Reform Our Broken Housing Finance System
Hensarling Lays Out Principles for Housing Finance Reform, Expresses Support for Bipartisan Approach
“I stand ready to negotiate….with any other stakeholder that shares my belief that America deserves a sustainable housing finance system, and deserves one now.”
WASHINGTON – House Financial Services Committee Chairman Jeb Hensarling (R-TX) today outlined reforms to fix America’s broken housing finance system.
During a speech at a conference on the future of the U.S. housing market, Chairman Hensarling said he would work on a bipartisan basis to come up with a reform package provided it included certain key principles. He also pointed to a proposal authored by Ed DeMarco, the former acting director of the Federal Housing Finance Agency, and Michael Bright, currently the executive vice president at Ginnie Mae, as a way to move housing finance reform forward.
Among the principles Chairman Hensarling outlined for any sustainable housing finance reform plan, are:
- Fannie Mae and Freddie Mac must be wound down and their charters repealed;
- Securitizers need strong bank-like capital and community financial institutions must be able to compete on a level playing field;
- Any new government affordable housing program needs to at least be on budget, results based, and target actual homebuyers for the purpose of buying a home they can actually afford to keep;
- The Federal Housing Administration must return to its traditional role of serving the first-time homebuyer and low- and moderate-income individuals.
Chairman Hensarling’s full remarks, as prepared for delivery, appear below:
“Choosing the Better System”
Thank you for inviting me to address you today. It is an honor to appear along with Dr. Shiller and Senator Heitkamp, and I hope this is the forum where we can have a frank discussion of the challenges confronting the U.S. housing industry, specifically the unequivocal need to reform our broken financing system now, not tomorrow, not next Congress, not next crisis. Now.
Comprehensive housing finance reform remains the great financial services challenge of our time, an elusive $14 trillion question in search of the political courage to answer it. But courage must be mustered, memories of the second worst financial crisis in our history cannot be allowed to fade. After all, we saw median household incomes climb to a peak of more than $58,000 in 2007, before cratering and not regaining that lost value until last year. In other words, a lost decade.
Ten years of lost economic wealth and opportunity, ten years where it was harder for working Americans to pay their bills and feed their families than it was in 2007, ten years where gas was too expensive if you were lucky enough to have a decent car, ten years where a family vacation was at best a four-day weekend, ten years where college was that much more out of reach and the necessity of a second job that much more of a reality.
Looking back it is indisputable that historic mortgage market volatility had real, pronounced, and extremely long-lasting negative effects on our economy that far exceeded any temporary value it might have generated. The unsustainable housing finance rollercoaster literally wiped out $16 trillion worth of household wealth in the seven quarters from Q3-2007 through Q1-2009. All the harmed lives and economic carnage arising from public policy in pursuit of a few percentage points of temporary homeownership growth, was simply not worth it.
No matter what some apologists might say, the lesson is clear: housing unsustainability doesn’t just create unaffordability, it creates economic catastrophe.
Looking forward, we simply cannot rely on government promises and schemes, no matter how well-intentioned, to provide long-term, sustainable economic success. It is what Austrian economist Friedrich Hayek aptly termed “fatal conceit.”
For decades, the federal government has tried to micromanage, manipulate, and mandate policies to create economically favorable outcomes, always with disappointing results. Instead, if we want healthy economic growth and sustainable economic growth, we need less government and more freedom, and it all starts with fundamental tax reform.
Importance of economic growth, not government fiat
For far too long our tax code has been inefficient, unfair and complicated. It has diminished the dreams of our fellow citizens. It has cost our country countless jobs and businesses. That’s why I proudly supported the historic tax reform bill passed by the House of Representatives last month to create a fairer, flatter, simpler, and more competitive tax code. And I’m ecstatic the Senate passed its counterpart this weekend.
I know [you have] taken a different view of the House bill. Now, I want to be a polite guest but I cannot be a silent guest. The topic is far too important. So let me clear up some mischaracterizations out there about what fundamental tax reform will and will not do. Some have prophesized that our bill will decimate the housing market, especially for high value homes by limiting the Mortgage Interest Deduction to the first $500,000 in principle value down from its current $1 million threshold.
This hyperbolic rhetoric is not accurate for several reasons. First of all, fewer than one-third of all 150 million taxpayers itemize their deductions, and roughly 75 percent of itemizers claimed the Mortgage Interest Deduction. Second, as the Washington Post has noted, only about “2.5 percent of Americans are paying mortgages on homes valued at $500,000 or more.” Even for that small segment of our country, the reality remains that the deductibility of mortgage interest does not materially affect the rate of homeownership.
But here’s what does: a strong, growing economy – and the Tax Cuts and Jobs Act will significantly grow the economy. According to an analysis from the nonpartisan Tax Foundation, this bill is estimated to grow the economy by 3.5 percent. As a result of this economic growth, paychecks will increase substantially – by an estimated 3.8 percent. In other words, Americans will earn bigger paychecks – at lower tax rates – so they will have even more money to invest in even more homes.
A 3-plus percent economy will do such more for housing then a 1 ½ – 2 percent economy. It’s that simple.
Flaws of the old system
But before our fellow citizens can invest in more homes we need to give them a sustainable housing finance system. We all should know what didn’t work about the old system, but it does bear repeating. The old Fannie Mae, Freddie Mac hybrid public-private chartered system was the basic Let’s Privatize All the Profits and Socialize All the Losses government scheme. Its premise? To have two giant corporations monopolize a market and perform four critical tasks all under one roof in the name of efficiency. The GSEs set the underwriting standards, they aggregated all the loans, they performed the alchemy to turn loans into MBS, and they guaranteed that MBS with money they didn’t have but kindly took from taxpayers when the going got tough.
Now, from time to time, some status quo housing finance apologists will pop up and proclaim that the old system wasn’t really all that flawed, and if we just tried it one more time with feeling, we could iron out the kinks and it would work without a hitch. So let me be abundantly clear here: they are wrong. The current system is rigid and risky, distortive and inefficient, and it devalues individual choice and inhibits long-term prosperity. In other words, the hybrid GSE model is wrong. It is unfair. It is broken. It is irreparable.
It cannot be saved, it cannot be salvaged, it must not be resurrected, and needs to be scrapped. Otherwise, I have no strong opinions on the matter.
What we ought to expect in a Better System
Americans deserve a better system, and if you’ve ever talked to a creditworthy person who was denied a mortgage or someone who went through the pains of foreclosure as the dream of homeownership morphed into the nightmare of financial ruin, you know Americans want a better system.
A better system would give all Americans the chance to become homeowners, if they so choose and are qualified, in a way that encourages responsible mortgage lending and promotes long-term economic growth and stability.
Why the PATH Act is and remains the best solution
Such a system would need to be predicated on individual choice, competition, market discipline, effective disclosure, and consumer protection.
It would need to promote long-term stability and prosperity by decreasing the crippling volatility that has destroyed so much household wealth. It would effectively protect taxpayers against future credit risk. In my mind, there is already one proposal out there that would accomplish all of those goals and then some: the PATH Act passed by the Financial Services Committee in the 113th Congress.
By clearly defining the government’s role in our housing markets and setting clear, transparent, and enforceable rules for transactions to foster competition and restore market discipline, the PATH Act would give Americans a sustainable market based housing finance system. Sustainable for homeowners so they can keep their homes; sustainable for taxpayers so they are never again forced to fund another multi-billion dollar Washington bailout; and sustainable for our nation’s economy so we avoid the boom-bust housing cycles that have hurt so many in the past. The PATH Act also gives consumers real choice in determining which mortgage products best suit their individual needs, free from arbitrary government restrictions, and it promotes long-term economic growth by tearing down artificial barriers to private capital to attract investment and encourage innovation.
It also builds on existing elements of our current system – a right-sized FHA, an independent and open common securitization platform, and transitional GSE financing – as well as providing new and enhanced ways to finance mortgage lending via greater portfolio lending, privately securitized transactions, and new covered bond options.
If not the PATH Act, then what?
Now that we have a new Administration, the once-dormant efforts to take up comprehensive reform like the PATH Act appear to have a new chance at success. And, while I personally have not changed my principles or my mind that the best path forward remains the PATH Act, after carefully surveying today’s political landscape, I do not see the PATH Act’s passage likely, especially in light of super-majority threshold in the Senate.
Although I have not given up hope, the House Financial Services Committee has been exploring all options. The Committee has now held more than half a dozen hearings as well as numerous stakeholder roundtables to solicit and review input on building consensus to go forward with at least some fundamental reforms resulting in a more sustainable and improved housing finance system.
Principles in pursuit of the better system
Here are some basic principles that I think must guide any successful and cooperative effort. First, to be clear, Fannie and Freddie must be wound down and their charters repealed. I fear any plan to recap and release may very well constitute déjà vu all over again. I do not believe that you can have a competitive and innovative housing finance market otherwise. The barriers to entry would be too formidable. Unacceptable risk will yet again reside in only two places.
Also, to further protect taxpayers, securitizers will need strong bank-like capital. Barriers to entry will have to be removed and community financial institutions must be able to compete on a level playing field. Although I hate to have the federal government in the position of deciding which mortgages can be securitized, with $5.7 trillion in guarantees, decide it must. One way to do this is to allow only prime mortgages underwritten to historically prudent standards to be allowed to be securitized.
Unfortunately, history shows us that such standards inevitably erode over time under the weight of political pressure. We must be vigilant to ensure that this does not happen again.
Since the dawn of our republic, the most effective, affordable housing program has always been a good job, in a promising career, in a growing economy; not a subsidy, tax credit, or deduction. Again, that is why we need fundamental tax reform, as I have discussed earlier.
Still to forge a bipartisan reform plan, I acknowledge there will likely be yet another government affordable housing program to be added to the other ones already in existence. It at least needs to be on budget, results based, and target actual homebuyers for the purpose of buying a home they can actually afford to keep. Finally, no sustainable housing finance system can exist without FHA reform as well as GSE reform.
If all we do is reform Fannie and Freddie, it is like pushing in on one end of the balloon and not expecting it to bulge out on the other. FHA must return to its traditional role of serving the first-time homebuyer and low- and moderate-income individuals.
How and what to guarantee
So much of this debate again revolves around one central question: does the government need to provide a guarantee for the system to work, and if so how should that happen.
I continue to believe that a government guarantee in the secondary mortgage market remains a bad idea, a risky idea, and an un-needed idea. I also believe the idea is not going away anytime soon and I fully expect it to be part of any successful reform effort in this Congress. Thus, if we’re going to be stuck with it for a while, we must look for a more logical, smaller and safer government guarantee than the one we have today. As an aside, the conversation on government guarantees always invites talk of what would become of the 30 year fixed rate mortgage. Although I do not believe a pre-payable 30 year fixed rate mortgage is the right product for everybody, and I note parenthetically it currently can and does exists without a government guarantee, I have no doubt that policies in a reform package will ensure it both survives and thrives. Let me, now offer a number of suggestions for how we might develop a smarter government guarantee. One, any new government guarantee must be limited to catastrophic losses within the system only.
That means the government needs to be in the last-loss position, with multiple layers of private capital, as diversified as possible, stacked up before it.
Number two, any new government guarantee should consolidate existing structures and avoid a duplication of efforts.
Right now, it simply makes no rational sense to have a government-backed Fannie Mae guarantee competing against a government-backed Freddie Mac guarantee, and both competing against a government-provided Ginnie Mae guarantee.
Third, any new government guarantee would need to be transparent both in its attachment and its pricing, and the guarantee itself should only be applied to well-defined, qualified obligations and not to the offering entities themselves. Lastly, any new government guarantee must be limited in its applicability to qualified transactions only, and not hardwired into the system on all transactions.
In a mortgage market as diverse as ours, we should neither be adding to taxpayer risk to insure loans that fail to meet historically prudent underwriting standards for success, nor should we restrict lenders only to one set of rules when they are willing to use their own money to back up their promises.
Such guardrails on a new guarantee would be a vast improvement over the murky rules of our housing finance system today.
Besides ensuring that the federal taxpayer is only placed in the catastrophic loss position, other key principles must be part of a new and reformed housing finance system. As the taxpayer is placed in the catastrophic loss position, the pricing of this guarantee must be market based.
From the NFIP to the PBGC to a myriad of other government guarantees and insurance programs, the facts are clear: the government does a lousy job of pricing risk. History shows the political pressures will always weigh in favor of underpricing the risk.
The best path forward
Given all those considerations and the feedback we have received throughout this year, I have been particularly encouraged by one proposal that seems to accomplish many of the goals I have outlined here today. That proposal is the one offered up last year by former FHFA Acting Director Ed DeMarco and current Ginnie Mae Acting President Michael Bright.
At its core, the DeMarco-Bright proposal would provide a new explicit government guarantee for mortgages by revising the Ginnie Mae charter to authorize it to accept mortgages with non-government credit enhancements from the private sector.
Under their proposal, the existing framework and certainty of the Ginnie Mae full faith and credit of the federal government guarantee would be harnessed to begin accepting privately-insured mortgages and entice private guarantors to deploy their resources and knowledge to manage risktaxpayers are asked to pick up the tab.
Coupled with the basic tenants of the PATH Act, the DeMarco-Bright proposal creates another pathway under a better system to increase choice, help diversify risk, and promote stability within the marketplace.
For those who want loans with explicit government guarantees, those products would be there. For those who want to privately finance or hold on their books the risk of their own loans, that choice would be available. And for those who wish to innovate and reach out to new markets on their own terms, those opportunities would be there as well.
I believe the DeMarco-Bright proposal provides a credible, implementable, battle-tested way to create a new, limited government guarantee in a post-GSE housing finance system, and one that deserves to be fully explored by Congress as part of any comprehensive housing finance reform effort.
Now is the time for reform
As we weigh these heavy questions, it is important to keep in mind that we have an historic opportunity before us, but one that is fleeting with each passing day. To be sure, the work of enacting comprehensive housing finance reform is no easy task. The material is difficult, the consequences are tremendous, and the details really matter. In other words, it’s not a friend-making exercise in a town where friends can be hard to come by.
But if we are to avoid another housing-driven financial crisis rivaling that of 2008, it remains vital work. That’s why it is so critical that all stakeholders resist the temptation to sit this one out and stick with the current system as “good enough for now.” That’s too risky. This is our best opportunity to reshape the landscape from something less than we deserve into something that does recognize the highest and best uses of our resources in the interests of the nation and our fellow citizens.
I stand ready to negotiate with an open mind, but not an empty mind with any other stakeholder that shares my belief that America deserves a sustainable housing finance system, and deserves one now.