Congress Reminds Us What’s Wrong with Housing Reform Process

Whoever quipped that a camel is a horse designed by committee surely would have appreciated the latest efforts at housing reform by Congress.

Several signs emerged last week from the House and Senate that securing an economically and fiscally sensible approach to housing finance reform is taking a backseat to entrenched political views on both sides of the aisle.

The Johnson-Crapo bill unveiled last week in the Senate on Federal Housing Administration reform does little to address the systemic issues associated with direct federal subsidization of housing while effectively legislating a host of underwriting and insurance pricing policies that should otherwise be left to professional managers rather than politicians and special interest groups. The bill treats the symptom but not the root cause of why the FHA Mutual Mortgage Insurance Fund finds itself underwater. Fundamentally, provision of an explicit full federal guarantee for credit losses on FHA loans by an agency lacking the resources to conduct risk management and insurance activities consistent with other major market participants invited years of adverse selection against the FHA. For example, the agency only got around to appointing its first chief risk officer in 2009 as the crisis was raging and since then has not provided the CRO with resources to manage risks commensurate with organizations with large mortgage portfolios. Rather than adopting actions that would directly address FHA problems, such as moving the FHA out of the Department of Housing and Urban Development and requiring some form of credit risk-sharing, Johnson-Crapo tinkers with debt-to-income ratios, insurance premiums, underwriting policies and lender indemnification standards. In this regard political expediency overshadows a broader economic perspective.

To further illustrate how politics leads to bad housing policy outcomes, consider the implications of Senate Democrats’ efforts last week to impose the "nuclear option" with regard to Senate confirmation of administration nominees. As Republicans decide whether expending political capital on this nomination is worthwhile, it is now likelier that a professional politician, rather than a housing market expert, will wind up taking the reins of the Federal Housing Finance Agency and whatever ultimately replaces it. This is a problem because the FHFA and its successor will shape the course of the mortgage secondary market for decades to come. If the focus of housing reform were community development rather than housing finance, perhaps the decision would be easier. However, the credibility of efforts by the FHFA to advance secondary market reforms will be watched closely by private investors and other capital markets participants should the nominee be confirmed. Affordable housing is essential to our housing system, but at this time the greater good would be better supported by leaders with deep administrative experience in establishing a sustainable mortgage secondary market.

Perhaps nowhere does politics rear its head more than with the most significant issue debated in housing reform; namely the nature and extent of any federal guarantee on mortgages. The consensus among housing finance experts and capital markets participants is that some form of limited guarantee such as that proposed in the Corker-Warner bill is essential for a mortgage secondary market to maintain the scale , liquidity and stability of today’s market. We experimented with a purely private mortgage market not that long ago with private-label securities. We saw that at the first hint of economic instability, private investment vanishes from markets. Hence, even with safeguards on loan quality, standardization of contracts and security instruments, a fully private mortgage market will greatly diminish the availability of mortgage credit. The proper role of governments in mitigating market failures is a classic problem in economic theory. Assertions that there can be no government guarantee in a post-GSE world underscore preferences by some in Congress to adhere to political dogma rather than find an economically viable path to minimizing taxpayer exposure while maintaining a deeply liquid and stable mortgage market.

Realizing that there are constituencies arrayed across the entire spectrum of housing finance policy on this issue, what does a potential "Great Compromise" for housing reform look like? First, it must feature a catastrophic guarantee by the federal government for there to be a viable secondary market. While this clearly is a major issue for some House Republicans, limiting such a guarantee to only the most severe economic events greatly mitigates taxpayer exposure and would represent a significant improvement from the GSE model. Further, the FHA should be removed from HUD and be required to engage in credit risk-sharing arrangements with other private investors. This would vastly improve the FHA’s ability to price risk while reducing taxpayer exposure. Some will argue that such a structure will greatly reduce support for low-income housing. On the contrary, private/public risk-sharing would provide a more efficient mechanism for distributing the credit risk of FHA loans and in the process maintain the lowest premiums possible for risk in its programs.

It is painful to watch housing policy developments in Congress unfold as what we have so far looks more like a freak of nature than a camel or a horse.

Clifford Rossi is the Executive-in-Residence and Tyser Teaching Fellow at the Robert H. Smith School of Business at the University of Maryland.