The American Prospect
By: Barry Zigas
Barry Zigas is the director of housing policy at the Consumer Federation of America. He previously served as SVP/Community Lending at Fannie Mae and as president of the National Low Income Housing Coalition.
After more than 70 years of steady and remarkable success, America's housing and homeownership policies have been rocked by the rise of subprime lending, the financial sector's subsequent collapse, and the millions of resulting mortgage delinquencies, defaults, and foreclosures. Housing continues to be a drag on the recovery. The confidence Americans once had in homeownership as a path to family wealth has been shaken. And a backward conservative narrative has capitalized on regulatory and market failures to launch an all-out assault on any government role in housing. Progressives and advocates for families and communities are struggling to make sense of the wreckage and are asking themselves what future housing policies should look like.
But the very scale of the crisis provides an urgent opportunity to rethink and reset housing policy--to learn the right lessons from the mess and to focus on the needs of both homeowners and renters. A stable and durable policy platform could emphasize these goals:
* safe and sustainable opportunities for homeownership;
* restoration of housing as a source of family asset accumulation, especially for less affluent Americans;
* policy shifts to focus tax subsidies where they are most needed;
* a mortgage finance system that supports a deep and liquid market without inviting or tolerating reckless practices;
* renewed attention to the needs of renters, especially low-income and working renters
Housing in the U.S. has been supported by deliberate federal policies going all the way back to Thomas Jefferson's egalitarian land-tenure policies and the Homestead Act of the Lincoln era. The modern system, dating to the 1930s, is deep and pervasive. The Federal Home Loan Bank System was created in 1932 to give savings and loan associations and other thrift institutions a reliable source of credit to make home loans. The Federal Housing Administration created the first long-term fixed-rate mortgages in 1934 by putting the government's full faith and credit guarantee behind working families' home loans. Fannie Mae
was enacted in 1938 to create a "secondary mortgage market"--a liquid source of refunding for lenders making long-term mortgage loans. At first, Fannie was a government agency. After it was privatized in 1968, an implicit government guarantee of its commitments was generally understood. Then in 2008, with its takeover by a government conservator, Fannie again became an explicit government responsibility. Freddie Mac, a second quasi-public entity, followed a similar path. Federal deposit insurance further encouraged capital to flow into the housing sector.
But this framework and the policies that underlay it have been severely challenged by the current crisis. One in four mortgaged homeowners nationally is carrying more mortgage debt than their home is worth; 2.8 million owners have received foreclosure notices, with millions more likely to be foreclosed on as well; 3 million more are dealing with some kind of modification to their mortgage to stave off a default; and entire neighborhoods have been ravaged by the flood of foreclosed and abandoned homes.
Some argue that federal policies bred the crisis by encouraging too much homeownership and encouraging credit to too many families who could not handle it; critics contend that homeownership is suitable only for those wealthy enough to come to the closing table with a large down payment. The very premise that buying a home is a safe investment and a path to building wealth is being questioned. House Republicans recently proposed eliminating funding for the Obama administration's loan-modification program, complaining that it helped too few households.
Mistakes were surely made in encouraging "the American dream." Predators took advantage of lax regulation. Speculators were allowed to run rampant. And some families' homeownership reach far exceeded their financial grasp. But it's important not to draw the wrong lessons. To do so risks slowing the housing-market recovery, delays the revitalization of neighborhoods devastated by predatory lending and subsequent foreclosures, and closes the door to security and wealth building for millions of American families.
Homeownership historically has been a powerful wealth-building opportunity for American families. The Federal Reserve's Survey of Consumer Finances documented that in 2007, 69 percent of all U.S. households surveyed owned their primary residence. Even in the lowest quintile, this figure was 41 percent, or more than three times the share holding retirement accounts. In the second quintile, 55 percent owned their home, more than 50 percent greater than the share holding retirement accounts.
The value of primary residences also far exceeded that of retirement accounts, with a median primary-residence value of $200,000 overall, and $100,000 for the lowest quintile, $120,000 for the second lowest, and $150,000 for the third lowest. These figures do not take into account the debt that households have on the properties; their equity in the homes is obviously smaller than the total value. And while these values undoubtedly have declined since 2007, the difference in both participation rates and overall asset size documented in these figures is striking. Homeownership will continue to be the single most valuable asset for families as they age as well as their most significant source of potential retirement savings.
A sample of moderate income borrowers studied by the Center for Community Capital experienced steady appreciation and earned a remarkable annualized 29 percent return on their original equity. This wealth-building effect is a critical reason housing policy should continue to help new homeowners--where else in America today can a working family put down a small amount of money and leverage it for a significant return with a historically high likelihood of success?
Over the last 30 years, house prices nationally actually rose at a modest pace before the bubble and crash--about 3 percent nominally and 1 percent after accounting for inflation, leading some to suggest that renters would be better served by investing in super-safe Treasury bonds. But a $1,000 Treasury note costs $1,000. Any gains are based on the full investment. A 3.5 percent down-payment home purchase allows you to buy the equivalent of a $1,000 Treasury note for $35 but get the interest and appreciation on the entire $1,000. Plus, the buyer gets a consumption benefit on this investment that otherwise would have to be paid in rent--as well as tax advantages. It's no wonder that the single biggest factor in wealth disparities for moderate income families in America today is whether a family owns a home.
No doubt, we are better off today without the culture of "flip this house" and expectations of unending double-digit growth of house prices. But even with minimal appreciation, the combination of housing consumption and forced savings through the repayment of a stable long-term fixed-rate loan remains the single most important way for American families to build wealth. Thus support for sensible and sustainable home lending should remain an important objective for housing policy.
GOOD PRODUCTS WORK
The immediate pre-crisis housing market was marked by unsavory practices that accelerated the housing boom and exposed consumers to unsafe and unstable mortgages. These subprime and so-called Alt-A mortgages were promoted to borrowers as "affordability" products as the housing-market bubble inflated and costs outstripped everyday families' ability to purchase. They were touted to investors as can't-lose, high-yield assets. By layering in such features as low "teaser" rates for adjustable mortgages whose rates later skyrocketed; low or no documentation of income, assets, or employment; interest-only loans that did not amortize the principal owed; prepayment provisions that kept consumers from refinancing out of mortgages they couldn't handle; and balloon payments, lenders fooled many borrowers into taking out unaffordable loans. Investors, meanwhile, were willing to pay a premium for loans converted to supposedly safe securities, because of their projected higher yields.
But there is a much longer history of responsible lending that predates the headlong deterioration of underwriting standards to feed Wall Street securitization machines. That history belies the notion that only consumers who are rich and have sterling credit can be trusted with home loans.
Starting in the 1990s, with encouragement from the Community Reinvestment Act (CRA) and demand from neighborhood and urban leaders, banks began tentatively offering home loans to borrowers in neighborhoods the banks had shunned for years. These borrowers had nontraditional ways of documenting their creditworthiness and could make only lower down payments. In 1994, Fannie Mae
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began offering to finance loans with 3 percent down payments. Throughout the next 10 years, these practices produced strong positive results, as long as they were not mixed with shabby underwriting practices and dubious mortgage products such as subprime loans.
One example is Self Help Venture Fund in North Carolina, which joined with the Ford Foundation and Fannie Mae
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in 1998 to foster responsible lending to low-wealth borrowers. (See "A Needless Housing Collapse" by Alyssa Katz, page A7.) Community land trusts and city programs that work closely with borrowers play an active role in overseeing the kinds of mortgage products borrowers receive, and also help shield borrowers from predatory advances. These programs have shown high levels of success in promoting sustainable ownership. In 2010, the Center for American Progress reported that "a 2009 examination of the foreclosure experiences of five city-based affordable homeownership programs in Boston, Chicago, Los Angeles, New York, and San Francisco found that out of nearly 9,000 low-income families who turned to these programs to purchase their homes, the overall default rate was below 1 percent."
These approaches have a common focus on addressing the full slate of obstacles that can frustrate and defeat low-wealth borrowers. The loans are fully underwritten and documented. Borrowers don't have to have perfect credit records, but they have to demonstrate the ability and willingness to repay debts. The real and persistent lack of savings caused by stagnant wages and the lack of intergenerational wealth must be addressed through low down payments or public financing that contributes equity on a shared or temporary basis. And families that have never experienced both the joys and the hardships of homeownership--broken appliances, heating or air-conditioning failures--need support through education and ongoing help.
Even when not part of specialized programs, low down-payment lending has a successful history. Economist Mark Zandi wrote in a recent paper that "while there is no question that larger down payments correlate with better loan performance, low down payment mortgages that are well underwritten have historically experienced manageable default rates, even under significant economic or market stress." He cited data from the Mortgage Guaranty Insurance Corporation showing that foreclosure rates for mortgages made to borrowers with good credit and 45 percent debt-to-income ratios, with only 3 percent down payments in 2006-2007, at the height of the boom, were only 4.7 percent. Subprime serious delinquency and foreclosure rates from the same period are well above 20 percent.
Of course, not all homeowners are successful. Historically, the overwhelming causes of failure are simple: death or serious illness of a wage earner, divorce, or the loss of a job. In the last 10 years, homeowners' odds of success were shortened brutally by aggressive sales of high-risk mortgages both to buy and refinance homes that put millions underwater or drowned them altogether. The odds of homeownership success can be increased if national policy fosters responsible lending and safe products. The Dodd-Frank legislation adopted last year goes a long way toward establishing new national standards for mortgage lending. The bill tilts the table heavily toward straightforward long-term loans without exotic and unstable features. It severely restricts the ability to pay loan originators premiums for selling consumers more expensive products that provide little or no benefit to them. And it requires lenders to underwrite a loan on the basis of a borrower's ability to repay it.
The new Consumer Financial Protection Bureau will have broad authority over these and other provisions of the law designed to make mortgage lending safer for consumers. It's a welcome change from the unregulated chaos that led to the mortgage crisis, and it should go a long way toward restoring what has historically been a very stable and valuable set of policies for consumers.
MATCHING SUPPLY WITH DEMAND
The sudden and unprecedented plunge in housing values in 2008 has cost American families trillions in market value and equity. For those who bought at the height of the market, these losses can be devastating. But while about a quarter of all mortgaged owners are estimated to be "underwater" on their mortgages today, the bubble's impact varies dramatically by state and by metropolitan area. CoreLogic's February 2011 report on real-estate prices and values documents that in November 2010, the share of negative equity in 11 states was less than 10 percent; another 16 had negative equity shares between 10 percent and 15 percent. Only eight states have negative equity shares above the national average, and a few of these have levels that are startlingly high--Nevada at 66.9 percent; Arizona at 49 percent; Florida at 45.7 percent. Within these states, certain metro areas are hit even harder--Las Vegas with 71.6 percent, Phoenix with 54.7 percent, and Orlando-Kissimee at 53.3 percent.
Further, in some of these hardest-hit markets, speculators and investors, not aspiring homeowners, were big drivers of the bubble's inflation. The blocks of empty condominiums in Miami are the result of speculation and investor-driven overbuilding, not of affordable lending to aspiring working-class homeowners, for instance.
The questions for policy-makers are complicated. The severe contrast between what borrowers owe and what their houses will fetch is a serious drag on the economy. Owners in high negative-equity states cannot refinance their mortgages to get lower rates. They can't sell without taking significant losses that they cannot cover with savings.
The Obama administration's policies to deal with this problem have been weak and ineffectual. The Home Affordable Modification Program (HAMP) overpromised results for 3 million to 4 million homeowners and has been branded a failure for directly helping only about 600,000 owners. Participation by servicers was and remains voluntary. Servicers began slowly and subjected applicants to such hurdles as lost documentation, missing files, inconsistent points of contact, and robo-signing of documents to speed foreclosures. More-robust approaches are needed to attack high loan delinquencies and defaults:
* Government should step in and buy troubled mortgages from investors and resolve them through a single, streamlined program. Many distressed owners probably could succeed if they were refinanced into a lower balance with a decent mortgage. This was proposed to the Obama administration in 2009 but was rejected. It's time to try again.
* Borrowers should have ultimate recourse through bankruptcy to have their home loans modified. The Obama administration supported legislation to do this in 2009, but tepidly and without conviction. The other big banks stonewalled a solution even when Citigroup was ready to agree. It's still the right idea.
* State and local governments where delinquencies and foreclosures are heavily clustered should consider using eminent domain to acquire the properties and restructure them. Eminent domain once displaced the urban poor--now it can be used to help them. The banks' poor decisions and lousy loans are causing whole neighborhoods to become blighted. The properties can be resold to provide affordable home purchases or as rentals for families that desperately need them. Local governments and others can follow Boston Community Capital's example and buy foreclosed homes at distressed prices before owners move out and resell them to the owners so they can remain in place with a greatly reduced mortgage. Loans that are modified with principal reductions rather than lower interest rates alone have better success records, particularly where homes are significantly underwater. This tool needs to be used more widely and aggressively.
These moves would help slow the steady flow of foreclosed homes onto the market, where they are depressing prices and keeping the market off balance. But without effective demand, the market will not find a bottom, either. Lenders already have tightened up their minimum requirements for borrower credit profiles, and Fannie and Freddie have increased their fees. All of these make it harder for consumers to buy--at exactly the time when prices in many markets and interest rates are at generational lows. Unfortunately, the administration's February white-paper recommendations to raise fees and down payments for Fannie and Freddie as well as fees for the Federal Housing Administration would create even more hurdles.
Lately, much of the financial industry and many in both parties have been promoting higher down payments as a one-size-fits-all brand of reform. It doesn't require advanced math to conclude that high down payments will shut out millions of aspiring borrowers who would be good credit risks.
A presentation by Harvard University's Joint Center for Housing Studies to a recent FDIC session noted that median cash savings for white, non-Hispanic renters in a 2007 Federal Reserve study was about $1,000; for minority renters the median was less than $500. Even the 75th percentile of white renters had cash savings of only a little more than $5,000; that group of minority renters had just over $2,000. Total wealth for median white renters was about $7,500; for minority renters it is just over $2,000. Even the 75th percentile of white renters had only about $33,000 in total wealth; minorities in this group had net wealth of about $11,000. Assuming a relatively modest home price of $150,000, far below current levels in many markets even in this depressed economy, the ability to come up with $15,000 for a 10 percent down payment, or $30,000 for 20 percent, is obviously far beyond the reach of most renters.
Home prices will remain depressed and the housing economy sluggish unless two things occur: effective demand by buyers increases, and the supply of surplus homes declines. Neither one of these is going to happen unless pro-consumer policies that support credit to responsible borrowers are steadied and readied.
TAX AND SPEND
The congressional Joint Tax Committee estimates that deductions for mortgage interest on owner-occupied homes will cost the Treasury $101 billion in the current fiscal year. But roughly 95 percent of the value of the deductions flow to the top two income quintiles. Shifting the home mortgage deduction to a more progressive credit focused on first-time homebuyers or restricted by income would yield a much better result. The idea of substituting a credit, once farfetched, is gaining ground. The Bipartisan Policy Center's Deficit Reduction Task Force proposed substituting a 15 percent credit for the current mortgage interest deduction as part of a comprehensive tax overhaul, for instance.
This is also an opportunity to consider a refundable renter's tax credit. Harvard's Joint Center for Housing Studies reported in 2010 that one-quarter of all renter households paid more than 50 percent of their income for rent. Another 21 percent of all renter families paid between 30 percent and 50 percent of their income for rent. About 75 percent of the most heavily cost-burdened renters were in the bottom income quintile, and about half of all bottom-quintile households had these high burdens, the report noted. During the last 50 years, the share of renter households paying more than half their income for rent has doubled. The National Low Income Housing Coalition reports that "over two years (2007-2009), the number of extremely low income (ELI) renters grew from 9.3 million to 10 million households while affordable units decreased from 7.1 million to 6.5 million."
Tax policy alone will not enable these renters to escape such heavy burdens. Funding for rental-assistance programs such as Section 8 vouchers to help tenants, and money to underwrite the preservation of existing affordable rental housing is desperately needed. The Harvard Joint Center on Housing Studies found last year that "despite federal support for rental assistance of about $45 billion per year, only about one-quarter of eligible renter households report receiving housing assistance."
Even with no increase in net government support, a progressive restructuring of the income-tax advantages now flowing to the top two income quintiles could produce a budget-neutral dividend that would help close the shortfall in those households receiving low-income assistance.
The future success of both the single- and multifamily markets will depend on the re-establishment of a functioning secondary mortgage market. The collapse of Fannie Mae and Freddie Mac in September 2008 has set the stage for a major fight over their future and that of the entire system of funding for mortgages. (See "Fannie, Freddie, and the Future" by Dan Immergluck, page A19.)
The Obama administration released a white paper on this topic in early February. The paper offered only a broad outline of what a future system might look like, providing three options and a host of observations about their respective pros and cons. Rep. Jeb Hensarling, a Republican from Texas, recently reintroduced legislation that would wind down the two companies in two to five years and with them, federal support for this market. His colleagues in the House Financial Services Committee leadership have turned cautious on this topic, however, and the Senate appears likely to take considerable time before proposing any specific directions.
Because of Fannie's and Freddie's spectacular failure, this debate likely will be highly polarized, and it is unlikely that anything significant will be adopted before 2013. But some form of federal support will be necessary in the future to assure continued consumer access to affordable long-term, fixed-rate mortgages, which are by far the safest and most advantageous home loans for consumers. The market will have to be regulated to assure that regional and community banks and credit unions are not shut out of the market by the largest banks that already have increased their share of the mortgage market. Safeguards will be needed to prevent "creaming" in the market that leaves some borrowers and communities underserved.
A SOBERING OUTLOOK
Congress and the administration are locked in what promises to be a drawn-out war of attrition over the budget. The Federal Housing Administration, Fannie Mae, and Freddie Mac
have already tightened their credit terms, making it harder for borrowers to qualify, and the administration's white paper suggests that more constraints are likely on the horizon.
The Republican House has passed bills to zero out funding for the HAMP loan-modification program, the Neighborhood Stabilization Program that authorized $7 billion to state and local governments to cope with foreclosures as well as $3 billion in short-term relief for unemployed homeowners. Without these supports, further significant house-price declines could put more owners underwater. The pipeline of foreclosures remains a powerful brake on home sales and starts, undermining broader economic recovery.
Bolder actions that could accelerate the clearing of the housing market are politically unattainable for now. For instance, aggressive government purchases of distressed mortgages could enable them to be restructured immediately and on patient terms for distressed owner-occupants. The rest could be sold at steep discounts with shared equity to assure the government of a portion of future appreciation.
In the short term, it's important to focus on the areas where the administration can act without Congress. But the recommendations in the February white paper bode ill for consumers. The White House already has raised Federal Housing Administration premiums by a quarter of a percent. Its paper calls for a 10 percent minimum down payment and significantly higher fees for loans eligible for purchase by Fannie and Freddie. The white paper has emboldened Republicans who want to kill off these entities.
Unfortunately for Middle America, the combination of conservative exploitation of a crisis caused by conservative deregulatory policies to push for further reductions in the federal role, cautious administration policies, and congressional gridlock likely signals a significant further tightening of housing credit. This could relegate homeownership only to those with high savings or rich parents and do nothing to alleviate high-rent burdens for poor families. The facts don't support this course. But it will take determined advocacy and pressure to turn around the trend.