With a new administration in office, members of Congress have awakened once again to the unsolved problem of Fannie Mae and Freddie Mac — the country’s two government-sponsored enterprises (GSEs) that have been in a conservatorship since 2008, when they were bailed out by American taxpayers.
Once again members of Congress are pledging to work together to develop a workable housing finance system to replace the two GSEs. We are skeptical about the success of these efforts. Too many in Congress believe that only a government program can produce both affordable housing and a 30-year fixed-rate mortgage.
{mosads}Reform will flounder unless those who insist on a government role in the housing finance system come to understand that the private sector can, and does, offer 30-year fixed-rate mortgages at rates lower than Fannie and Freddie, and that it is the government’s past and current policies that have made homes more expensive for the low- and moderate-income families they are trying to help.
The argument that only a government guarantee can make a 30-year fixed-rate mortgage possible, and at the lowest market rate, seems logical because the government itself can get the lowest rates, but it is easily disproved by looking at what banks are offering on the internet today. For example, earlier this month, anyone could have gone to WellsFargo.com and found a 30-year fixed-rate mortgage for $650,000 at an interest rate of 4.125 percent — a mortgage amount above the GSE loan limit, and thus not a loan the GSEs can buy.
At the same time, Wells Fargo was also offering a $624,100 mortgage — within the GSE limit — at an interest rate of 4.25 percent. In other words, the rate for the bigger 30-year fixed-rate loan, with no government backing was lower than the one for the loan backed by the government. This is not an anomaly — the private sector has been offering lower rates than the GSEs for at least the last four years.
There are many reasons why this is true, but the simplest is that the GSEs are cross-subsidizing the low quality and riskier loans they are required to purchase under the Affordable Housing Goals that Congress has imposed on the GSEs. How, then, are the GSEs and current housing policies raising home prices for low and moderate income buyers? This is the direct result of the reduced underwriting standards that have been required since the adoption of the Affordable Housing Goals in 1992.
The principal means for lowering underwriting standards — as required by the housing goals — is to reduce down payments and allow borrowers to increase their debt-to-income (DTI) ratios. First, the borrower is allowed to buy a home with a down payment of 5 percent, half the size of the 10 percent down payment that used to be the minimum for a prime loan. Then the borrower is permitted to qualify for a mortgage even though his DTI ratio after the mortgage is closed is more than 38 percent, the traditional level for a prime mortgage.
It is easy to see why reducing down payments raises home prices. If a prospective buyer has $10,000 for a down payment, and underwriting standards require a 10 percent down payment, he can buy a $100,000 home. But if the underwriting standard is 5 percent, the prospective buyer can acquire a $200,000 home. Instead of borrowing $90,000, the buyer borrows $190,000, taking on more risk. That’s where the debt-to-income ratio becomes important. If the debt-to-income ratio is increased, the buyer can then qualify for the larger loan.
This additional borrower leverage puts upward pressure on home prices, causing them to increase faster than the incomes of low- or moderate-income families. During the course of the housing bubble before the financial crisis, the GSEs were accepting loans with 5 percent, 3 percent and even 0 percent down payments; these policies fed the home price bubble. Between 2000 and 2007, home prices rose an average of 6.3 percent per year, while wages rose by 2.5 percent, so home prices far outpaced the incomes of low- and moderate-income buyers.
The higher debt-to-income ratios allowed buyers, who were already financially stretched, to buy the more expensive home with a lower down payment. The buyers could take on the additional debt and still meet the looser underwriting standards. For those who followed this path during the housing bubble years, the results were tragic. Many families lost their homes and their down payments because they couldn’t meet their obligations in the downturn that followed.
Yet the lesson has not been learned by policymakers. The Consumer Financial Protection Bureau, for example, now accommodates loose standards by allowing debt-to-income ratios to go to 43 percent as a general matter, and above 43 percent if the loan is sold to the GSEs or the Federal Housing Administration (FHA). Some loans insured by FHA have had DTIs of 57 percent. It’s an odd way to protect consumers.
A well-meaning Congress, unfortunately, pursues policies that hurt the most vulnerable. Sound underwriting standards would stabilize prices at levels that low- and moderate-income homebuyers could afford, but legislators are swayed instead by interested parties. Many of the so-called advocates for low- and moderate-income buyers receive payments from government-authorized funds to provide assistance to these buyers.
No government funds — meaning no risky mortgages — thus, no payments. Also, realtors and homebuilders profit from higher-priced homes, but don’t bear the losses that result from higher risk mortgages. Even banks, which avoid these risks by acquiring only high-quality mortgages for their portfolios, profit from trading in government-backed instruments that are issued by the GSEs.
Because of the government’s housing policies, housing prices are rising again — and on the same trajectory they followed in the 2000s. It’s not yet a crisis, but if Congress follows its usual patterns, we should prepare for the same result.
Peter J. Wallison is a senior fellow and co-director of financial policy studies at the American Enterprise Institute. He served as general counsel for the Treasury Department during the Reagan administration.
Edward J. Pinto is a resident fellow and co-director of the International Center on Housing Risk at the American Enterprise Institute. He served as an executive vice president for Fannie Mae until the late 1980s.
The views expressed by contributors are their own and are not the views of The Hill.