Tag Archives: Housing Finance Policy Center

Three Paths to Housing Finance Reform

Posted on by

photo by theilr

The Urban Institute’s Jim Parrott has posted Clarifying the Choices in Housing Finance Reform. It opens,

The housing finance reform debate has often foundered under the weight of its complexity. Not only is it a complicated topic, both in its substance and its politics, but the way that we talk about it makes the issues involved indecipherable to all but a few. Each proponent brings a different nomenclature, a different frame of reference, often an entirely different language, making it enormously difficult to sort through where there is agreement and where there is not.

As a case in point, three prominent proposals for reform have been put on the table in recent months: one offered by Lew Ranieri, Gene Sperling, Mark Zandi, Barry Zigas, and me (Promising Road Proposal); one offered by Ed DeMarco and Michael Bright (Milken Proposal); and one offered by the Mortgage Bankers Association (MBA Proposal). These proposals have been discussed and debated in many forums, each assessed for its respective merits, risks, and likelihood of passage in Congress, but each largely in isolation from one another. That is, they are not compared in any intelligible way, forcing those hoping to come to an informed view to choose among what appear to be entirely different visions of reform, without any easy way to make sense of the choice.

In this brief essay, I thus bring these three proposals together into a single framework, making it clearer what they share and where they differ. Once the explanatory fog is lifted, one can see that they actually share a great deal and that deciding among them is not prohibitively complex, but a matter of assessing two or three key differences. (1-2)

After a review of each proposal, Parrott finds that there are two critical differences between the three proposals.

  • Ginnie versus CSP. For the securitization infrastructure in the new system, Milken uses the Ginnie Mae infrastructure, while the MBA and our proposal both use the CSP.
  • What to do with Fannie and Freddie. The MBA would turn them into privately owned utilities that compete with other market participants over the distribution of the system’s non-catastrophic credit risk, Milken would turn them into lender-owned mutuals that do the same, and we would combine them with the CSP to distribute that risk and manage the system’s securitization.

With these distinctions in mind, the proposals can be much more easily compared across the criteria that should ultimately drive our decisions on housing finance reform:

  • Access to sustainable credit. Which best maintains broad access to mortgage loans for those in a financial position to be a homeowner at the lowest rates?
  • Protecting the taxpayer. Which best insulates taxpayers behind private capital, aligns incentives systemwide and addresses the too-big-to-fail risk that undermined the prior system?
  • Promoting healthy competition. Which best maximizes the kinds of competition that will improve options and services for consumers, lenders, and investors?
  • Ease of transition. Which provides the least disruptive, least costly path of reform? (7-8)

This is a very useful tool for understanding the choices that we face if we are to move beyond the limbo of Fannie and Freddie’s conservatorships.  One limitation is that Parrott does not address the Hensarling wing of the Republican Party which is looking to completely privatize the housing finance system for conforming mortgages. Given that Hensarling is the Chair of the House Financial Services Committee, he will have a powerful role in enacting any reform legislation.

I am not all that hopeful that Congress will be able to come up with a bill that can pass both houses in the near future.  But Parrott’s roadmap is helpful preparation for when we are ready.

Enlarging The Credit Box

Posted on by

boxes-157191_1280

The Hill published my column, It’s Time to Expand The Credit Box for American Homebuyers. it reads,

The dark, dark days of the mortgage market are far behind us. The early 2000s were marked by a set of practices that can only be described as abusive. Consumers saw teaser interest rates that morphed into unaffordable rates soon thereafter, high fees that were foisted upon borrowers at the closing table and loans packed with unnecessary and costly products like credit insurance.

After the financial crisis hit, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The law included provisions intended to protect both borrowers and lenders from the craziness of the previous decade, when no one was sufficiently focused on whether loans would be repaid or not.

The Consumer Financial Protection Bureau (CFPB) promulgated the rules that Dodd-Frank had called for, like the ability-to-repay and qualified mortgages rules. These rules achieved their desired effect as predatory mortgage loans all but disappeared from the market.

But there were consequences, and they were not wholly unexpected. Mortgage credit became tighter than necessary. People who could reliably make their mortgage payments were not able to get a mortgage in the first place. Perhaps their income was unreliable, but they had a good cushion of savings. Perhaps they had more debts than the rules thought advisable, but were otherwise frugal enough to handle a mortgage.

These people banged into the reasonable limitations of Dodd-Frank and could not get one of the plain vanilla mortgages that it promoted. But many of those borrowers found out that they could not go elsewhere because lenders avoided making mortgages that were not favored by Dodd-Frank’s rules.

Commentators were of two minds when these rules were promulgated. Some believed that an alternative market for mortgages, so-called non-qualified mortgages, would sprout up beside the plain vanilla market, for good or for ill. Others believed that lenders would avoid that alternative market like the plague, again for good or for ill. Now it looks like the second view is mostly correct and it is mostly for ill.

The Urban Institute Housing Finance Policy Center’s latest credit availability index shows that mortgage availability remains weak. The center concludes that even if underwriting loosened and current default risk doubled, it would remain manageable given past experience.

The CFPB can take steps to increase the credit box from its current size. The “functional credit box” refers to the universe of loans that are available to borrowers. The credit box can be broadened from today’s functional credit box if mortgage market players choose to thoughtfully loosen underwriting standards, or if other structural changes are made within the industry.

The CFPB in particular can take steps to encourage greater non-qualified mortgage lending without needing to amend the ability-to-repay and qualified mortgages rules. CFPB Director Richard Cordray stated earlier this year that “not a single case has been brought against a mortgage lender for making a non-[qualified mortgage] loan.”

But lenders have entered the non-qualified mortgage market very tentatively and apparently need more guidance about how the Dodd-Frank rules will be enforced. Moreover, some commentators have noted that the rules also contain ambiguities that make it difficult for lenders to chart a path to a vibrant non-qualified mortgage line of business. Lenders are being very risk-averse here, but that is pretty reasonable given that some violations of these rules can result in criminal penalties, including jail time.

The mortgage market of the early 2000s provided mortgage credit to too many people who could not make their monthly payments on the terms offered. The pendulum has now swung. Today’s market offers very few unsustainable mortgages, but it fails to provide credit to some who could afford them. That means that the credit box is not at its socially optimal size.

The CFPB should make it a priority to review the regulatory regime for non-qualified mortgages in order to ensure that the functional credit box is expanded to more closely approximate the universe of borrowers who can pay their mortgage payments month in, month out. That would be good for those individual borrowers kept out of the housing market. It would also be good for society as a whole, as the financial activity of those borrowers has a multiplier effect throughout the economy.

2-4 Unit Properties: Housing’s Middle Child

Posted on by

photo by Kgbo

The Urban Institute’s Laurie Goodman and Jun Zhu have posted Do Two- to Four-Unit Properties Have Higher Credit Risk? An Analysis of Default and Loss Experience to SSRN. The abstract reads,

Two- to four-family properties make up 19% of all rental housing but receive almost no attention. Using a unique dataset from Freddie Mac and Fannie Mae, we show that, for any given set of loan characteristics and compared with one-unit properties, two- to four-unit properties are more likely to default, its owner-occupied (investment) properties are less (more) likely to liquidate, and all two- to four-unit properties are more likely to have a higher loss severity upon liquidation. Historically, these patterns have led to higher losses on two- to four-unit loans. Current tighten credit results in loss rates much closer to those on one-unit owner-occupied properties, indicating that policymakers can relax the credit requirements of two-to-four properties to better serve affordable rental housing.

It is great that the authors are looking at the neglected, middle child of the rental housing market. Providing 19% of the rental housing stock is nothing to sneeze at, even if other segments of the housing stock provide more.

It is particularly interesting to me that owner-occupied 2-4s do better than investor-owned 2-4s in terms of liquidation, even while overall 2-4s are roughly on par with 1-unit owner occupied properties in that regard. There are a lot of other interesting tidbits about this housing stock in the paper, such as the fact that these properties are more likely to be owned by lower-income households and that 2-units have the highest default rates of 1-4 unit properties.

The authors make the case that

though predicted losses on two- to four-unit production are now on par with one-unit owner-occupied properties, the low volume suggests that many borrowers (who are disproportionately likely to be low and moderate income and minority) are getting squeezed out. In the interest of expanding credit to these underserved populations and expanding, or at least preserving, the supply of affordable rental housing, the government-sponsored enterprises (GSEs) could relax the current loan-to-value requirements. If this relaxing were coupled with counseling for landlords, we believe it would make financing more available for this critical part of the market, with little additional risk to the GSEs. (3)

This all sounds good, although I am somewhat skeptical of the claim that reduced financing costs for owners will be passed onto tenants in the form of lower rents or rent increases. There are a lot of factors that go into rent levels, and costs are just one of them. The local demand for housing as well as the competing supply cannot be ignored. Owners may be able to keep all of those reduced financing costs as additional profits, depending on those local conditions.

The main question I am left with after reading the paper is — why haven’t Fannie and Freddie, whose data the paper is based upon, already reached the same conclusion about loosening credit for this type of housing? Do they know something about it that the author’s don’t?

Mortgage Market Overview

Posted on by

telescope-122960_1920

The Urban Institute’s Housing Finance Policy Center issued its May 2016 Housing Finance at a Glance Chartbook. This monthly report is invaluable for those of us who follow the mortgage market closely. The mortgage market changes so quickly and so much that what one thinks is the case is often no longer the case a few months later. This month’s report has new features, including Housing Credit Availability Index and first-time homebuyer share charts. Here are some of the key findings of the May report:

  • The Federal Reserve’s Flow of Funds report has consistently indicated an increasing total value of the housing market driven by growing household equity in each quarter of the past 2 years, and the trend continued according to the latest data, covering Q4 2015. Total debt and mortgages increased slightly to $9.99 trillion, while household equity increased to $13.19 trillion, bringing the total value of the housing market to $23.18 trillion. Agency MBS make up 58.2 percent of the total mortgage market, private-label securities make up 6.1 percent, and unsecuritized first liens at the GSEs, commercial banks, savings institutions, and credit unions make up 29.4 percent. Second liens comprise the remaining 6.4 percent of the total. (6)

It is worth wrapping your head around the size of this market. Total American wealth is about $88 trillion, so household equity of $13 trillion is about 15 percent of the total. With debt and mortgages at $10 trillion, the aggregate debt-to-equity ratio is nearly 45%.

  • As of March 2016, debt in the private-label securitization market totaled $613 billion and was split among prime (19.5 percent), Alt-A (42.2 percent), and subprime (38.3 percent) loans. (7)

This private-label securitization total is a pale shadow of the height of the market in 2007, back to the levels seen in 1999-2000. It is unclear when and how this market will recover — and the extent to which it should recover, given its past excesses

  • First lien originations in 2015 totaled approximately $1,735 billion. The share of portfolio originations was 30 percent, while the GSE share dropped to 46 percent from 47 in 2014, reflecting a small loss of market share to FHA due to the FHA premium cut. FHA/VA originations account for another 23 percent, and the private label originations account for 0.7 percent. (8)

The federal government, through Fannie Mae, Freddie Mac and Ginnie Mae, is insuring 69 percent of originations. Hard for me to think this is good for the mortgage market in the long term. There is no reason that the private sector could not take on a bigger share of the market in a responsible way.

  • Adjustable-rate mortgages (ARMs) accounted for as much as 27 percent of all new originations during the peak of the recent housing bubble in 2004 (top chart). They fell to a historic low of 1 percent in 2009, and then slowly grew to a high of 7.2 percent in May 2014. (9)

It is pretty extraordinary to see the extent to which ARMs change in popularity over time, although it makes a lot of sense. When interest rates are high and prices are high, more people prefer ARMs and when they are low they prefer FRMs.

  • Access to credit has become extremely tight, especially for borrowers with low FICO scores. The mean and median FICO scores on new originations have both drifted up about 40 and 42 points over the last decade. The 10th percentile of FICO scores, which represents the lower bound of creditworthiness needed to qualify for a mortgage, stood at 666 as of February 2016. Prior to the housing crisis, this threshold held steady in the low 600s. LTV levels at origination remain relatively high, averaging 85, which reflects the large number of FHA purchase originations. (14)

It is hard to pinpoint the right level of credit availability, particularly with reports of 1% down payment mortgage programs making the news recently. But it does seem like credit can be loosened some more without veering into bubble territory.

Hard to keep up with all of the changes in the mortgage market, but this chartbook sure does help.

Did Dodd-Frank Make Getting a Mortgage Harder?

Posted on by
Christopher Dodd

Christopher Dodd

Barney Frank

 

 

____________________________________________________________

The short answer is — No. The longer answer is — No, but . . .

Bing Bai, Laurie Goodman and Ellen Seidman of the Urban Institute’s Housing Finance Policy Center have posted Has the QM Rule Made it Harder to Get a Mortgage? The QM rule was originally authorized by Dodd-Frank and was implemented in January of 2014, more than two years ago. The paper opens,

the qualified mortgage (QM) rule was designed to prevent borrowers from acquiring loans they cannot afford and to protect lenders from potential borrower litigation. Many worry that the rule has contributed to the well-documented reduction in mortgage credit availability, which has hit low-income and minority borrowers the hardest. To explore this concern, we recently updated our August 2014 analysis of the impact of the QM rule. Our analysis of the rule at the two-year mark again finds it has had little impact on the availability of mortgage credit. Though the share of mortgages under $100,000 has decreased, this change can be largely attributed to the sharp rise in home prices. (1, footnotes omitted)

The paper looks at “four potential indicators of the QM rule’s impact:”

  1.  Fewer interest-only and prepayment penalty loans: The QM rule disqualifies loans that are interest-only (IO) or have a prepayment penalty (PP), so a reduction in these loans might show QM impact.
  2. Fewer loans with debt-to-income ratios above 43 percent: The QM rule disqualifies loans with a debt-to-income (DTI) ratio above 43 percent, so a reduction in loans with DTIs above 43 percent might show QM impact.
  3. Reduced adjustable-rate mortgage share: The QM rule requires that an adjustable-rate mortgage (ARM) be underwritten to the maximum interest rate that could be charged during the loan’s first five years. Generally, this restriction should deter lenders, so a reduction in the ARM share might show QM impact.
  4. Fewer small loans: The QM rule’s 3 percent limit on points and fees could discourage lenders from making smaller loans, so a reduction in smaller loans might show QM impact. (1-2)

The authors find no impact on on interest only loans or prepayment penalty loans; loans with debt-to-income ratios greater than 43 percent; or adjustable rate mortgages.

While these findings seem to make sense, it is important to note that the report uses 2013 as its baseline for mortgage market conditions. The report does acknowledge that credit availability was tight in 2013, but it implies that 2013 is the appropriate baseline from which to evaluate the QM rule. I am not so sure that this right — I would love to see some modeling that shows the impact of the QM rule under various credit availability scenarios, not just the particularly tight credit box of 2013.

To be clear, I agree with the paper’s policy takeaway — the QM rule can help prevent “risky lending practices that could cause another downturn.” (8) But we should be making these policy decisions with the best possible information.

GSE Reform, by Stealth?

Posted on by

Photo By Greg Willis

The Urban Institute’s Housing Finance Policy Center has issued its January 2016 Housing Finance at a Glance Chartbook. It opens by noting,

The FHFA recently released its 2016 Scorecard for Fannie Mae and Freddie Mac with updated guidance for credit risk transfer transactions. A year ago, under the 2015 scorecard, the FHFA had required Fannie Mae and Freddie Mac to transfer credit risk on a fixed dollar amount of UPB [unpaid principal balance] – $150 billion for Fannie Mae and $120 billion for Freddie Mac. Both exceeded those targets (Fannie $187 billion and Freddie 210 billion). Additionally, the 2015 scorecard did not indicate how much credit risk should be transferred (expected or unexpected, or a specific numeric threshold for example), instead leaving it to the GSEs’ discretion.
But that changes in 2016. FHFA’s 2016 scorecard is a notable departure from 2015 in that it requires the GSEs to transfer credit risk on “at least 90 percent” of the newly acquired UPB (with exceptions for HARP refinances, mortgages with maturities 20 years and below and with loan-to-value ratios 60 percent and below). Another departure from 2015 is the added requirement to transfer a substantial portion of credit risk covering “most of the credit losses projected to occur during stressful economic scenarios.” In other words, GSEs are required to transfer nearly all credit risk on new production, except for what is catastrophic. These two requirements are highly noteworthy because over time they will put the GSEs (and hence the taxpayers) in a remote, catastrophic risk position, letting private capital bear vast majority of credit losses the vast majority of the time – a key objective of most housing finance reform proposals. (3)
I have been arguing for a long time that the private sector should bear the credit risk in the mortgage market, so I think this is a good thing in principle. The FHFA needs to ensure, of course, that the agencies are pricing the transfer of credit risk properly, but overall this is a step in the right direction. Not being privy to any conversations in the Beltway, I always wonder if things like this happen with some kind of bipartisan acquiescence, but I guess we won’t know until someone tells us what happened behind closed doors.

Principal-ed Reduction

Posted on by

Torn Dollar

 

The Urban Institute’s Housing Finance Policy Center has issued a report, Principal Reduction and the GSEs: The Moment for a Big Impact Has Passed. It opens,

The Federal Housing Finance Agency (FHFA) prohibits Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs) from unilaterally reducing the principal balance of loans that they guarantee, known as principal reduction. When director Ed DeMarco established the prohibition, he was concerned that reducing principal would cost the GSEs too much, not only in setting up the systems required to implement it, but also— and to him more important — in encouraging borrowers to default in order to receive the benefit. DeMarco’s position generated significant controversy, as advocates viewed principal reduction as a critical tool for reducing borrower distress and pointed out that the program the Obama administration had put forward to provide the relief had largely eliminated the cost to the GSEs, including the moral hazard. We believe that at the time the advocates had the better side of the argument.

The FHFA is now revisiting that prohibition, though in a very different economic environment than the one faced by Director DeMarco. Home prices are up 35.4 percent since the trough in 2011, adding $5 trillion in home equity and reducing the number of underwater homeowners from a peak of 25 percent to 10 percent. This means that far fewer borrowers would likely benefit under a GSE principal reduction program today. (1, footnote omitted)

Principal reduction was highly disfavored at the start of the financial crisis as it was perceived as a sort of giveaway to irresponsible borrowers. Some academics have disputed this characterization, but it probably remains a political reality.

In any event, I think this report has the analysis of the current situation right — the time for principal reduction has passed. But it is worth considering the conditions under which it might be appropriate in the future (for that next crisis, or the one after that). The authors make four  assumptions for a politically feasible principal reduction program:

  1. borrowers must be delinquent at the time the program is announced, in order to avoid the moral hazard of encouraging borrowers to default;
  2. borrowers must be underwater;
  3. the house must be owner-occupied; and
  4. the principal reduction is in the economic interest of Fannie and Freddie.

It is worth noting that during the Great Depression, the federal government figured out ways to reduce the burden of rapidly dropping house prices on lenders and borrowers alike without resorting to principal reduction much. Borrowers benefited from longer repayment terms and lower interest rates. Below-market interest rates are similar to principal reduction because they also reduce monthly costs for borrowers. They are also politically more feasible. It would be great to have a Plan B stored away at the FHFA, the FHA and the VA that outlines a systematic response to a nation-wide drop in housing prices. It could involve principal reduction but it does not need to.