House Financial Services Subcommittee Issues Testimony From Center for American Progress
"Good morning Chairman Duffy, Ranking Member Cleaver, and members of the
"In today's testimony, I'll describe why the housing finance system matters to consumers, explore how the system failed consumers and taxpayers in 2008 and how to strengthen the housing finance system based on the lessons learned during the housing crisis.
A Healthy Housing Finance System Supports the Growth of the Middle Class
"Most American wealth is built through homeownership. Housing wealth accounts for about 60 percent of the typical white household's wealth and almost 70 percent of
"The housing finance system creates the conditions for mortgage lending in
"In the years following the Great Depression, when the private mortgage market was barely operating, the federal government stepped in with new resources to make homeownership possible for Americans.
"
"These government interventions helped to increase access to homeownership. Mortgages became less expensive and their terms standardized across the country, and the 30 year fixed-rate mortgage became widely available. Between the 1940s and 1960s, the homeownership rate in
"While the FHA,
"In the early 2000s, consumer advocates began to sound the alarm as lenders started peddling poorly-designed mortgage products in low and moderate-income communities.12 With "teaser rates" followed by exploding interest rates, pre-payment penalties, and little to no underwriting, these mortgages were designed to fail.13 With strong demand on
"The housing finance system broke down in the lead up to the housing crisis and has yet to fully recover. Americans lost
"Today, the mortgage market is again functioning yet many prospective homebuyers remain on the sidelines.
Lessons Learned from the Housing Crisis
"Building a stronger housing finance system for the future requires identifying the problems that caused the housing crisis and identifying the structural weaknesses that led
"Some conservatives have stated that the housing crisis was caused by policies at FHA and by
"While
"As the private securitization market grew in the early 2000s,
"
"And, when the housing crisis hit, the GSEs did not have enough equity on hand to withstand all of the losses that were anticipated.
"In 2008, the
Strengthening the Housing Finance Market
"In the aftermath of the crisis,
"As
"Establishing an explicit, paid-for, government guarantee is good for consumers and taxpayers: The 30-year fixed rate mortgage has helped to build the middle class in
"Promoting access and affordability: The housing finance system exists to serve America's housing needs. To build a strong housing finance market that serves
"Broad duty to serve:
"Affordable housing goals and the new duty to serve rule: These are important tools that help to ensure that the GSEs are complying with their mission. Neither the affordable housing goals nor the broad mission of the GSEs caused their financial challenges during the housing crisis. Few of the toxic securities purchased by the GSEs or the Alt-A mortgages they backed to increase shareholder profits, counted toward the GSEs affordable housing goals. The mistakes
"Affordability funds:
"Managing mortgage costs for homebuyers: Perhaps the most important factor that will determine access and affordability in the decades to come is the way in which mortgage credit is priced. A move toward more aggressive risk-based pricing, as might occur under some the housing finance reform proposals under consideration, could make it harder for low and moderate-income borrowers to buy a home using a conventional mortgage.
"Pricing policies already appear to be keeping some homebuyers from accessing conventional mortgage credit. Traditionally, the GSEs have pooled risk, charging similar fees to all homebuyers to ensure that mortgage risk is managed across their book of business. Since the GSEs have entered conservatorship, they and their credit counterparties, the MIs, have shifted toward a more individualized approach. Borrowers at the lower end of the credit score spectrum are charged higher fees, up to 300 basis points more, than borrowers with pristine credit through loan level pricing adjustments and mortgage insurance costs.30 With these pricing policies in place, it's no surprise that the average credit score on a loan purchased by
"Some of the proposals under consideration could make pricing even more prohibitive for low and moderate-income borrowers by encouraging sources of private credit that may be more likely to price risk on an individual loan-by-loan basis. Going forward, the GSEs or any entities that replace them, should not engage in risk-based pricing. For the housing market to thrive in the decades to come, all qualified borrowers should have access to the conventional mortgage market, not just the highest earners or wealthiest individuals.
"Preventing profit-seeking at the expense of consumers and taxpayers: As Fannie Mae and
"Protecting taxpayers through appropriate capital standards: In the lead up to the crisis,
"Strong regulatory oversight to protect the housing finance system: There should also be a strong regulator in place to ensure safety and soundness. In the lead up to the crisis,
"Moreover, consumers, investors and taxpayers all benefit from strong consumer protection. The rules put in place after the crisis to prevent a return to predatory lending are crucial to the long-term health of the housing finance system and the housing market. Regulators and
"Easy access to the secondary market for small lenders: Small lenders serve the credit needs of their communities and need a secondary market execution that is easy to access and does not favor larger lenders. Today, small lenders can sell loans to directly to
"The housing finance system must meet the needs of America's renters: The number of households that cannot afford their monthly rent is growing. According to an analysis by the Joint Center on Housing Studies of
"The housing finance system helps to determine the availability of affordable rental housing. For a new multifamily building to open its doors to renters, the building owner needs to be able to acquire permanent mortgage financing after the building is constructed. Periodically, building owners need to make renovations to keep rental units habitable and attractive. The Enterprises play an important role in the rental market, making financing for acquisition, refinancing and rehabilitation more easily accessible. The majority of the rental units financed by the Enterprises are affordable to low and moderate-income households.35
"Going forward, the Enterprises, or their successors, should increase focus on affordable rental housing. Recognizing the persistent affordability challenges in the rental market, it may be necessary to set higher thresholds for affordability than are in place today.
Assessment of Current Housing Finance Reform Proposals
"CAP believes that there are several structures that could accomplish these goals and serve the housing finance system well. A government corporation, private utility, or mutually-owned cooperative if structured right, could deliver well-priced, sustainable mortgage credit to qualified borrowers across markets and economic cycles.
"Over the past several years, there have been dozens of proposals published about how to best structure the housing finance system. There are areas where the conversation has progressed significantly and positively. First, there appears to be widespread agreement about the need for a paid-for, government guarantee for mortgage backed securities issued by
"However, important differences persist among the proposals that are significant for the consumers and the health of the housing finances system. Some experts believe that competition in the secondary market is a primary goal of housing finance reform which we believe may not be a sustainable approach. Some experts also envision a system that relies heavily on credit risk transfer structures, both pre and post loan origination and securitization, which we believe need to be developed further before assuming a larger role in the housing finance system.
Competition in the secondary market does not always yield benefits for consumers or taxpayers
"CAP believes that competition in the primary market is very desirable. Consumers do better when they shop around for a mortgage, and lenders push one another to offer better terms to consumers. CAP also agrees that some competition in the secondary market is preferable.
"However, it is important to consider whether much more competition in the secondary market is a desirable goal. In the lead up to the housing crisis, there was significant competition in the private market. The private label securitization market was robust and private mortgage insurers were very competitive. This competition did not lead to better terms for consumers nor did it protect taxpayers. In fact, competition among secondary market participants drove a race to the bottom, with each jockeying for market share.
"Several of the housing finance reform proposals under consideration make the mistake of setting secondary market competition as a goal of housing finance reform. Both the
"History tells a different story. When the housing market collapsed and the global finance system teetered on the edge of collapse, many firms with connections to the private label securities market needed bailouts. Competition among secondary market participants or among private mortgage insurance companies did not protect taxpayers or consumers during the crisis.
"Some of the largest issuers of private label securities -
"The models proposed by Milken and the MBA envision a competitive marketplace of many companies that can offer mortgage backed securities that are backed by the federal government.39 Our concern is that these proposed structures may create the conditions for the bad behavior we saw in the private label securitization market in the lead up to the financial crisis - this time, however, with the securities guaranteed by the federal government.
"In a new report,
""Even if there are multiple guarantor entities, it is likely that if one is failing the others are likely to be under pressure. Government might still need to intervene. Further, the risk isn't just that they fail, but that the damage that is done as they race toward the bottom. We have seen the impact of poor underwriting and lax standards on the broader financial system when competition to feed the machine led to a severe decline in underwriting discipline in the subprime market."40
"In a market with many guarantors, it may also be harder for a regulator to ensure safety and soundness and that the system is serving all qualified borrowers, including those who do not live in the nation's most desirable markets. Moreover, it is questionable whether a system of many guarantors would be sustainable over the long term. The secondary market business model is based on aggregating large numbers of loans into securities, with relatively low margins.
Credit risk transfer program needs more development
"Credit risk transfer is playing an increasingly significant role in our housing finance system and several of the prominent housing finance reform proposals envision a system where credit risk transfer is a primary means of shifting mortgage risk from taxpayers to the private market.41
"CAP believes that credit risk transfer structures are important tools that the GSEs should continue to develop. However, it is not yet clear whether the credit risk transfer program will be sustainable over the long term or whether credit risk transfer instruments will raise costs for consumers. These issues need to be taken into consideration before
"Since 2013, the GSEs have made progress toward creating a back-end credit risk transfer marketplace. They have transferred about
"The credit risk transfer marketplace needs significant oversight to reduce taxpayer risk and to promote stability through economic housing cycles, objectives established by the FHFA. 44 Credit risk transfer transactions should also make sense for consumers - they should not raise the cost of borrowing for working families.
"Credit risk transfer instruments only protect taxpayers if the credit risk is permanently transferred. If a counterparty fails or is unable to provide promised reinsurance, taxpayers are not protected. While this is less of a concern with fully collateralized transactions, regulators will need to closely monitor newer partially collateralized structures. In Quarter 1 of 2017, about 20 percent of the risk transferred through the CRT program was transferred through insurance and reinsurance transactions, which are not fully collateralized.45 More research may be needed on the state of supervision and risks within the reinsurance industry. While it is generally assumed that reinsurance companies present minimal correlation risk to the GSEs because of their highly diversified lines of business, there may be other risks to manage. For instance, AIG was believed to be a strong counterparty with limited correlation risk in the run up to the crisis. These transactions may need to be fully collateralized, as was recommended by the authors of A
"There are still remaining questions about the future of the credit risk transfer market. First, Enterprises' credit risk transfer offerings have been piloted during a time of economic expansion. Many experts have expressed concern that it could become prohibitively expensive to transfer risk to the private market during an economic downturn when mortgage defaults increase. Moreover, the future of the credit risk transfer market depends largely on the structure of the housing finance system. In a forthcoming paper,
"Finally, any use of deeper mortgage insurance to transfer credit risk needs to be carefully considered. As CRL explained in its recent testimony, overreliance on the private mortgage insurance market could lead to more differential pricing, which raises borrowing costs for working families. It may be possible to limit cost increases to low and moderate-income consumers by requiring private mortgage insurance counterparties to price based on the risk of the entire pool and not on a loan-by-loan basis. Guarantee fees could also be lowered to offset any increases for borrowers, as recommended by the authors of A
Moving Forward
"As policymakers consider ways to strengthen the housing finance system, it is critical that they preserve what's working, build on the reforms underway, and carefully consider additional reforms to ensure a sustainable system.
"
"The most important remaining work that requires new policy solutions includes addressing the misaligned incentives that led
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Footnotes:
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6 Federal National Mortgage Association Act, Title III of National Housing Act, 12 U.S.C.
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10 McArthur and Edelman;
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14 Ibid
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20 McArthur and Edelman
21 McArthur and Edelman
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23 McArthur and Edelman
24Kevin Park, "Fannie, Freddie and the Foreclosure Crisis" (
25 Ibid.
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28 Federal Home Loan Mortgage Corporation Act, Public Law No. 91-351, 84 Stat. 450, As amended through
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32 Housing And Economic Recovery Act of 2008, Public Law 110-289, 110th Cong., 2d sess. (
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43 Ibid
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47 Forthcoming,
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