May 21, 2013
FHFA acting Director Edward Demarco gave a thoughtful speech, Housing Finance, Systemic Risk, and Returning Private Capital to the Mortgage Market, on the future of federal housing finance policy. Given that the Administration has nominated Mel Watt as his permanent replacement, it is likely that DeMarco is seeking to leave a good final impression. I give the speech two real cheers, no more and no less.
First Cheer. The speech provides a review of two reasons why the government might intervene in the housing market. First, a “potential market failure could arise in housing finance if market participants have undue or unnecessary concerns about the ongoing stability and liquidity of mortgage credit in a purely private market across various economic environments.” (2) Second, another “potential market failure is what is often thought of as the positive externality associated with homeownership. In this view, the benefits of homeownership extend beyond the individual household to the broader aspects of society, hence if left solely to the market the number of homeowners will be less than optimal.” (3)
Second Cheer. The speech also provides a very nice summary of the two main approaches that the government can take to address housing market failures. First, is the issuer-based approach, which “is generally associated with a financial institution guaranteeing principal and interest repayment to investors. In this model, the issuer’s guarantee is backed by its shareholders’ capital. While not necessarily part of an issuer-based approach, typically this approach assumes a further credit enhancement in the form of a government guarantee on the securities issued.” (4) Second is the securities-based approach. With this approach, “as opposed to credit risk being absorbed by the equity of the securities issuer, credit risk would be absorbed through capital markets.” (6)
And One Bronx Cheer. That’s right, no real third cheer for DeMarco. Does he take a clear stand as to what course we should follow? No. Like the Administration in its oft-discussed White Paper, DeMarco sets forth the options and effectively punts on the trillion dollar question.
My two cents? The federal housing finance infrastructure should focus on two goals: (i) increasing housing affordability for low- and moderate-income households and (ii) providing a backstop during liquidity crises. Leadership is needed now, before Congress gets riproaringly drunk on Fannie and Freddie’s massive return to profitability. Otherwise, we have let one perfectly good crisis go to waste.