Not seeing the forest for the trees

When the financial crisis began in 2007, the incredibly complex system which supports the home mortgage system and allows Americans to purchase their own home was shown to be have been inappropriately leveraged by some in the private sector through new financial products but that problem was infinitely compounded by poor ratings given to those products by the companies like Moody’s. However what the crisis perhaps demonstrated most harshly were several glaring oversight gaps in our federal oversight system. These holes in the regulatory regime provided the impetus which drove Congress to pass the Wall Street Reform and Consumer Protection Act – otherwise known as the Dodd-Frank Act.

Recently, the White House’s Office of Management and Budget published yet another proposed rulemaking in their ongoing effort to eliminate what they deem as excessive risk within the financial services industries. This rule, would cause the Federal Home Finance Agency (FHFA) to exclude some of insurance companies from participating in the Federal Home Loan Bank (FHLB). Sadly, it is completely unknown what outcome this type of “solution in search of a problem” would have on the still tenuous American housing market.

{mosads}The FHLB system was established following the Great Crash of 1929 and its broad purpose was to provide a backstop and systemic ease to any future financial crisis. By pooling mortgage debit held by banks and other financial institutions within separate regions of the United States, the FHLB system allowed those lending mortgages to do two simple and hugely positive things.

First, the FHLB spread risk inherent to mortgage lending throughout a circle of peer institutions with a vested interest in stable and secure home ownership. This meant that a sudden crisis, such as a hurricane or any other disaster, would not result in an individual bank failing as those mortgage held by the single bank would suddenly be worth only a fraction of the amount lent. This concept empowers the generosity of spirit and support that Americans show time and again following a natural disaster. It means that local financial institutions can maintain mortgages of homes without fear of foreclosure and homeowners can have a chance to recover.

Second, the FHLB system created another opportunity that increased the ability of small, local lenders to help the people of their communities. The pooling of debit created a secure secondary marketplace for the lenders. This secondary market enabled local mortgage lenders to sell a portion of the debit to trusted groups, groups approved by the Federal Government. While maintaining a portion of the original mortgage, the sale resulted in new capital that in turn empowered the original local institution to lend to others within their community.

Secondary markets such as these are utilized in many sectors of the financial industry – a ready example can be seen in the government guaranteed loan systems offered by the U.S. Small Business Administration and the U.S. Department of Agriculture.

Leveraging debit through a stable secondary market allows small financial entities – again local community banks and member driven credit unions – to lend amounts which are multiples of the amount of money deposited in that institution. Leveraging debit in this manner further unites borrowers, financial institutions and yes, even the investors in a virtuous circle. This positive and uplifting group increases opportunities for Americans to own their own home and increases the rationale for homeowners to keep their own house regardless of episodes of financial crisis and uncertainty.

While community banks and credit unions are just like the large multinational banks on every street corner of large cities, the local financial institution often serves a specialized portion of American citizens. Each mortgage lent by any financial entity must proscribe to the same federal guidelines recently enhanced by the Dodd-Frank Act. What is often overlooked by the debate within the Washington Beltway is that the financing provided by these mortgage loans does so much more than simply help people buy a home. Home mortgages provide capital which allow people to not only buy their first homes or for families to renovate their existing house but also for entrepreneurs to take their ideas from concept to creating new businesses or for local small businesses to become cornerstones of their neighborhood.

It is important for extensive analysis to be completed to understand what the impact of this regulation would have on the existing home mortgage system. It is imperative for the public to fully understand how this regulatory change will shrink the level of liquidity available to finance home mortgages – and what it would mean for every home owner, for those who want to buy a house and for those who want to utilize the value of their home to start or expand a small business. It is important for the Administration not to move forward with this proposed rule until that research has been conducted and publicly reviewed.

Horowitz is an independent consultant based inside of the Washington Beltway. He has served as staff for members of both the House and Senate, including the House Committee on Small Business. He has also served as the assistant administrator for Policy at the U.S. Small Business Administration under President George W. Bush.