An "Unusual" Mortgage Coalition Reassembles
Recent media reports have remarked on the development of an unusual coalition - lenders, consumer groups and low-income housing advocates - formed to oppose the requirements for a high quality mortgage originally proposed by the federal bank and securities regulators under the Dodd-Frank Act. The principal issue seems to be the 20 percent downpayment requirement for a low-risk mortgage. Members of the coalition were quoted as saying that this would freeze many buyers out of the housing market.
"We still need to be able to make affordable mortgages that don't just go to the wealthy," David Stevens, head of the Mortgage Bankers Association, told the New York Times. "These rules will so significantly deter the ability of first-time buyers to break into the market that we will see a real decline in home ownership," said a representative of La Raza, the Hispanic advocacy organization, also in the Times. And John Taylor, the head of the National Community Reinvestment Coalition, told Bloomberg "This is a civil rights issue. It falls around people of color. It's a class issue."
Although not quoted in these articles, these groups have been joined by the homebuilders, the realtors and the large banks, also seeking the preservation of government backing and lower underwriting standards for mortgages. This isn't a new or unusual coalition in housing finance; it's the same grouping that has consistently garnered the taxpayers' largesse in the past.
Are we going to have to watch this movie again? The arguments are the same as they were in the late 1980s, and will lead to the same place: government policies that will lower mortgage standards so that nearly everyone will qualify. Some in this coalition will get the low lending standards they want, others will get the government backing they think they need. The taxpayers once again get it in the neck.
The complex and convoluted Dodd-Frank structure is not the answer, but underwriting standards are necessary to protect the taxpayers and the economy, and no one in this coalition wants to impose them. History, after all, should tell us something. The same arguments were made to Congress in the late 1980s and early 1990s, when Fannie Mae and Freddie Mac, following the command in their government charters that they buy only loans that would be acceptable to institutional investors, were imposing tough underwriting standards on the loans they would buy and securitize. The standard downpayment then was 20 percent, and it yielded a home ownership rate of about 64 percent, where it had been for roughly 30 years.
But Congress ultimately heeded the same calls we are hearing today: the standards are too tough; there are groups who cannot get mortgage credit and buy homes; and the familiar language of entitlement - it's a "civil rights" issue that some people cannot buy a home because they don't have sufficient savings. In 1992, Congress required Fannie and Freddie to abandon their underwriting standards and instead - for at least 30 percent of the loans they acquired - to buy only "affordable housing" mortgages, without regard to their quality.
What was an "affordable housing" mortgage? A loan to a borrower who was at or below the median income where he or she lived. Once those income requirements were laid on, the Department of Housing and Urban Development began to enlarge the goals, so that by 2000, the end of the Clinton administration, 50 percent of all mortgages acquired by Fannie and Freddie had to be made to people who were at or below that income level, and this quota was pushed even further by HUD during the George W. Bush administration that followed.
Of course, it's perfectly possible to find some prime mortgages among people who are below the median income, but when huge government-backed organizations like Fannie and Freddie are directed to find below-medium-income borrowers for more than 50 percent of all the loans they buy each year, it's inevitable that they will have to drop their underwriting standards. That's what they did, that's why they are now insolvent, and that's why their regulator has estimated that their losses - eventually to be paid by the taxpayers - could approach $400 billion.
Research by my AEI colleague Edward Pinto, and included in my dissent from the majority report of the Financial Crisis Inquiry Commission, showed the result of these government policies. By 2008, Fannie and Freddie were exposed to the credit risk of 12 million subprime and other high risk mortgages; government policies were directly responsible for an additional 7.2 million similar mortgages held by government agencies or organizations following the directives of government; and including these 19.2 million loans, almost half of all U.S. mortgages - 27 million loans - were subprime or similarly weak and high risk (for example, mortgages with low or no downpayments).
The huge number of defaults among these mortgages, beginning in 2007, drove down housing prices, caused the insolvency and instability of many financial institutions, and sparked the prolonged recession and housing price collapse we are now experiencing. Even Congressman Barney Frank (D-MA), a long-time advocate of increased affordable housing and a congressional protector of Fannie and Freddie admitted in 2010 that "[I]t was a great mistake to push lower-income people into housing they couldn't afford and couldn't really handle once they had it."
The government policies that poured money into affordable housing mortgages did in fact increase home ownership. The rate in the U.S. rose from 64 percent in 1995 to more than 69 percent in 2004. But at what cost - huge taxpayer losses, an economic recession, high unemployment, and the destruction of housing values for most homeowners in the U.S. That's what the advocates for easier housing credit are ignoring when, once again, they argue that traditional underwriting standards for mortgages are too tough. And what about homeownership rates that had peaked in 2004? They are once again returning to the historic rate of 64 percent that was achieved with a 20 percent downpayment requirement.
We will never be free of the threat of another mortgage-led financial collapse until we make it impossible for people to use the government for their own ends. And that can only happen when we take the government out of the business of backing mortgages.