention to the recent revolution in the quantity, quality and access to market, submarket and property specific real estate data, which is fueling a significant uptick in the sophistication of strategic housing planning at the community level. These advances may be the best reason to think that smarter federal homeowner subsidies are possible. This article closes by suggesting that Congress authorize HUD to pilot a program of community-specific homeowner subsidies, seeking to foster community level innovation that might later be more broadly adaptable.

The article challenges us to think of tax reform as an opportunity to do more than just move money up or down an income bracket:

The prospect of smarter homeowner subsidies is tantalizing. When considering the sheer scale of what the federal government currently invests in homeowner subsidies that inure primarily to the benefit of higher income households and are completely insensitive to negative housing externalities, it is difficult not to wonder what a more carefully considered system of allocating subsidies might yield. If done right, a powerful tool could be added to the mix of federal housing strategies. (59)

The current state of affairs in DC does not give me much hope that Congress has the stomach to think big about housing tax policy right now, but this article will provide much food for thought when it does.

How Important Is Skin in The Game?

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Haoyang Liu has posted a paper to SSRN that challenges the effectiveness of skin-in-the-game market discipline: Does Skin-in-the-Game Discipline Risk Management? Evidence from Mortgage Insurance. The abstract reads,

Many mortgage reform proposals suggest replacing Fannie Mae and Freddie Mac (the GSEs) with private entities. A common assumption underlying these proposals is that unlike the GSEs, private insurers will properly manage risk and set fair prices. Inconsistent with this assumption, this paper presents evidence that private insurers less effectively managed home price risks during the 2000-2006 housing boom than the GSEs did. Mortgage origination data reveal that the GSEs were selecting loans with increasingly higher percentages of down payments, or lower loan to value ratios (LTVs), in boom areas than in other areas. These lower LTVs in boom areas reduced the GSEs’ exposure to overheated markets. Furthermore, the decline of LTVs in boom areas stems entirely from the segment insured by the GSEs only, and none of the decline stems from the segment where private mortgage insurers take the first loss position. Private insurers also did not lower their exposure to home price risks along other dimensions, including the percentage of high LTV GSE loans they insured and the percentage of insured mortgage balance. My results highlight that post-crisis reform of the mortgage insurance industry should carefully consider additional factors besides moral hazard induced by the government guarantees, such as mortgage insurers’ future home price assumptions and the industry organization of the mortgage origination chain.

The paper’s conclusions are sobering for those interested in increasing the role of private capital in the mortgage market (including yours truly):

Many mortgage market reform proposals assume that private insurers will set fair prices and properly manage risk. Evidence from this paper suggests that private insurers less effectively managed home price risk during the 2000-2006 housing boom than Fannie and Freddie did.

These somewhat surprising results are nevertheless consistent with the history of the private mortgage insurance industry, including its repeated and concentrated failures. Most recently in the 2008 crash, three out of the eight largest private mortgage insurers failed. However, perhaps 31 overshadowed by the highly publicized and controversial bailout of the GSEs, private mortgage insurers’ failures have received relatively little attention from academics and the popular press. Many post-crisis proposals also assume that replacing the GSEs by private insurers would be a panacea. My results suggest that privatizing the GSEs alone is unlikely to ensure sufficient risk management in the mortgage insurance industry. Additional factors besides private capital, such as assumptions about future house prices and bargaining power of private insurers in front of large lenders, are important in shaping risk management practices. One way to establish reasonable house price assumptions is to stress test mortgage insurers, forcing the industry to consider their exposure to the housing downturn scenarios proposed by regulators.

The mortgage insurance industry plays a crucial role in financing Americans’ mortgages. Their insurance reduces or removes mortgage default risks, thereby enhancing the liquidity of mortgage backed securities and lowering homebuyers’ borrowing costs. The risks they face and the optimal regulatory structure for them deserve more study to prevent them from being a source of systemic risk in the financial system. (31-32)

The paper suggests that we should not expect that private mortgage insurers can play an outsized role in keeping us safe from booms and busts. They have succumbed to bubble thinking in the past and there is no reason to think that they would not in the future as well.

Your Lender, The Federal Reserve Board

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photo by United States Federal Reserve

Federal Reserve Chair Yellen

Laurie Goodman and Bing Bai at the Urban Institute have posted Normalizing the Federal Reserve’s Balance Sheet The Impact on the Mortgage-Backed Securities Market. It is quite extraordinary to realize that the Federal Reserve owns nearly a third of outstanding residential mortgage-backed securities. When we think about the appropriate role of the government in the housing finance market, we cannot forget about this type of involvement. The paper opens,

During the crisis, the Federal Reserve found the traditional tools for monetary policy insufficient to stimulate the economy. From December 2008 to December 2015, the Fed’s primary policy tool, the target Fed funds rate, was set between 0 and 0.25 percent. But the economy remained weak, and there was no room to cut rates further. As a result, the Fed began to purchase large quantities of assets from the private sector. These programs are referred to as quantitative easing or large-scale asset purchases. The Fed owned $1.77 trillion of agency mortgage-backed securities (MBS) and $2.45 trillion of US Treasury securities (Treasuries) in late September 2017 and began to reduce the amount of these portfolio holdings in October 2017.

Some background: Since the Great Recession, the Fed has done three rounds of quantitative easing. From November 2008 to March 2010, it purchased $1.75 trillion in long-term Treasuries, Fannie Mae and Freddie Mac agency debentures, and agency mortgage-back securities (comprising Ginnie Mae, Fannie Mae, and Freddie Mac issuances). From November 2010 to June 2011, the Fed purchased an additional $600 billion of Treasuries. From September 2012 to September 2014, the Fed engaged in its third round of quantitative easing, initially purchasing $85 billion a month in Treasuries and agency debt and MBS, with $40 billion of agency MBS. The Fed began to taper its purchases in December 2013 and ended the program in October 2014. From October 2014 through September 2017, the Fed has reinvested its runoff. Through these actions, the Fed owned $1.77 trillion of agency MBS, nearly 29 percent of all outstanding MBS as of late September 2017.

The Federal Open Market Committee announced on September 20, 2017, that it would begin to normalize its balance sheet in October 2017. The committee has been transparent about the course. It will begin by reducing the reinvestment rates on its portfolio. In months 1 through 3, the Fed would let the System Open Market Account (SOMA) portfolio run off by $10 billion each month, increasing to $20 billion in months 4 through 6, $30 billion in months 6 through 9, $40 billion in months 10 through 12, and $50 billion a month thereafter. The maximum runoff in each month, if met, would comprise 60 percent Treasuries and 40 percent MBS. If there is not enough runoff in that month, the Fed will not sell to meet these targets.

Although this timetable is clear, additional questions arise about the MBS portfolio that the Fed should shed some light on. The largest questions include the following: What size and mix of assets does the Fed eventually want to hold? And how does it intend to get there? In this brief, we argue that this is not an academic exercise. When the Fed reaches its desired balance sheet size, it will hold approximately $1.18 trillion in mortgage assets. It will take a long time for these to run off if there is no selling. This may be fine, but the Fed has made several comments that indicate it could sell the “residual.” For example, the minutes of the September 2014 meeting includes the following statement:

The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance.

It is not at all clear what constitutes a “residual.”

This brief has four sections. The first shows that under assumptions reasonably close to what the Fed has used, there will still be close to $1.18 trillion of MBS on its books when the Fed balance sheet normalizes. We then review the arguments about the Fed’s long-term desired portfolio mix. If it is Treasuries only, this raises questions about whether and how quickly the Fed should change its mortgage and treasury mix to avoid making asset allocation decisions that distort financial markets. In the third section, we argue that the Fed should do some active portfolio management while they are still doing a small amount of reinvestment. Finally, we make the case that the Fed could play a costless and helpful role in launching the single government-sponsored enterprise (GSE) security. (1-2)

The paper raises some important policy questions:

There has been considerable discussion on what role mortgages should play in the Fed’s portfolio. There is general but not universal agreement that the Fed should not be in the asset allocation business over the long term because it distorts financial market prices. Lawrence White has stated that “government programs that divert credit away from the most productive uses, as evaluated by the marketplace, are inherently wasteful, even if policymakers have the best of intentions.” Charles Plosser, a former president of the Federal Reserve Bank of Philadelphia, sees additional dangers, noting that holding securities other than Treasuries opens the door for Congress (or the Fed) to use the balance sheet for political purposes. The Fed’s balance sheet could be “a huge intermediary and supplier of taxpayer subsidies to selected parties through credit allocation.” For example, if there was an infrastructure bill, the funds could be used to purchase the bonds that support the infrastructure initiative. Similarly, the funds could be used to purchase bonds to keep a municipality from defaulting. (9, citations omitted)

The Fed should address these policy questions head on, before any unintended consequences of such a dramatic policy intervention make themselves known.

Regulatory Approaches to Airbnb

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photo by Open Grid Scheduler

Peter Coles et al. have posted Airbnb Usage Across New York City Neighborhoods: Geographic Patterns and Regulatory Implications to SSRN. Two of the co-authors are affiliated to Airbnb and the other three are affiliated to NYU. The paper states that “No consulting fees, research grants or other payments have been made by Airbnb to the NYU authors . . .” (1) The abstract reads,

This paper offers new empirical evidence about actual Airbnb usage patterns and how they vary across neighborhoods in New York City. We combine unique, census-tract level data from Airbnb with neighborhood asking rent data from Zillow and administrative, census, and social media data on neighborhoods. We find that as usage has grown over time, Airbnb listings have become more geographically dispersed, although centrality remains an important predictor of listing location. Neighborhoods with more modest median household incomes have also grown in popularity, and disproportionately feature “private room” listings (compared to “entire home” listings). We find that compared to long-term rentals, short-term rentals do not appear to be as profitable as many assume, and they have become relatively less profitable over our time period. Additionally, short-term rentals appear most profitable relative to long-term rentals in outlying, middle-income neighborhoods. Our findings contribute to an ongoing regulatory conversation catalyzed by the rapid growth in the short-term rental market, and we conclude by bringing an economic lens to varying approaches proposed to target and address externalities that may arise in this market.

I found the review alternative regulatory approaches to be particularly helpful:

City leaders around the world have adopted a wide range of approaches. We conclude by reviewing these alternative regulatory responses. We consider both citywide as well as neighborhood-specific responses, like those recently enacted in Portland, Maine or in New Orleans. A promising approach from an economic perspective is to impose fees that vary with intensity of usage. For instance, in Portland, Maine, short-term rental host fees increase with the number of units a given host seeks to register, and a recent bill from Representatives in the Commonwealth of Massachusetts (H.3454) propose taxes that vary with the intensity of usage of individual units. Such varying fees may help discourage conversions of long-term rentals to short-term rentals and better internalize externalities that might rise with greater use. That said, overly-customized approaches may be difficult to administer. Regulatory complexity itself should also be a criterion in choosing policy responses. (2-3, citations omitted)

We are still a long ways off from knowing how the short-term rental market will be regulated once it fully matures, so work like this helps us see where we are so far.

Insuring Sustainable Housing

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photo by Mark Moz

I posted Insuring Sustainable Housing to SSRN (and BePress). The abstract reads,

Today’s FHA suffered from many of the same unrealistic underwriting assumptions that have done in so many lenders during the 2000s. It had also been harmed, like other lenders, by a housing market as bad as any seen since the Great Depression. As a result, the federal government announced in 2013 that the FHA would require the first bailout in its history. At the same time that it faced these financial challenges, the FHA has also come under attack for the poor execution of some of its policies to expand homeownership. Leading commentators have called for the federal government to stop employing the FHA to do anything other than provide liquidity to the low end of the mortgage market. These arguments rely on a couple of examples of programs that were clearly failures but they fail to address the FHA’s long history of undertaking comparable initiatives. This article takes the long view and demonstrates that the FHA has a history of successfully undertaking new homeownership programs. At the same time, the article identifies flaws in the FHA model that should be addressed in order to prevent them from occurring if the FHA were to undertake similar initiatives in the future.

This short article is drawn from Underwriting Sustainable Homeownership: The Federal Housing Administration and The Low Down Payment Loan, 50 GA. L. REV. 1019 (2016).