Tag Archives: taxpayer

Strange Love for Homeowner Tax Rates

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                                  Peter Sellers as Dr. Strangelove

With a nod to Dr. Strangelove, David Hasen has posted a scary little thought experiment, How I Learned to Stop Worrying and Love our Homeowner Tax Rules on SSRN. The essay “estimates the magnitude of life-cycle tax benefits available from home ownership for representative taxpayers.” (1)

Hasan starts with a not-that-far-fetched example of a couple who purchases a California home in the 1960s. The home passes to their daughter and son-in-law in 2013. he documents a federal and state tax savings of about $15,000 per year for every year the home is owned by the family.

Hasan concludes,

A large literature has examined the distributional and allocative effects of the homeowner tax rules described above. Summarizing, the literature notes that the rules favor homeowners over renters, owners of larger homes over owners of smaller ones, and residents of states with a large owner-occupied housing sector over residents of other states. The literature also notes the efficiency costs associated with the rules, as taxpayers respond by adjusting their economic positions in ways that reduce total social wealth. The responses may include holding property rather than selling it, occupying it rather than renting it, and swapping it rather than selling it for cash, all as described above. Each of these choices, when tax-motivated, creates real economic costs.

The contribution of the present discussion is modest. One largely hidden aspect of the rules has been just how large the dollar tax savings can be relative to affected taxpayers’ overall tax liabilities, especially when considered in life-cycle terms. The discussion above gives a sense of the numbers for a relatively typical, albeit profitable, course of investment over two generations for an upper-income, but by no means wealthy couple. The bottom line is that for such a couple, taxes are reduced by 40 to 50 percent.

Benefits that are heavily skewed to higher income taxpayers and, consequently, that undermine the general distributional structure headlined in the law promote neither civic pride nor a sense of common purpose; benefits that have massive allocative effects create a large drag on the economy. If I hadn’t learned to stop worrying and love our homeowner tax rules, I might even be upset myself. (10, footnotes omitted)

Academics, myself included, rail against the way that federal housing policy overwhelmingly favors owners (wealthier, on average) over renters (poorer, on average), primarily through the tax code. It does not seem like the political will is there to change that dynamic at present. Nonetheless, it is important to keep reminding everyone of the facts:  federal housing policy heavily favors the wealthy over the poor, a sure sign of a poorly designed social policy.

Be Careful What You Wish For GSEs

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Genie Lamp

Jim Parrott and Mark Zandi have released a report, Privatizing Fannie and Freddie: Be Careful What You Ask For. The authors go through a very useful exercise in which they break down the cost of reprivatizing. The report opens,

Few are happy with the current housing finance system that has Fannie Mae and Freddie Mac in conservatorship and taxpayers backing most of the nation’s residential mortgage loans. Yet legislative efforts to replace the system have largely faltered, raising concern that we may not have the political will or competence to replace it any time soon.

This has created an opening for those who contend that we should not replace the system at all, but simply recapitalize the government-sponsored enterprises and release them from conservatorship. Fannie and Freddie were remarkably profitable prior to the financial crisis, after all, and have been consistently in the black recently. Why embark on the laborious, risky and now stalled process of fundamental reform when we can simply return to a model that we know can provide steady access to affordable, long-term fixed-rate lending?

While we both have serious concerns with the wisdom of releasing the duopoly back into the market, we thought it useful to set those concerns aside for the moment to explore the economics of the move. The discussion often takes for granted that this path would take us back to the world precrisis, but economic conditions and the regulatory environment have changed in ways that would significantly affect how Fannie and Freddie would function as reprivatized institutions. (2)

Parrott and Zandi conclude that

The debate over whether to recapitalize and release the GSEs into the private market is often framed as a choice of whether or not to return to a prior period in lending. For all its shortcomings, the argument goes, at least we know what to expect in the cost and availability of mortgage credit. But this is a misconception. In releasing the GSEs into the private market again, we would release them into a very different regulatory and economic environment, and they would respond, not surprisingly, by charging very different mortgage rates. (4)

I really have no argument with Parrott and Zandi’s paper, but I would note that their conclusions don’t differ so much from the pre-crisis academic papers that attempted to quantify the increase in mortgage rates that would result from privatizing the two companies — fifty basis points, give or take (see, for example, The GSE Implicit Subsidy and Value of Government Ambiguity).

I value Parrott and Zandi’s paper because it reminds us to keep pushing forward with real housing finance reform even though Congress has not yet made any progress on that front.

Krimminger and Calabria on Conservatorships

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When the Federal Housing Finance Agency (“FHFA”) was appointed conservator for Fannie Mae and Freddie Mac, it was the first use of the conservatorship authority under the Housing and Economic Recovery Act of 2008 (“HERA”), but it was not without precedent. For decades, the Federal Deposit Insurance Corporation (“FDIC”) has successfully and fairly resolved more than a thousand failing banks and thrifts using the virtually identical sections of the Federal Deposit Insurance Act (“FDIA”).
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The predictability, fairness, and acceptance of this model led Congress to adopt it as the basis for authorizing the FHFA with conservatorship powers over Fannie Mae and Freddie Mac in HERA. Instead of following this precedent, however, FHFA and Treasury have radically departed from HERA and the principles underlying all other U.S. insolvency frameworks and sound international standards through a 2012 re-negotiation of the original conservatorship agreement.
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.
     This paper will:
  • Describe the historical precedent and resolution practice on which Congress based FHFA’s and Treasury’s statutory responsibilities over Fannie Mae and Freddie Mac;
  • Explain the statutory requirements, as well as the procedural and substantive protections, in place so that all stakeholders are treated fairly during the conservatorship;
  • Detail the important policy reasons that underlie these statutory provisions and the established practice in their application, and the role these policies play in a sound market economy; and
  •  Demonstrate that the conservatorships of Fannie Mae and Freddie Mac ignore that precedent and resolution practice, and do not comply with HERA. Among the Treasury and FHFA departures from HERA and established precedents are the following:
    • continuing the conservatorships for more than 6 years without any effort to comply with HERA’s requirements
      to “preserve and conserve” the assets and property of the Companies and return them to a “sound and solvent” condition or place them into receiverships;
    • rejecting any attempt to rebuild the capital of Fannie Mae or Freddie Mac so that they can return to “sound and solvent” condition by meeting regulatory capital and other requirements, and thereby placing all risk of future losses on taxpayers;
    • stripping all net value from Fannie Mae and Freddie Mac long after Treasury has been repaid when HERA, and precedent, limit this recovery to the funding actually provided;
    • ignoring HERA’s conservatorship requirements and transforming the purpose of the conservatorships from restoring or resolving the Companies into instruments of government housing policy and sources of revenue for
      Treasury;
    • repeatedly restructuring the terms of the initial assistance to further impair the financial interests of stakeholders contrary to HERA, fundamental principles of insolvency, and initial commitments by FHFA; and
    • disregarding HERA’s requirement to “maintain the corporation’s status as a private shareholder-owned company” and FHFA’s commitment to allow private investors to continue to benefit from the financial value of the company’s stock as determined by the market. (1-3, footnotes omitted)

I am intrigued by the recollections of these two former government officials who were involved in the drafting of HERA (much as I was by those contained in a related paper by Calabria). But I am not convinced that their version of events amounts to a legislative history of HERA, let alone one that should be given any kind of deference by decision-makers. The firmness of their opinions about the meaning of HERA is also in tension with the ambiguity of the text of the statute itself. The plaintiffs in the GSE conservatorship litigation will see this paper as a confirmation of their position. I do not think, however, that the judges hearing the cases will pay it much heed.

Life Post-Fannie, Post-Freddie

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The Congressional Budget Office has released a report, Transitioning to Alternative Structures for Housing Finance. This report

examines various mechanisms that policymakers could use to attract more private capital to the secondary mortgage market. The report also addresses how those mechanisms could be combined in different ways to help the market make the transition to a new structure during the coming decade. CBO analyzed transition paths to four alternative structures that involve choices about whether the government would continue to guarantee payment on mortgages and MBSs and, if so, what form and prices those guarantees would have. Under those different structures, the government’s activities would range from providing full or partial guarantees for a large share of the mortgage market to playing a minimal role in a largely private market (except perhaps during a financial crisis). Any transition to a new type of secondary market would also require decisions about what to do with the existing operations, guarantee obligations, and investment holdings of Fannie Mae and Freddie Mac. (1, footnotes omitted)

The report has three key findings:

1.  A transition to a new structure for housing finance that emphasized private capital could reduce costs and risks to taxpayers. One drawback to such a transition is that mortgages could become somewhat less available and more expensive to borrowers. Thus, over the longer term, it could also result in a modest shift of the economy’s resources away from housing toward other activities.
2.  Although the transition to a new structure could significantly decrease the number of borrowers who received mortgages backed by Fannie Mae or Freddie Mac, additional private capital would replace most of the lost funding. Borrowers would probably not face significant increases in interest rates because the two GSEs’ current pricing is not too far below market pricing. Consequently, a gradual transition would probably exert only modest downward pressure on house prices.
3.  Because policymakers have already raised the guarantee fees charged by Fannie Mae and Freddie Mac close to those that CBO estimates would be charged by private insurers, the budgetary costs of the two GSEs’ activities over the next 10 years are expected to be small. As a result, the budgetary savings would also be small under any of the transition paths to a more private system that CBO considered. Thus, the choice between the different market structures probably rests primarily on considerations other than budgetary costs. (2)
I have been a long-time advocate for attracting more private capital to the secondary mortgage market, so I welcome this report. Given the public statements of the Obama Administration and the composition of the new Congress, there appears to be an opportunity to move in that direction. A bipartisan reform plan for the housing finance system will need to provide for a lender of last resort; appropriate consumer protection; and assistance for households that are underserved by the private market. There seems to be bipartisan will to reform this system, so we just need to chart a way to achieve it. This report leads us down the right path.

Reiss on GSE Privatization

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GlobeSt.com quoted me in Waiting to Say Goodbye to the GSEs. It reads in part,

US HUD Secretary Julian Castro added another “to do” item to the lame duck Congress’ list of things they should get done before they adjourn on Dec. 11: pass the bipartisan Johnson-Crapo Senate bill introduced earlier this year that would wind down the GSEs.

“This could be, I believe, a good victory in the lame duck session or next term of Congress for housing finance reform,” he said in an interview with Bloomberg Television earlier this week. The crux of the plan – doing away with Fannie Mae and Freddie Mac, creating a backstop for these loans and removing tax payer risk – are all supported by the Obama Administration, he said.

“Housing finance reform will continue to be a priority for the Obama Administration,” Castro said.

The multifamily finance industry has been expecting GSE reform for years now; certainly there have been calls for their dismantlement when they were placed in conservatorship in 2008 during the depth of the financial crisis. Many in the industry, in fact, would welcome their sunset, in the expectation that the private sector could fully and more efficiently and more cheaply provide the same level of funding.

That is not the unanimous sentiment though. In fact, opinions about the subject in commercial real estate range, widely, across the board from “it is about time” to “the politics are too strident for it to happen” to “maybe it will happen but it is difficult to believe the GSEs could entirely be replaced by the private sector.”

*     *     *

David Reiss, a professor of Law and Research Director, Center for Urban Business Entrepreneurship (CUBE) at Brooklyn Law School, has been calling for the privatization of Fannie and Freddie for some time and is dismissive of the “Chicken Little claims” that the sector will collapse if the government reduces its footprint in multifamily and single-family housing finance.

“With a carefully planned transition, it is eminently reasonable to believe that we can put private capital in a first loss position for multifamily housing so long as the government retains a role in subsidizing affordable housing and acting as a lender of last resort when necessary,” he tells GlobeSt.com.

Reiss on Housing Finance Reform

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Inside MBS and ABS, the trade journal, quoted me in DeMarco Cites ‘Structural Improvements’ in Housing Six Years After GSE Conservatorship, More Needed (behind a paywall). It reads,

Six years after the government takeover of Fannie Mae and Freddie Mac, the former regulator of the government-sponsored enterprises noted that the housing finance system has made “significant progress.” But even as critical structural changes are underway, comprehensive improvement is still several years out.

In a policy paper issued last week, Edward DeMarco–new senior fellow-in-residence for the Milken Institute’s Center for Financial Markets–said that house prices, as measured by the Federal Housing Finance Agency, have recovered more than 50 percent since their decline in 2007.

“While the damage from the housing crisis has been substantial, we are finally seeing a sustained market recovery,” said the former FHFA chief. “The crisis showed that numerous structural improvements were needed in housing–and such improvements have been underway for several years.”

Poor data, misuse of specialty mortgage products, lagging technologies, weak servicing standards and an inadequate securitization infrastructure became evident during the crisis.

“New data standards have emerged…with more on the way,” wrote DeMarco. “These standards should improve risk management while lowering origination costs and barriers to entry.” Development of the new securitization structure, begun more than two years ago, “should be a cornerstone for the future secondary mortgage market,” he added.

DeMarco said the major housing finance reform bills in the House and Senate share key similarities: “winding down Fannie Mae and Freddie Mac, building a common securitization infrastructure and drawing private capital back into the marketplace while reducing taxpayer involvement.”

DeMarco added, “We should build on these similarities, making them the cornerstone features of final legislation.” Prolonging the GSEs’ conservatorship, he warned, “will continue to distort the market and place taxpayers at risk.”

David Reiss, research director of the Center for Urban Business Entrepreneurship at the Brooklyn Law School, lauded the common securitization project. But Reiss worried the former FHFA head is too optimistic about the state of Fannie and Freddie.

“The GSEs have been in a state of limbo for far too long,” said Reiss. “All sorts of operational risks may be cropping up in the entities as employees sit around or walk out the door waiting for Congress to act.”

Fannie and Freddie’s Debt to Treasury

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Larry Wall of the Federal Reserve Bank of Atlanta has posted one of his Notes from the Vault, Have the Government-Sponsored Enterprises Fully Repaid the Treasury? It opens,

Have U.S. taxpayers been fully compensated for their bailout of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac? The Treasury is reported to have argued that “the value of Treasury’s commitment to the GSEs was “incalculably large,'” with the implication that it could never be repaid. Richard Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution [and who discloses that he consults “with several hedge funds with positions in Fannie and Freddie”], responded that “the level of the Treasury commitment was not ‘incalculably large’: it was $188 billion, all of which will shortly be repaid.” The significance of Epstein’s argument is that if Treasury has been fully compensated for its bailout of Fannie and Freddie, a case can be made that the future profits of the two GSEs should go to their private shareholders.

As an accounting matter, one could argue that Epstein is correct; the dividends equal the amount of Treasury funds provided to the GSEs. And as a legal matter, the issue may ultimately be resolved by the federal courts. However, as an economic matter, the value of the government’s contribution clearly exceeds $188 billion once the risk borne by taxpayers is taken into account.

In this Notes from the Vault I examine the value of the taxpayers’ contribution to Fannie and Freddie from an economic perspective. My analysis of these contributions is divided into three parts: (1) the GSEs’ profitability prior to the 2008 conservatorship agreement (bailout), (2) the value of the taxpayer promise at the time of the bailout, and (3) support of new investments since they were placed in conservatorship. (1)

The article goes on to explain each of these three parts of the taxpayers’ contribution and concludes,

The claim that the taxpayers and Treasury have been fully repaid for their support of Fannie Mae and Freddie Mac is based on an accounting calculation that does not withstand economic analysis. The claim that Treasury’s commitment has been fully repaid attributes no dividend payments to Treasury starting in 2012, attributes no value to the government guarantee to absorb whatever losses arose in the pre-conservatorship book of business, and arguably reflects Treasury setting too low of a dividend rate on its senior preferred stock. Moreover, the profits that are being used to pay the dividends did not arise from the contributions of private shareholders but rather entirely reflect risks borne by the Treasury and taxpayers. Thus, the Treasury claim that the value of the aid was “incalculable” is an exaggeration; the value surely can be fixed within reasonable bounds. However, the implication of this claim, that the GSEs cannot repay the economic value on behalf of their common shareholders, is nevertheless accurate. (2)

This article offers a useful corrective to the story one hears from those representing Fannie and Freddie’s shareholders. They have constructed a simple narrative of the bailout of the two companies that ignores the way that the two companies’ fortunes have been intrinsically tied to the federal government’s support of them. That simple narrative just nets out the monies that Treasury fronted Fannie and Freddie with the payments that the two companies made back to Treasury.  After netting the two, they say, “Case closed!” Wall has demonstrated that there are a lot more factors at play than just those two.

I would also highlight something that Wall did not: the federal government actually determines the level of profits that Fannie and Freddie can make by setting the fees the two companies charge for guaranteeing mortgages. So, the federal government could wipe away future profits by lowering the guaranty fees. And wiping away those profits would make those outstanding shares worthless.

So the question remains: what is the endgame for the investors who have brought these lawsuits?