The Cost of Housing Policy: There’s Little Reason Left to Keep the Feds’ Financing Structure the Way It Is
Sam Chandan Sept. 23, 2010, 3:21 p.m.
At the behest of Massachusetts Congressman Barney Frank, the Congressional Budget Office (CBO) has prepared, and last week submitted, its assessment of the long-term budgetary impact of the activities of Fannie Mae and Freddie Mac.
Under the assumptions that the two government-sponsored enterprises (GSEs) remain federal entities in some fashion, that they guarantee somewhere in the region of $1 trillion in new residential mortgages each year, and using the procedural rules outlined in the Federal Credit Reform Act (FCRA)1, the CBO has determined that new mortgage guarantees issued between fiscal years 2011 and 2020 will add $44 billion to federal coffers.
But this finding is qualified by its calculus and by its focus on new activity to the exclusion of future losses on legacy exposures; in itself, it does not offer any basis for perpetuating the current structure of U.S. housing finance.
A Long Road to Clarity
This September marks the second anniversary of the Federal Housing Finance Administration’s assignment of Fannie and Freddie to conservatorship, an arrangement under which the FHFA is vested with the powers normally assigned to management, its board and shareholders. During this period, senior preferred share investments by the Treasury Department have totaled $148 billion, an enormous sum by any measure.
Proponents of conservatorship–which was put in place under a Republican administration–argue that the government’s intervention has kept the ailing housing market functioning, even if its pulse remains shallow. In testimony before the House Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises on Sept. 15, the acting director of the FHFA, Edward DeMarco, reaffirmed the view that “neither company would be capable of serving the mortgage market today without the ongoing financial support provided by the Treasury.”
But in September 2008, the notion that the costs would rise so high or that GSEs’ future would remain in limbo for this long might have been dismissed out of hand. Though with the debate over the fate of these institutions only now coming to the fore, and with the GSEs operating as tools of policy even though they are not agencies of the government formally, the budgetary update is a necessary reality check.
Since 2008, losses at the GSEs have totaled $226 billion. Losses on single-family credit-guarantee-business represent almost 75 percent of this total. The difference between the Treasury investment and the GSE losses accounts for $78 billion in losses borne by shareholders. The FHFA is currently working on an update to its assessment of total projected losses, which it has so far indicated will be less than $400 billion in severe stress scenarios. In the adjacencies to Fannie Mae and Freddie Mac, mortgage insurers are also under pressure. On the other hand, 10 of the 12 Federal Home Loan Banks were profitable in the second quarter.
So why the upside assessment of the GSEs’ contribution in the CBO report? The positive result from the by-the-book analysis reflects material limitations in the parameters of the prescribed analysis. In particular, the CBO points out that a risk-free discount rate will necessarily fail to account for market risks faced by the government. But the government does face market risk through its GSE exposures.
And so in an alternative fair-value accounting, the CBO finds that GSE activities will cost taxpayers $53 billion over 10 years. Advocates of long-term conservatorship might argue this is a small price to pay for trillions in guarantees that will keep mortgage rates low. Setting that argument aside for the moment, $53 billion is the number used by the CBO in its published budget estimates.
Complicating matters somewhat, the Obama administration accounts for the costs of the conservatorship on a cash basis, isolating the stream of senior preferred share investments and resulting dividend payments. The assumptions underlying this analysis offer room for skepticism but do result in a net-positive budgetary contribution of $8 billion.
I will be clear about my priors: While imperfect, the CBO’s estimate of a $53 billion public price tag is more credible than the FCRA and administration’s calculations of upside gains.
Will GSEs Shutter the
In assuming that the GSEs remain instruments of policy over the next decade, the CBO analysis becomes an academic exercise. Across the range of possible outcomes, a long-term entrenchment of conservatorship without any adjustment in the GSEs’ mandate, scale and activities is the least likely scenario. So far, conservatorship has meant tight restrictions on new product and service development. In his aforementioned testimony, Mr. DeMarco stated as follows:
“… in conservatorship, the Enterprises will be limited to continuing their existing core business activities and taking actions necessary to advance the goals of conservatorship. I have not authorized any new products due to the operational challenges inherent in new product offerings and the need for the Enterprises to devote full attention to loss mitigation activities and remediation of internal weaknesses … This approach is even more pertinent for the Enterprises, given their uncertain future and reliance on taxpayer funds …”
Among the observable metrics of the GSEs’ tighter risk management, the average credit score for borrowers in the single-family business pools has increased at Fannie Mae (from 716 in 2007 to 758 year-to-date) and Freddie Mac (from 718 to 750). Loan-to-value ratios have fallen. And alt-a and interest-only loans have fallen from about one-third of new business to about 2 percent at Fannie Mae and 1 percent at Freddie Mac.
The basic question remains: Should the full faith and credit of the federal government be used to subsidize the cost of homeownership? Or should the government’s role be more narrowly defined; limited to addressing the need for low-income housing options, for example? We still have no answer to where policy will take the housing finance. Early indications suggest that public intervention will be more focused. Mr. DeMarco’s testimony reflects as much:
“… In the future design of our housing finance system, careful consideration should be given to targeting subsidies to specific groups that lawmakers determine warrant that benefit. … Regardless of any particular government allocation or pricing initiatives, explicit credit support for all but a small portion of mortgages, on top of the existing tax deductibility of mortgage interest, would further direct our nation’s investment dollars toward housing. …”
Counting Our Pennies
In this last statement, Mr. DeMarco raises the increasingly pertinent question of the costs of housing policy, apart from the specifics of the current downturn’s losses. In the wake of the financial crisis, our collective sense of what constitutes a large sum of money has changed. As compared to the first stimulus under President Bush–when relatively small checks were sent to Americans in the spring of 2008–we have been numbed by the size of the ensuing efforts to stabilize and reinvigorate the economy.
The hard reality is that we cannot afford to do everything, nor should we seek to. Subsidies for conventional mortgages and assumptions about the need for public support of the secondary mortgage market should be separated from the herd of sacred cows and scrutinized–for their appropriateness as policy goals and for their impact on the economy and fiscal and financial stability.
A sunset of long-standing government intervention in conventional housing markets must be among the options in this debate.
Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.