Can the Apartment Market Manage Without Fannie and Freddie?

The debate over housing finance reform has taken place largely behind closed doors, with public discourse limited to speculation. Since the collapse of Fannie Mae and Freddie Mac into effective insolvency in September 2008, the public has been shielded from serious discussion about their future. At least for the time being, weakness in the housing market has encouraged the status quo; policymakers have sidestepped the question of the government’s long-term role in shepherding homeownership outcomes.

chandan silo for webThe beneficiaries of the prevailing market structure, in ownership and rental markets alike, have held sway in warning of dire consequences absent continued, large-scale public support of housing. They’re right in some cases and just well incentivized in others. Among their ranks, you will find at least a few ratings agencies and industry groups that—until it was a matter of fact—argued that conservatorship in some form was entirely improbable.

The enterprises themselves rebuked their critics in the days and weeks leading up to conservatorship, in one case stating emphatically that “we are well capitalized and positioned to continue to serve our vital housing mission.” Assuaging skeptics, reassurances depended on the implicit guarantee that was a contributor to the housing crisis.

During the summer of 2008, one industry spokesperson offered, “just given the size of the two companies, surely the government would not stand aside.” The message: Don’t worry, we’re too big to fail.

Approaching the five-year anniversary of conservatorship, the enterprises have become increasingly conventional tools of policy. Any illusion to the contrary was shattered in late 2011, when Congress extended the payroll tax holiday and unemployment benefits. Ever frugal, Congress paid for these measures by increasing fees the enterprises charge lenders for home loan guarantees and the premium the Federal Housing Administration charges homeowners for mortgage insurance. Revenues generated by the enterprises were now fungible with every other public dollar.

With housing on the mend, the enterprises are in the black once again. Their profitability should underscore that a public debate over the government’s long-term role in subsidizing housing—by definition and design, a distortion of market outcomes—is increasingly overdue. Under the current structure, the risks taken by the agencies in generating their profits imply off balance sheet liabilities held by the public. With billions of dollars of draws on the Treasury, that relationship is tangible, even if the enterprises are now in a position to remit.

When the conservatorship was first announced, then-Secretary of the Treasury Henry Paulson assigned blame to “the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction.” In some circles, that view is softening now that the enterprises are turning a profit. Absent anything approaching a long-term plan from Congress or the administration, the initiative in housing finance reform has been taken by the Federal Housing Finance Agency. Its leadership is in flux, in part because of the steps it is taking. In early March, Acting Director Edward DeMarco announced plans for new risk-sharing arrangements, higher guarantee fees and a new, shared platform for the issuance of mortgage-backed securities. The enterprises’ dominance in the multifamily market will be reduced in 2013 by at least 10 percent, in part by tightening underwriting standards.

The multifamily market can stomach the change, even if it protests. In the most hotly contested markets, we can argue credibly that competition from nonagency lenders has converged on the enterprises’ subsidized capital to crowd out banks and strain underwriting quality. In these markets, a measured adjustment to a more limited role for the enterprises is consonant with long-term market stability.

The field is uneven; not every market is Manhattan or waterfront Brooklyn. While some markets are flush with liquidity, there are many others where credit needs would be undeserved if the enterprises pulled back abruptly. There is a legitimate policy rationale for the participation of quasi-public institutions in these cases, which at least for now can be found in abundance.

The challenge is that a drawdown of the enterprises’ activities may see them pull back from underserved markets and not the markets where banks and life companies are actively engaged. To address that potential, the FHFA needs to do more than set a volume target. In the public interest, it should define clearly when a subsidy is appropriate and when it is not.

Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.

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