ECONOMY OCTOBER 21, 2011
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When historians look back at this benighted moment in time, they may find themselves puzzled by how we refused to take the necessary steps to improve our economic situation. Depending on what happens in coming months, they may find that the best solutions—aggressive fiscal and monetary stimulus here in the United States, bank recapitalization and debt restructuring in the EU—were left on the table, while millions unnecessarily suffered.
A footnote in that history may be the decision of Fannie Mae and Freddie Mac not to do more to help the housing market recover. Faced with a flailing market and an alarming amount of underwater mortgages, Fannie and Freddie have nonetheless refrained from implementing bold plans to help out homeowners, citing their fiduciary duty to taxpayers as the reason. But by encouraging more refinancing and principal reductions of the mortgages these institutions either hold directly or insure, our government-sponsored housing giants could simultaneously improve both housing security and the overall economy.
At present, there are about 14 million underwater mortgages out there, with almost half of them more than 30 percent below sea-level, and most are insured or owned by Fan and Fred. Research has been very clear on this point: The most effective intervention to help these homeowners is to reduce their loan principal and bring what they owe more in line with what their home is now worth.
It’s no slam dunk—even with loan haircuts, some folks will still default. And there’s real moral hazard here: a legitimate fear that if people don’t face the economic consequences of buying too much house for their wallets, a lot more people will take that risk. But there are ways to diminish that risk, and the greater hazard isn’t moral, but economic: If Fannie and Freddie insist on staying out of the principal write-down business, the housing market will, at best, keep bumping along with hardly any growth for much longer than it needs to.
Of course, there’s a rationale for the behavior of these agencies: From their perspective, they’re protecting the taxpayer. Because of massive losses to their portfolio when the housing bubble burst, these two government sponsored enterprises (GSEs) became essentially wards of the state. That was a necessary move to keep the housing market from completely shutting down, as private banks got out of the mortgage business for a while (since the bust, the GSEs have originated or insured over 90 percent of new mortgages). But it also had a negative side effect. These agencies are independently regulated by the Federal Housing Finance Agency (FHFA). The regulator’s mandate is to protect the taxpayer from further losses and, as it sees it, any loan forgiveness is a direct hit on taxpayers. (I’ll elaborate in a moment how the mandate could be interpreted in ways that do get Fannie and Freddie into the refinancing and writedown business.)
But it’s not just the regulators: The GSEs are themselves complicit in the failure to get the housing market on more sustainable footing. Given how low mortgage rates are right now, we should be seeing twice the refinancing activity currently taking place across the country. But the only way banks will refinance mortgage loans right now is if the GSEs will backstop them, either through insurance or through buying bundles of the refinanced mortgages, packaged as MBS (mortgage-backed-securities). Having been burned before, however, the GSEs are now insisting on some protection against defaults: They’re either charging the banks a hefty fee or the right to “put back” the loan (i.e., sell it back to the originating bank) if it fails, or both.
Once again, the GSEs are ostensibly just protecting the taxpayer, but these protections are blocking a critical exit ramp from the recession. One mechanism that’s supposed to be helping the economy right now works through the Federal Reserve getting interest rates down—which they’ve done—and homebuyers responding with refinancing and new purchases. But the policies of the GSEs, motivated by the FHFA’s mandate to avoid losses and protect taxpayers, are blocking refinancing and therefore jamming the machine.
But is the FHFA really protecting the rest of us? Like I said, I understand and respect their rationale, but I think they’re wrong. Without shaving off principal from a number of these loans, they will default, and who foots the bill when that happens? That’s right—Fannie and Freddie themselves, because they either own or insure the loans. In this respect, they’re doing the same “extend and pretend” shuffle that private banks are doing, hoping that home prices reverse course and what’s now underwater will eventually be sailing on the surface. For a lot of borrowers, however, that’s just not going to happen. Granted, there are loans that would be okay without reductions, and I’m not suggesting it’s a cakewalk to figure out the best ones to bet on. But as discussed here, some private banks are already finding promising ways to do just that.
And the GSEs’ resistance to refinancing doesn’t make much sense either. Again, because they’re insuring most of these loans anyway, making it easier for homeowners to make their payments is a winner for both these individuals and the economy at large. Shave a couple points off of the typical mortgage and you’re saving between two and three-hundred bucks a month. Aggregate that across all the people who could benefit from such a mortgage refinance and you’ve got an economic stimulus worth tens of billions.
What we have here is a case of regulatory failure: The mission of the agencies, as they perceive it (protecting taxpayers by avoiding refinancing and writedowns) stands in direct opposition to what homeowners and the broader economy needs right now.
So what should we do? Nudging or replacing the FHFA’s current regulator, Edward DeMarco, might work, but the conflict here is the regulator’s mission, not the individual. The only surefire solution is for Congress to temporarily assign control of the GSEs to the administration. This would mean passing legislation that temporarily put the administration in charge of the GSEs so they could implement the loan modifications their current regulator has resisted.
The government has already assumed temporary responsibility for financing the GSEs, but there’s a strong rationale for the government to actively change their mission as well. Taxpayers own 80 percent of these agencies, after all, and we’re in extremely unusual times in terms of housing finance: If Fannie and Freddie are going to be public agencies, they should be made to serve public ends.
Admittedly, the precedent would be worrisome here—just suppose a later Congress decided to take over the Fed for a while. But it’s less so given that within the next few years the GSEs are set to either die off or be recreated in a new, less interventionist format, as proposed by the Treasury and HUD white paper a few months back. Fannie and Freddie, in other words, are already living on borrowed time.
Of course, such legislation would be a heavy lift for any Congress, and far more so for this one. But the logic is solid. The FHFA sees itself as following its mandate. They may be wrong, but they’re not likely to move much. As a result, the only path I see to quickly getting the refinancing and writedowns that will finally get homeowners the help they need, and the macroeconomy the boost it needs, is for the administration to take over from the FHFA until the crisis has passed.
Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and the former chief economist to Vice-President Biden. He hosts jaredbernsteinblog.com.
13 comments
I'm surprised Bernstein didn't mention the three proposals from Orszag, Feldstein, and Roubini (and his two co-authors) offered in just the past two weeks. When those three say that home debt relief is the key to and sina qua non of economic recovery, three very different and well-respected economists, there must be something to it. I rate the proposals Roubini, Feldstein, and Orszag; Roubini relying on a deed in lieu of forclosure together with a five-year lease-back to the homeowner, Feldstein relying on debt forgiveness (to 110% of value) together with recourse (many home loans are non-recourse, California being the largest non-recourse state with the largest underwater crisis), and Orszag relying on a taxpayer funded gift to bankers (sorry, but somebody needs to reel this guy in). As for Bernstein's focus on refinancings at these historically low rates, forget it. Lenders are charging upwards of 6% of the loan amount, and that's just to get the low rate (i.e., no money out). Bernstein may be suggesting that the Administration deal with this obstacle but he doesn't say it directly. This comment isn't intended as critism of Bernstein's essay, but rather to add to it; it's an excellent and timely essay.
- rayward
October 21, 2011 at 6:56am
You said the word "Congress." That means this won't happen, however good an idea it may be. In fact, the better the idea is, the less likely it will pass. Is there any way for Obama to do this without going through Congress?
- Dausuul
October 21, 2011 at 7:24am
FHFA is protecting taxpayers in the short-run and not the long-run. If you can get it to shift the ideology of Wall Street that all we care about are profits this quarter, then you start to win the messaging war. Replacing DeMarco, though, is still helpful, though. I'm just not convinced he would respond, even to the expanded mission.
- chaitless
October 21, 2011 at 9:28am
You are so timely! A friend of mine in Arizona has a house that fell in value from 360,000 to 250,000. She is retired and can't continue paying so much mortgage. Because her mortgage in with Fannie Mae the mortgage reduction doesn't apply. It is disgusting!
- Poupic
October 21, 2011 at 10:19am
"Shave a couple points off of the typical mortgage and you’re saving between two and three-hundred bucks a month. " is exactly what I told Bank of America last week when I explained that, although I am not underwater or behind, I will be forced to sell my house to someone who will NOT be getting a mortgage from BoA in order to avoid further financial stress. Same BoA who has decided that the APR on cash advances from creidt cards will be 20%. This failure to somehow get the benefit of Fed's low interest rates really is the HEART of the absence of economic recovery. Dennis Cardoza slammed Obama on this when he announced his retirement from Congress. Sheila Bair was ignored by Obama's boys club for two years. Bair/Cardozo in 2012!
- K2K
October 21, 2011 at 11:41am
DOn't anybody pummel me, but... 1) doesn't the act of bailing people out of their mortgage constitute a moral hazard? 2) just how much effort should we be poutting in to "fix" the housing market? I pray for anyone who loses their home, no one should be out in the street... but the housing market itself doesn't need to be fixed, unless by "fix" you mean allowing prices to continue to drop. Average prices for single family homes are still overpriced.
- Tristan
October 21, 2011 at 11:55am
Tristan is right. The problem is that home might have sold for $450K now is on the market for $350K but is actually valued at $275K. Artificially keeping things pumped up and not letting them fall to their actual value IS part of the reason the economy isn't getting started. Also, currently, then the lenders "writes down" a loan to adjust for falling values, the IRS considers that a gift. And you must pay taxes on in. That is what is sinking most here, and writing a column without addressing that piece of the puzzle is kind of silly. And even though they've changed the rules somewhat, those that still treated their house as an ATM machine (credit cards, TVs, etc) will be hosed by this rule.
- seattleeng
October 21, 2011 at 12:49pm
You're absolutely right Tristan. I feel bad for people in distress too, and not every story is black and white, but in general: using my tax dollars to pay off someone else's bad mortgage - when my husbnd and I never even got to buy a home because we knew it was just too expensive - it just too much. As fairly well-employed Manhattanites during the 1990's-2000's, we had a dozen real estate agents over the years hand us forms that would have given us basically anything we wanted, millions of dollars in some cases, and we'd just shake our heads in disgust and walk away muttering things like "this will ALL end in such pain." Just because banks made it easy to buy too much house did not mean you had to do so or were entitled to do so. Basic rules of thumb never changed: don't buy a house if you can't afford one and don't use your home as a piggy bank. If you choose to do so, do it at your own risk. That said, we as a nation may not have much choice. The cold, hard reality is that the cheapest fastest fix for this whole mess is to flat out buy everyone's mortage, ala "Obama immediately taking over Fannie, etc."
- WandreyCer
October 21, 2011 at 1:12pm
I feel much the same way about moral hazard as Tristan and Wandrey, but at the same time you have to realize how people got into underwater situations. They found a job. They needed to live near their workplace. They wanted some space (not just one-bedroom condos that even a well-paid single person would have had trouble buying in a major city). Everything's priced sky-high, but their real-estate agent and their banker tells them they can qualify for the mortgage, even without much money down. And house prices were still rising. What were they going to do? They were going to take that money and try to make the big payments. I have a hard time blaming them.
- polcereal
October 21, 2011 at 3:13pm
These proposals for debt relief aren't to "help" the indebted; they are to achieve economic recovery for everybody. Do Bernstein, Roubini, et al. want to "help" those who took on too much debt? No! They want to avoid a prolonged and, some fear, a deepening recession, or depression.
- rayward
October 21, 2011 at 6:15pm
Thank you rayward. and my point was about the impossibility of getting a refi to benefit from the current low interest rates, the second of Bernstein's two main points, copied below. No moral hazard there! BoA loses some profit, I stay in my home, and spend that extra $243 per month, starting with a new refrigerator and new garage door, both Made in America. Then I might be able to buy a car Made in The USA when the transmission on my 11-year old car goes thunk. After I hire local contractors to fix the dry stone retaining walls that threaten my foundation in the NW corner, and a new driveway, and be able to hire someone to plow snow... "...And the GSEs’ resistance to refinancing doesn’t make much sense either. Again, because they’re insuring most of these loans anyway, making it easier for homeowners to make their payments is a winner for both these individuals and the economy at large. Shave a couple points off of the typical mortgage and you’re saving between two and three-hundred bucks a month. Aggregate that across all the people who could benefit from such a mortgage refinance and you’ve got an economic stimulus worth tens of billions...."
- K2K
October 21, 2011 at 8:14pm
Geez, Wandrey, can't disagree with a single thing you wrote...I'll be ready for other unexpected things this saturday, including bear attacks, sunshine, meteors, etc
- seattleeng
October 22, 2011 at 1:33pm
memo to Jared Bernstein: Today, VP Joe Biden told CNN's Candy Crowley that the WH was working on exactly what I need - an easy way to reduce those of us with current mortgages above 6% down two percent to 4+%. EXACTLY what I asked BoA last week. So, is this really going to happen? or will the DNC decide that BoA needs their higher profits before they fire too many of their employees?
- K2K
October 23, 2011 at 4:53pm