Affordable Rent and Access to Homeownership Refreshing the Debate in the Context of Housing Finance Reform

MichaelBrightandEdDeMarco

May2017

Introduction Thecontinuingpolicydebateoverrestructuringtheplumbingofthesecondarymortgagemarketmayultimatelyprovetobetheeasypart—atleastpolitically—ofhousingfinancereform.Thepasteightyearsofproposalsandcounterproposalshavefocusedtherangeofoutcomesincreasinglywithinafairlynarrowband—moreprivatecapital,amortgage-backedsecurity(MBS)explicitlyguaranteedbythegovernment,theeliminationofthegovernment-sponsoredenterprise(GSE)duopoly,andflawedownershipmodelallbeingconsistentthemes.TheproposalweputforwardlastyearfavoredleveragingasinglegovernmentMBS—theGinnieMaesecurity—coupledwithawell-regulatedandcompetitivemarketforcreditenhancement.1

Arguably,though,themoreimportantpartofreform—thepartstillinneedoffreshthinking—iswhetherandhowtoproducebroaderandmoresustainableaccesstocreditforfirst-timehomebuyersandlow-andmoderate-incomeAmericansaswellashowtoincreasethesupplyofaffordablerentalhousing.Allofthisisavitalpartofensuringthatreformcreatesasystemthatcanmeettheneedsofanevolving21stcenturyAmericaneconomy.Andafterall,ifWashingtonisgoingtoengageinafinancialrestructuringexercise,thefocusshouldbeonimprovingthelivesofcurrentandfuturegenerationsofAmericans.

1MichaelBrightandEdDeMarco,“TowardaNewSecondaryMortgageMarket,”September2016.http://www.milkeninstitute.org/publications/view/823

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Whilethisisaseparatepaper,wewantourreaderstobeawarethatwedidnotputthecartbeforethehorse;theplumbingreformsweproposedweredesignedinlargeparttohelpaddressissuesofaccessandaffordability.Howso?Byembracingacompetitivemarketplace,webelievethatinnovationanddisruptioncanusherinanerainwhichmoremortgagesaremadeandonmoresuccessfulterms.Andbyusingasinglegovernment-backedMBS,wecancreateatransparentandaccountablerevenuestreamtoproperly—andtransparently—helpsubsidizeaccesstohousingopportunitiesforallcommunities.

Inthispaper,weanalyzemoredeeplythediscussionaroundaccessandaffordability.WebelievethatthehousingfinancechallengesfacedbyAmericanfamiliestoday,whethertheybemillennialsenteringthemarketforthefirsttimeorbabyboomersheadingintoretirement,needfreshthinkingandsolutions.Webelievethatourhousingmarketisnotworkingaswellasitcould.Importantly,webelievethathousingfinancereformoffersustheopportunitytotacklethesechallenges.

Ourkeyconclusionsandrecommendationsmaybebrieflysummarizedasfollows:

(1) TherentalmarketinAmericatodayisfrequentlyinhibitedbylocallanduse,zoning,andbuildingrestrictionsthat,whilewell-intentioned,canimpedethecreationofaffordablerentals.Thefederalgovernmentcan’tsolveeveryproblem.Tacklingthesupplyconstraintsindevelopingmore-affordablerentalunitsstartswithlocalgovernments.Still,webelievepolicymakersinWashingtonneedafullerappreciationofthemagnitudeofthechallengesfacingmanylow-incomeAmericans.Near-termadditionalfederalassistancecouldbringimmediaterelief,butinthelongerterm,localchangesthatunlocksupplyconstraintswillmakethemostmeaningfulimpact.

(2) Inmultifamilyfinance,werecommendkeepinginplacemuchoftheloss-sharingarrangementsusedbyFannieMaeandFreddieMacintheirK-SeriesandDUSprograms2butwesuggestseparatingFannieandFreddie’smultifamilyunitsintoindependentlyownedandoperatedprivatecompaniesseparatefromtheirsingle-familybusinessunits.AnygovernmentguaranteeofMBSsbackedbyaffordablemultifamilyloanswouldbedonethroughGinnieMaeandaccessedbyanyeligibleentity.

(3) Turningtosingle-familyhousing,forthosewhobelievethattherearegoodloansthatarenotbeingmade—apropositionforwhichthereissomeevidence—ourviewisthatmorecompetitionandinnovationinunderwritingiscriticaltosolvingthischallenge.Thiscanbestbeachievedbyopeningthemarketforcreditenhancementtonewparticipants.Ifpolicymakerswanttofacilitatenewentrantsandinnovationinmortgagecredit,thedatathatsitatFannieMaeandFreddieMacthathelpinformtheir“blackbox”underwritingengines(DesktopUnderwriterandLoanAdvisor)shouldbemadeavailabletoallentitieseligibletoissueorcredit-enhanceGinnieMaeMBSs.Thesenewentrants,subjecttoFederalHousingFinanceAgency

2https://www.fanniemae.com/multifamily/multifamily-delegated-underwriting-servicing-dushttp://www.freddiemac.com/multifamily/investors/kcerts.html

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(FHFA)oversight,shouldbepermittedtoevolvethecreditboxbybuildingtheirownunderwritingsystems,subjecttoFHFAapproval,toimproveuponthatoftheGSEs.This“disruption”isacriticalpartofmeetingtheevolvingneedsofrentersandhomebuyersandtheirchangingdemographics.Nomarketfunctionswellwhenmanagedentirelythroughaprivilegedduopoly;housing—andthemarketformortgagecreditrisk—isnotinherentlyanydifferent.

(4) Areformedsecondarymortgagemarketshouldencouragelendingtoallincomelevelsandcommunities.Ifpolicymakersaredecidingtohelpsubsidizeandfacilitatethismarket,itisaboutreachingthemarginalborrower.Assuch,thegovernment-supportedmarketshouldbebuiltontheconceptthatparticipatingfirmshaveadutytoservetheentiremarketplace,notjusthigh-endorthemostcreditworthyborrowers.Arequirementonapprovedcreditenhancerstoproduce“geographicallyandeconomicallydiverse,representativesamplepools”ofmortgagesforsecuritization,combinedwithdetailedloanreporting,wouldestablishapublicbaselineforallsecondarymarketentitiesthatcredit-enhanceloansputintogovernment-backedMBS.

(5) Toaugmentthis“dutytoserve,”weproposeasimple,transparent,andaccountablefeeonallborrowersbenefitingfromaccesstoagovernment-backedsecuritizationprocess.Theproceeds,generatedbyachargeof10basispointsorsoaddedtoborrowerinterestrates,wouldbeusedtoprovideaffordable-rentsubsidiesforlow-incomefamilies,toprovidefinancialassistancetoeligiblefirst-timehomebuyers,andtosubsidizetheservicingofloansmadetotargetedlow-incomehomebuyerswhobecomedelinquentontheirmortgages.

(6) TheFederalHousingAdministration(FHA)shouldbemodernized,startingwitharestatementofitsmissionandpurpose.Itthenmustbegiventheresourcesneededtoupdateitsystems,processes,andtechnologytofulfillitsnewmission.Thatmissionmustincludeservingasacountercyclicalforceiforwhenprivatecreditmarketspullbackfromtimetotime,astheydidintheyearsimmediatelyfollowingthefinancialcrisis.Whenassessingwhetherthehousingfinancesystemasawholeisservingallmarkets,loansinsuredbytheFHAshouldbeincludedintheanalysis.

(7) Aslongaswearegoingtohavesubsidiesandpublicpolicydesignedtohelplow-incomefamiliesorcommunitiesonthemargintobuyhomes,wemustrecognizethatwhatcountsisnotsimplyhowmanyloansaremade,butwhethertheloansaresuccessful.Itisthefinal,long-termoutcomethatmatters,notsimplythemakingofaloan.Weproposethatanyregulationsaround“dutytoserve”measuresuccessinawaythatdoesnotcountloansthatgointodefaultwithin24monthsofbeingmade.Putanotherway,anyloanthatgoesintodefaultwithin24monthsofbeingmadeshouldnotbeviewedashavingfulfilledtheobligationtoserveahomeowner,afamily,oracommunity.

(8) Thesingle-familymarketneedstofocusmoreonpreparingrenterstobesuccessfulhomeowners.Theprocessshouldincludeprogramsdesignedtohelpprospectivehomeowners

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saveforadownpayment,supplementedbypublicandprivatedown-paymentassistanceandbyborrowereducationandcreditcounseling.Innovativewaysofhelpingnewborrowersbecomehomeownersshouldbeconsideredandencouraged,subjecttorobustconsumerprotections.

Part I: The Rental MarketWhiletherentalmarketoftentakesabackseatinhousingfinancereformdiscussions,ithasthegreaterpotentialtoimproveaffordable-housingopportunities,anditisthemarketwheremostpeoplestarttheirhousingjourney.Weunderstandthatmuchofhousingreformisgearedtowardthecostofownership,andweappreciatethatfocus.Still,forahostofreasons,wewouldberemissifwedidnotincludeabroadandsubstantivelookatthechallengesfacingAmericanrenters.Afterall,manyoftoday’srentersaretomorrow’sfirst-timehomebuyers.Therefore,tous,theissuesareinextricablylinked.Therefore,webeginwithananalysisoftherentalandmultifamilymarkets.

Allisnotwellhere.Infact,itisquitetheoppositeformanyfamilies.TheJ.RonaldTerwilligerFoundationforHousingAmerica’sFamilies,amongotherresearch,reportsthatmorethan11millionfamilies—morethan1in4renterhouseholds—paymorethan50percentoftheirmonthlyincomeonrent.3Thisunacceptableimbalancebetweenincomeandrenthindersbotheconomicgrowthandfamilywell-beingandraisesmoralissues.

Ofcourse,theissueishighlycomplex.Forexample,whilerentalhousingmayconjurevisionsofdowntownhigh-riseapartmentbuildingsorperhapssuburbangardenapartments,thefactisthatthemajorityofrentalsareinone-tofour-familyhouses.AccordingtotheCensusBureau’sAmericanCommunitySurvey,in2015justoverone-thirdoffamiliesinrentalhousingwereindwellingsoffiveormoreunits.Accordingly,weconsidermultifamilyrentalseparatefromsingle-family.Bothareasneedsolutions,butbothhaveuniquechallenges.MultifamilyRentalMarketFinancingofmultifamilyrentalpropertiesisnotlikethatofsingle-familyhomes.Thepropertyownerdoesnotobtaina30-year,fixed-ratemortgageandpayofftheprincipalofthebuildingover30years.Instead,thecommercialloanisoften10years,withonlyaportionoftheprincipalbeingpaid.Astheloantermexpires,theownerrefinancestheproperty.Individualpropertiesmaybeseparatelyincorporated,andthusthelender’srecourseistothepropertyitself,nottothebroaderassetsofthebuildingowner.

Basiceconomicssuggestthatthesupplyofmultifamilyrentalhousingshouldrespondtocurrentandprojectedincreasesordecreasesindemandinagivenarea.Thus,ifdemandforrentalsincreasesand

3J.RonaldTerwilligeretal.,FoundationforHousingAmerica’sFamilies,“TheSilentCrisis:ASnapshotofCurrentandFutureConditions,”June18,2015.https://www.joomag.com/magazine/the-silent-housing-crisis/0290011001434491644?shortTheTerwilligerreportcitesDanielMcCue,“TheBurdenofHighHousingCosts,”Cascade,n.26,Winter2015,FederalReserveBankofPhiladelphia.Seealso“ProjectingTrendsinSeverelyCost-BurdenedRenters:2015-2025,”EnterpriseCommunityPartnersandJointCenterforHousingStudiesofHarvardUniversity,2015.http://www.enterprisecommunity.org/download?fid=10007&nid=13350

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rentsincreaseinresponse,onewouldexpectanincreaseinsupplytofollow.Buttherealityismorecomplicatedthanthat.

Notonlydoesittaketimetoincreasethesupplyofmultifamilyrentalproperty—obviouslyonedoesnotbuildanapartmentcomplexovernight—itisahighlyregulatedcommercialactivity,withmostregulationsoriginatingatthestateandlocallevels.Indeed,thebiggestbarrierstoamarket-drivenresponsetothedemandformorerentalhousingarelanduserestrictions,buildingcoderequirements,andlocalopposition.Landuserestrictionsdictatewhetherandwherevacantlandorlandbeingusedforotherpurposesmaybeconvertedintorentalhousing.Inmanymetroareas,thoserestrictionscanbesubstantial.Buildingcoderequirements,whetherforhealthandsafety,environmentalimpact,aesthetics,localinfrastructure,orotherreasonsincreasethecostofbuildingandmaintainingrentalproperties.4Whateverthemeritsofsuchrequirements,theyultimatelyaddtocostandthusaddtorent.Whilethismaynotaffectmattersmuchforahigh-income,luxuryapartmentbuilding,itcanbethedifferencebetweentherentbeingaffordableorunaffordableforalower-incomefamily.

Anotherregulatoryissueisthecostsoffederal,state,andlocalprogramsandsubsidiesdesignedtodirectinvestmenttowardtheconstructionandmaintenanceofaffordablerentalhousing.Theseprogramsaremeanttolowercostsandincreasesupply,eachleadingtolowerrentsandgreateraccess.Understandably,thegovernmentsthatcreatesuchprogramswantaccountabilitytoensurethatfundsareusedasintended.Fairenough.Butastheprescriptionsregardingrentereligibility,buildingcharacteristics,andahostofothermattersincreaseindetailandcomplexity,compliancecostsriseaccordingly.

Thisleadstoatleastthreeresponsesthatincreasecostswhentheintentofthegovernmentprogramwastodrivethemdown.First,therearetherequiredrecord-keepingandcompliancemechanisms.Second,somedevelopersorlandlordsmaynotparticipateinthesemarkets,makingthebiddinglesscompetitive,becausetheyeithercannotaffordthecompliancecostsorareunwillingtoriskthepenaltiesforcompliancefailures.Andthird,affordable-housingprojectsfrequentlyhavemultiplesourcesofsubsidyandeachsourcehasitsownrequirementsforindependentreviewsandaudits.Thatalsodrivesupcosts.So,whiletaxpayersrightlyexpectgovernmentofficialstoensurethattaxpayerfundsareusedappropriately,therealityisthatonehandisloweringcostswhiletheotherisraisingthem.

Incommunitiessufferingfromshortagesofaffordablemultifamilyrentalhousing,citizensandtheirrepresentativesneedtoevaluatelocallanduseordinances,buildingcodes,laborrules,legalrequirements,taxes,andanyotherrequirementthatlimitssupplyordrivesupthecostofaddingnewsupply.Often,thereareunderstandableandlegitimatedifferencesofviewanddifferentvaluejudgmentsaboutopenspace,traffic,sightlines,infrastructurerequirements,andsoon.Butthesadtruthisthatthesemyriadrequirementscombinedwithlocalpoliticalbattlesandnever-endinglitigation

4Foradeeperexplanationofthesourcesandimpactofcostsonaffordablerentalsupply,seeAndrewJakabovics,LynnM.Ross,MollySimpson,andMichaelSpotts,“BendingtheCostCurve:SolutionstoExpandtheSupplyofAffordableRentals,”Washington,DC:UrbanLandInstitute,2014.http://uli.org/wp-content/uploads/ULI-Documents/BendingCostCurve-Solutions_2014_web.pdf

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canhaltdevelopmentofnewhousingsupplyformanyyears.Theendresultisthatcreatingmoreofthisbasichumanneed—affordablehousing—isstifled.Increasingthemultifamilyrentalsupplyisnotjustaboutbuildingwherethereisopenspace.Itisaboutpreservingandrehabilitatinganagingstockofrentalhousingwherethisiseconomicallyfeasible,andnotjustforluxuryrentalunits.Itisalsoaboutrepurposingexistingstructuresforhousing.Yettoomanybarriersseemtobestandingintheway.

TheObamaadministrationurgedlocalofficialstoreducethegovernment-imposedimpedimentstomarkets’workingforallincomelevels.Lastyear,theWhiteHousepublisheda“HousingDevelopmentToolkit”outliningmethodstoreduceobstaclesthatdiscouragedtheprivatemarketfromsupplyingmore-affordablehousing.5AstheRStreetInstitute’sJonathanCoppagenoted,thissensiblesetofguidelinesforlocalgovernmentsdoesnotexemptthefederalgovernmentfromrethinkingthechallengesitunwittinglyimposes.Inparticular,hecitestheFHA’sstringentlimitsonmixingcommercialandresidentialdevelopment.6

ThefederalroleinsupportingthelocalsupplyofmultifamilyrentalhousingcomeslargelyfromtheLow-IncomeHousingTaxCredit(LIHTC)andthroughvariousHUDprograms(suchastheHOMEProgram)tosupportthebuilding,rehabilitation,andfinancingofmultifamilydwellings.Significantsupportalsocomesfromtenant-basedandproject-basedhousingvouchers(whatusedtobeknownasSection8vouchers,nowreferredtoastheHousingChoiceVoucherProgram).Theefficacyoftheseprogramsisbeyondthescopeofthispaper.7Sufficeittosaythereareadvocateswhobelievetheseprogramsarevastlyunderfundedwhileothersarguethattheymakemattersworsebyconcentratingpovertyandactuallylimitingsupplybypreventingmarketsfromfunctioning.8Regardless,weareoftheviewthatlawmakersandtheTrumpadministrationshouldmovepastolddebatesinpursuitofresults-orientedideassuchaslinkingfederalprogramstoaffordable-housingdevelopmentinwalkablecommunitiesorinconjunctionwithliberalizedlandusetoaddresssupplyconstraints.This,inalllikelihood,willrequireadditionalfunds.

5“HousingDevelopmentToolKit,”WhiteHousewebsitehttps://www.whitehouse.gov/sites/whitehouse.gov/files/images/Housing_Development_Toolkit%20f.2.pdf6JonathanCoppage,“ToEndtheAffordableHousingCrisis,WashingtonNeedstoLegalizeMainStreet,”WashingtonPost,October4,2016.https://www.washingtonpost.com/posteverything/wp/2016/10/04/to-end-the-affordable-housing-crisis-washington-needs-to-legalize-main-street/?utm_term=.195c362225577Harvard’sJointCenterforHousingStudiespublishedacomprehensiveanalysisofmultifamilymarketconditionsandtheroleofvariousfederalprogramsinthismarket.See“America’sRentalHousing:ExpandingOptionsforDiverseandGrowingDemand,”JointCenterforHousingStudiesofHarvardUniversity,December2015.http://www.jchs.harvard.edu/sites/jchs.harvard.edu/files/americas_rental_housing_2015_web.pdf 8Forthreeperspectivesonwhetherandhowthefederalgovernmentshouldincrease,decrease,oralterhowitsupportsaffordablerentalhousing,seeNationalLowIncomeHousingCoalition,“2017-2018PublicPolicyPriorities,”http://nlihc.org/sites/default/files/2017-2018_Policy-Priorities.pdf;BipartisanPolicyCenterHousingCommission,“HousingAmerica’sFuture:NewDirectionsforNationalPolicy,”February2013,http://cdn.bipartisanpolicy.org/wp-content/uploads/sites/default/files/BPC_Housing%20Report_web_0.pdf;andHowardHusock,“PublicHousingandRentalSubsidies,”ontheDownsizingtheFederalGovernmentwebsite.AccessedMarch31,2017.https://www.downsizinggovernment.org/hud/public-housing-rental-subsidies

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Housingvouchers,arguablythemostdirectwaytosubsidizelow-incomerenters,haveadegreeofsupportacrossmostofthepoliticalspectrum,makingthisprogramapossibleavenuetoconsensus.Itisalsothemostefficientwaytosubsidizerentsuntillocalrulesarechangedtohelpclearthepathformore-affordableunits.Overthelongrun,then,ourviewisthatlocalgovernmentsneedtobemoreforward-leaninginensuringthattheymodernizezoningrulessothatregulationssuchasthosegoverningparkingspotsperunitdonotunwittinglyincentivizeluxuryrentalattheexpenseofaffordablerental.Inthemeantime,webelievethathousingfinancereformcouldcreateanexplicitandtransparentmechanismforhelpingaugmentrentalvouchers(moreonthatbelow).

Intheend,itisfairtoaskwhetherdecadesoffederaleffortstogeneratemorerentalhousingandinparticularmore-affordablerentalsforlow-andmoderate-incomefamilies,haveachievedmorethanifthemarkethadsimplybeenallowedtoworkwithlessgovernmentinvolvement.Theevidencesuggeststhatcollectivelywearefallingshortwiththeapproachesusedtodayandthatmakingcurrentprogramsmorecomplicatedisnotlikelytohelp.Streamliningrequirements,reducingduplication,andlooseningsomelocalrestrictionsonlanduseandunnecessarybuildingrequirementsappeartobemorepromisingapproaches.Marketsshouldbefreetorespondtodemand,andthereappearstobeplentyofunmetdemandinmanycities.Single-FamilyRentalMarketThelastdecade’sfinancialcrisisandtheresultingforeclosuresonseveralmillionhomeownersledtothedevelopmentofanewmarket—theinstitutionalmarketforsingle-familyrentalhousing.Buyingupdistressedpropertiesinmetropolitanareashithardbythecrisis,institutionalinvestorsbuiltlargeinventoriesofsingle-familyhomeswiththeintenttomanagethepropertiesasrentalunits.Atonelevel,thereisnothingnovelaboutthis.One-tofour-familypropertiesconstitutethemajorityofrentalunits.Whatisdifferentistheinstitutionalownershipandmanagementofthesetypesofproperties,whichtraditionallyweresmall,localoperations.

Thefinancingchallengesforthesetwocompetingapproachestosingle-familyrentalaredifferent.Institutionalinvestorshavehundreds,orthousands,ofpropertiestofinance.Thereisnoreasonsuchentitiescannotandshouldnotobtainfinancingthroughnormalcommercialfinancingstructures.Inourview,therecentdecisionleadingFannieMaetoguaranteea$1-billionloantooneoftheseentitiesisnothingmorethanusingFannie’sgovernmentbackstoptosubsidizethecostofcredittothatentity.Thereisnomarketfailurehere,onlytheopportunityforaprivatefirmtoloweritsfundingcostslightlybyavailingitselfofagovernment-backedguarantor.Ifwearegoingtohaveagovernmentroleintherentalmarket,itshouldtargetareaswheremarketfailuresactuallyexist.

Inthemeantime,mom-and-popoperatorsgetnosuchassistance.LimitedbyFannieMaeandFreddieMacrulestoahandfulofmortgagesperlandlord,smalloperatorspayahigherprice,reflectingthehigherrisksrelativetothoseassociatedwithowner-occupiedhousing.Inthefuture,acompetitivesecondarymortgagemarketpost-conservatorshipneedstofocusonexpandingcredittothesesmallerrentaloperationsbyrelaxingtherestrictionsonvolumeinexchangeforrigorousunderwritingoftheproperty,neighborhood,andowner.

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ThisisanexampleofwhatwebelievearethedetrimentaleffectsoftheprotectedFannieMae–FreddieMacduopoly.Inthiscase,theylackincentivetocompeteforloanstosmallsingle-familyrentalgroups.Amorecompetitivemarketwherelendershavemorepathstoattractprivatecapitalneededtosupporttheseloansshouldincreasesupplyandlowercoststolocalsingle-familylandlords.Post-ConservatorshipMultifamiliyFinance:GreaterCompetitionUnlikeinthesingle-familymarket,FannieMaeandFreddieMacareimportantbutnotdominantplayersinmultifamilyfinance.Moreimportant,theirbusinessmodelhasmanydesignfeaturesthatweactuallyaimtoreplicateinthesingle-familymarket.Mostnotably,risk-sharingthattakesplaceattheonsetofadealhaslongbeenpartofeachGSE’smultifamilylineofbusiness.Allmultifamilydealscomewithsubstantialamountsoffirst-losscapitalbornebyprivateinvestors,nottheGSEs.

Still,amorecompetitivemarketplacecanbringadvantages.WecanstartbyseparatingtheGSEmultifamilybusinesslinesandallowthemtooperateinamarketwithotheractors.Themultifamilybusinesslinesattheenterprisestodayoperateindependentlyfromthesingle-familylineofbusiness;therearefewornosynergiesbeyondsharingcommonadministrativefunctions.Separatingthemultifamilylinesfromthesingle-familybusinesseswouldlosenosignificanteconomiesofscale.Indeed,freeingthemultifamilybusinessoperationstocompeteinthemarketplacewithoutthebenefitsandlimitationsofGSEstatusortheencumbranceofbeingsecondfiddletothemuchlargersingle-familyoperationscouldactuallystimulateinnovationandgrowthinthemultifamilybusinesssegment.Itisalsoworthconsideringsingle-familyrentalaspartofthemultifamilybusinessline.

Theexpertiseandmanagementoversightateachfirmsurelyhasvaluethatcouldberealizedinoperatingasastand-alonebusinessoperation.Thus,werecommendthatwhenFannieMaeandFreddieMacarewounddownandplacedinreceivership,asweproposedinourpreviouspaper,themultifamilylinesofbusinessbespunofftopurelyprivate,commercialownership.Thenewmarketwould,bystatuteandregulation,operatesimilarlytothatofthepast,namelywithenterprisesrequiredtoobtainsignificantcapitalinastructuredtransactionaheadofanygovernmentrole.

Eitherasatransitionmechanismorasaremainingfederalsupportformultifamilyfinance,theprivatizedmultifamilybusinessesshouldbegivenaccesstoGinnieMaemultifamilysecuritizationformultifamilymortgagesthatmeetaclearstandardforaffordablehousing.Eventhere,wewouldrequirethatthefirst-lossrisk-sharingrequirementsberetained.ThisisnotentirelynewforGinnieMae.GinnietodaysecuritizesmultifamilyloansguaranteedbytheFHAandbytheDepartmentofAgriculture’sRuralDevelopmentprogram.Aswithourproposalforthesingle-familysecondarymarket,Ginnie’schartercouldbeamendedtoallowforGinniesecuritizationofeligiblemortgagesbackingaffordablemultifamilypropertiesthatmeetasufficientstandardofprivatecreditenhancement.

Again,wearecomfortablewiththisapproachbecauseGSEmultifamilysecuritizationalreadyrequiresasubstantialamountofprivatefirst-losscapital.Ofcourse,ifgreatermultifamilyaccesstoaGinniewrapisallowed,itshouldnotberestrictedtojustthemultifamilyspin-offsfromFannieandFreddiebuttoanyprivateenterprisethatmeetstheeligibilityandcreditenhancementrequirementsforpropertiesthatmeetthespecifiedaffordabilityrequirements.

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Part II: The Ownership Market Weturnnowtotheownershipmarket.Senateeffortstoadvancehousingfinancereformin2014stalledinlargepartduetounresolveddebatesoverhowthenewsystemwouldensurecreditforlow-andmoderate-incomehouseholdsandcommunities.Yetfewbelievetheoldregimeactuallymadeameaningfuldifferenceandmanybelieveitcontributedtothefinancialcrisis.Ratherthanseeknewapproaches,policydebateshavefallenbackontheoldsystemas,inourview,“thedevilweknow.”

Wewanttohelpadvancetheevolvingdiscussionaboutaffordable-housingpolicy.Inthissection,wewillconsidernewwaysofthinkingaboutgovernmentprogramsandtheroleofthesecondarymortgagemarket,bothasitwasandasitcouldbe.Wealsooffersomethoughtsonchangeswebelieveareneededinhowgovernmentprogramsandtheprivatemarketsupportaffordablehousing.GovernmentAffordable-HousingProgramsFederalHousingAdministrationTheFHAisthefederalgovernment’sflagshipprogramforencouraginghomeownership.Establishedin1932,theFHAloanguaranteecontributedgreatlytothegrowthofhomeownershipandtheestablishmentofsoundunderwriting.Yetthehomeownershipratehasremainedlargelyunchangedsincethelate1950s,withthebriefexceptionofthelastdecade’shousingbubble.WhichistosaythatifthepercentageofAmericanswhoownahomeisourmetricforsuccess,wehavenotmovedtheneedlemuchinthepast60years.

Ofcourse,thatisnottheonlymetric.Successcanalsobemeasuredinthequalityofthehomeswebuy,theamountofdisposableincomeaborrowerhastopayforahome,thesustainabilityofhomeownership,thehousingwealthaccumulatedovertime,andthedurabilityofhousingcreditthroughtheeconomiccycle.Onthesepointsthedataareabitmoregenerous.

ContinuedunderinvestmentintheFHA,however,threatenstheagency’sfinancialstability.Morethanthat,though,underinvestmenthaslefttheagencylessresponsivetotheevolvingneedsofpotentialhomeowners.WebelievetheFHAhastheopportunitytorestoreitsleadershiproleasakeysourceofmortgagecreditforfirst-timeandforlow-andmoderate-incomehomebuyers,ifitweregivenarenewedfocusandmadepartofstructuralreform.Inourview,housingfinancereformshouldgivetheFHAaclearmandateappropriatetotoday’schallengesandtheresourcestoachievethatmandate.

AmodernizedFHA,forexample,couldhelpdevelopandimplementthoughtfultransitionprocessesthatwouldestablishbestpracticesforpreparingpotentialhomeownersbyteachingthemprinciplesoffinance,equitybuilding,andself-sufficiency.Thiswouldnotonlyreducethelikelihoodofforeclosurebutwouldalsobetterequipfamiliesforretirementandforlife’sexigencies.Inthisway,theFHAcouldguidepeopleintohomeownershipandgreaterfinancialindependenceandself-sufficiency.

Byimprovingthetransitionprocesstoownershipandstrengtheningitsunderwriting,theFHAshouldexperiencelowerdefaultrates.Bymakingloansmoresustainable,theFHAwouldfoster

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homeownershipwhilereducingtheenormouscostsfrommortgagedefaultsandimproveitsfinancialstrength.ThatwouldprovideasoundbasisforloweringFHAguaranteepremiums.

Tohelpmaketheseidealsareality,wesuggestthefollowingchangestotheFHA:

§ BuildtheFHAreservetothesamecapitallevelrequiredofbanks:atleast4percentofoutstandingloans.Thatwouldmakeitatruecountercyclicalbufferstrongenoughtoprovideaddedsupporttothemarketintimesofstress.

§ Fundtheneededtechnologyupgrades.Ideally,thiswouldbedoneviaappropriations.Ifthatispoliticallyunachievable,tousthereisareasonablepolicyargumentforallowingtheFHAtofundtheupgradesusingassessmentsitcontrols.Outsourcingshouldalsobeconsidered.

§ AccountfortheFHAonafair-valuebasis.Whilethisispartofalargerdebateaboutfederalaccountingforcreditsubsidies,thecurrentapproachisoutofstepwithnormalaccountingconventions,includingthemethodologyusedbytheCongressionalBudgetOfficetoaccountforFannieMaeandFreddieMacinconservatorship.

§ GivetheFHAamandatetoexperimentwithdown-paymentassistanceoptions,transition-to-homeownershipprograms,risk-sharing,enhancedborrowercounseling,residualincomeunderwriting,borrowerreserves,andotherapproachestocreatingapathwaytosustainablehomeownership,andthengiveittheauthoritytodevelopthosetools.

§ EliminatethemisalignmentacrosstheFHA,itsinspectorgeneral,andtheDepartmentofJusticethatisproducinglenderuncertaintyandunmanageablelenderliabilityrisk.Intra-governmentalargumentsaboutwhatispermittedleavesprivatetheFHAlendersatrisk,constraininglending.Moregenerally,bytreatingbadlendingoutcomes,orevenpoorlendingpractices,ascriminaldefraudingofthegovernmentarguablyharmsborrowersasmuchasormorethanithelpsthem.Punishinglendersforviolatingprogramrulesisonething;imposingpenaltiesthatareoutsizedrelativetotheinfractionandtotheharmdoneonlymakesmattersworse.Ahealthierlendingenvironmentwouldhaveclearprogramrulesandproportionatepenaltiesforviolatingthoserules.Theseconcernsextendtoservicingpracticesaswellasloanorigination.

§ Finally,webelievethathousingfinancereformshouldgivetheFHAamandatetoserveasacountercyclicalbuffer.Beforethecrisis,whenfinancialmarketswentthroughoneoftheirperiodicdisruptions,investorswouldfleetosafety.SeeingFannieMaeandFreddieMacascloselyalignedwiththegovernment,marketstreatedtheGSEsasasafeharborduringsuchevents,whichgreatlybenefitedFannieandFreddieshareholders.Intheirabsence,theFHAisthelogicalsourceofsuchcountercyclicalstability(aswasrecognizedintheHouseFinancialServicesCommittee’sPATHAct).TheFinancialStabilityOversightCouncil(FSOC)couldbeauthorizedtodeclareatemporarymarketdislocation,therebybroadeningtheFHAloaneligibilityparameters.

Importantly,policymakersshouldrecognizethatthe“government”marketandthe“conventional”marketarenotoperatingindifferentuniverses.Instead,theycanandshouldplaycomplementaryroles.Weshouldexpecttheprivatemarketstoseeaslightdropinmarketshareintheeventofacreditdownturn.Andwhenthishappens,weshouldexpectthattheFHA’smarketsharemightrowabit.Vice

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versaduringeconomicexpansions,especiallyastheprivatemarkettestsoutanevolvingsetofunderwritingstandardsandworkstoreachlower-income

Americansinnew,innovative—butsafe—ways.Thisisallfineandshouldbeexpected.Andso,whenregulatorsasktheprivatemarketstohelpensureaccessforallcommunities,theyshouldcautionagainstsettingupanendlesspricewarbetweentheFHAandtheprivatemarketsandinsteadrecognizethatitissustainableandcontinuousaccessthatcounts,notwheretheloancomesfrom.StateHousingFinanceAgencies(HFAs)Statehousingfinanceagenciescollectivelymanageimportantgovernmentprogramssupportingaffordablehousingandfirst-timehomebuyers.WeretheFHAtotaketheapproachwehavejustoutlined,itwouldimmediatelyhave50laboratoriestoexamine.Eachstate’shousingfinanceagencyoffersprogramstosupportcitizenswantingtobecomehomeowners.Mostoftheseprogramsandservicestargetfirst-timehomebuyersandlow-tomoderate-incomefamilies.Borrowereducation,counseling,anddownpaymentassistanceareintegraltomostoftheprogramsoffered.Typically,HFAsmustfundthemselvessothattheprogramstheyofferarefiscallysound.ManyHFAsworkcloselywithprivatelendersandnonprofitsintheirstates,formingpartnershipsthatleveragetheexpertiseofeachpartner.

HFAshavetheirownconcernswithhousingfinancereform.Theywanttobesurethatreformsmaintainadeepandliquidsecondarymortgagemarketthatcontinuestosupportaffordablehousinggenerallyand,inparticular,givesHFAsa“preferredpartnership”withthenewsecondarymortgagemarket.9Thatis,HFAswanttoensurethatmortgagestheymakeorguaranteeinsupportofaffordablehousingcontinuetohaveeasyacceptanceintosecondarymarketsecuritizations.TheyalsoseektocontinuetheirspecialrelationshipwiththeFHAandGinnieMae.SinceGinnieMaeisatthecenterofourproposalforsecondarymarketreform,webelievethattheoutcomeenvisionedbythestateHFAscanberealizedinourreformframework.

AdvocatesforfederalismandforaffordablehousingshouldbothbestrongsupportersofstateHFAs.Housingneedscanvarydramaticallyfromstatetostate.Insome,thereisarobustdemandformortgagesforfirst-timehomebuyers.Inothers,thedemandismorefocusedonseniorhousing.Insomestates,thereisasurplusofhousingunitsaspopulationhasdeclined;inotherstates,demandfarexceedssupply.Allowingforscarcedollarstobedistributedatthestatelevel,wheretheneedsaregreatest,makesmoresensethanasingle,nationalsolution.SincetherearealreadystrongpartnershipsbetweenthefederalgovernmentandstateHFAs,housingfinancereformshouldreinforcethosebondswhileensuringHFAsmaycreditenhanceandselltheirmortgagesthroughthenew,nationalsecondarymarketsystem.

9“CreatingAffordableHousingOpportunitythroughaPreferredPartnershipbetweentheNewSecondaryMortgageMarketandStateHousingFinanceAgencies,”NationalCouncilofStateHousingAgencies,2014.https://www.ncsha.org/resource/ncsha-white-paper-housing-finance-reform-2014

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Rethinking$190BillioninHousingExpedituresBeforesearchingfornewfederaldollarsforaffordablehousing,legislatorsshouldtakeahardlookatthe$190billionindirectexpendituresandtaxexpendituresdevotedtohelpingpeoplepurchasehomesorpayrentin201510andask:Isthisthebestuseofthesefundsinthehousingsector?Whiletheentirefederalhousingbudgetshouldbescrutinized,aremarkableshareofhousingexpendituresgoestoupper-incomefamilies,largelythroughthemortgageinterestdeduction.Weacknowledgethatthesetaxsubsidiescouldlikelybedirectedmoreefficiently,althoughwerecognizethatjurisdictionalissuesintheHouseandSenaterelegatethistoadiscussionoftaxreformasopposedtohousingfinancereform.TheSecondaryMortgageMarketTheWayItHasBeenSomeseethesecondarymortgagemarket,operatedthroughthetwoGSEs,asanimportantfederalpolicytoolfortworeasons.Thefirstconsistsoftheexplicitaffordable-housinggoalseachGSEmustmeet.Thesecondistheaveragecostpricingapproach,inwhichborrowerswithstrongercreditsubsidizemortgagecostsforthosewithweakercredit.Wewillbrieflysummarizeeachoftheseapproachesandtheirshortcomingsbeforeturningtoalternatives.Affordable-HousingGoalsIn1992,Congressimposedasetofexplicitaffordable-housinggoalsonFannieMaeandFreddieMacandassignedtheDepartmentofHousingandUrbanDevelopmenttoperiodicallyupdatenumericaltargetsforeach.In2008,CongressupdatedthegoalscategoriesandassignedthesettingofnumericaltargetstotheFHFA.Whetherthosegoalscontributedtothefinancialcrisisiscontroversial,andwedonotintendtoresolveithere.11Regardless,webelievethatinordertomodernizeourparadigmforaccesstohomeownership,weneedtoanalyzeobjectivelythefollowingquestion:Howdowebestensurethatthesecondarymortgagemarketishelpingtheprimarymortgagemarkettoserveallcommunitiesresponsibly?

SinceFannieandFreddiedonotmakeloansbutratherbuyloansfromlenders,theaffordable-housinggoalsregimesetsupanoddcompetitionbetweeneachGSEandlenders.Forexample,inthepre-crisisregime,multifamilyloans,whichwereoften“goalsrich,”wouldbeheldfromtheGSEsuntillateintheyear,settingupabiddingwarbetweenthetwoenterprises.Thisdidnotbenefitrenters;rather,thegainsaccruedtothelenderswhoweresimplygamingthehousinggoalsregime.

Inthesingle-familyspace,manyofthesametypesofgamingtookplaceaswell.Loanstolow-incomefamiliesoftenwereusedtoachievepremiumpricingthatbenefitedthelendersnottohelpthe

10WillFischerandBarbaraSard,“FederalHousingSpendingIsPoorlyMatchedtoNeed:TiltTowardWell-OffHomeownersLeavesStrugglingLow-IncomeRentersWithoutHelp,”CenteronBudgetandPolicyPriorities,March8,2017.http://www.cbpp.org/sites/default/files/atoms/files/12-18-13hous.pdf11TheFinancialCrisisInquiryCommissionconcludedthatthegoals“contribute[d]marginallytothesepractices”thatledtotheGSEs’failure.PeterWallison,anFCICmember,vigorouslydissentedinthisconclusion,arguingthatU.S.governmenthousingpolicy,includingthehousinggoals,causedthecrisis.SeeTheFinancialCrisisInquiryReport,2011(p.323)andPeterWallison,HiddeninPlainSight,EncounterBooks,2015.Allofthemajorlegislativereformproposalsin2013-14wouldhaveeliminatedthehousinggoalsregime.

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homeowner.Worse,thedesiretogivetheappearanceofeffectivenessattimesinthepastledtheGSEstorespondtoever-increasinggoalswithever-weakeningunderwritingstandards.Fewwerelookingoutforthelong-termhealthofthehomeownerorwhetherthehomeownerreallywasamarginalborrower,sinceallthatmatteredwasmakingaloan.Whateveronethinksofthedegreetowhichthehousinggoalsregimecontributedtothefinancialcrisis,wenowknowthataracetothebottomoccurredonsomelevelandthatitfailedourmostvulnerablefamilies.

Webelieveareliable,affordableflowofcreditformortgagestocreditworthyborrowersisanonpartisangoal.Wealsobelievethatitisanonpartisanobjectivethatsuchborrowerssucceed.Wealsobelievethat,withsomenewthinking,theseneednotbemutuallyexclusiveobjectives.Inlightofthemanyproblemsassociatedwiththepre-crisishousinggoalsregime,webelievethatourcountryoughttobesearchingforabettermeanstothisend.Cross-SubsidizationPre-conservatorship,FannieMaeandFreddieMacchargedthesameguaranteefee—effectivelythecreditinsurancepremium—foralmostalltheloanstheysecuritized.(Thenotableexceptiontothiswasthattheywouldchargelowerguaranteefeestolenderswhosoldthemmoreloansthantheychargedtosmallerlenders,regardlessofthecreditqualityoftheunderlyingmortgages.)Bychargingoneinsurancepremiumregardlessofrisk,theGSEs’pricingsystemproducedacross-subsidywherebylower-riskborrowerspaidmoreforcreditthantheirrisksrequiredwhilehigher-riskborrowerspaidless.Notsurprisingly,weendedupwithmore-riskyborrowers,andhigherleverage,thanamorerisk-basedregimewouldhaveproduced.TheWayItShouldBeBydistortingthepriceofcredit,thecurrentsystemfailstoproducethenormalpricesignalsassociatedwithfinancialriskthatwouldinformborrowers,alignincentives,andcompensatelendersforrisk-taking.Inaworldofrisingnominalhousepricesandstableemploymentandincome,peopletendednottothinkmuchabouttheserisks.Thepastcrisisshowedustheconsequences.WeproposereplacingtheoldregimeanditsmanyflawswithamoretargetedyetflexiblesystemthatplacesCongressincontrolofdirectingsubsidiesandthatencouragesthemarkettoserveandinnovate.Thefollowingthreeapproachesstandoutforus:establishingaduty-to-servemechanismforallcommunitiesbeyondruralandmanufacturedhousing,establishinganexplicitaffordable-housingrevenuestream,andopeningthedoortodisruptionandinnovation.DutytoServeThedebateoveraffordablehousing,inthecontextofhousingfinancereform,isunderpinnedbythisquestion:Howcanpolicymakersbesurethatprivateoperatorsdonotsimply“cream”themarketbymakingloansonlytothoseindividuals,families,andcommunitiesthathaveverylowrisksofdefault?Otherkeyquestions:HowcanwebesurethatinreplacingtheGSEswecreateasecondarymortgagemarketthatwillresponsiblybuildanewgenerationofhomeownersasdemographicsrapidlyevolve?Shouldwehaverisk-basedpricing,andifso,howmuch?

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WhateverentityorentitiescometoreplacethesecondarymarketfunctionscarriedouttodaybyFannieMaeandFreddieMacshouldhavearesponsibilitytoensurethatthesecondarymarketservesalleligibleborrowers.Butgiventhatsecondarymarketentitiesdonotoriginatemortgages,theideaofsettingsecondarymarketpurchasegoalswithoutknowingorcontrollingfortheactuallendingtakingplaceintheprimarymarketbothskewsincentivesandinvitesgame-playingbetweenprimaryandsecondarymarketplayersthathaslittletodowithservingborrowers.

Webelieveabettersystemcouldcomeintheformofanexpandedandinteractivedutytoserveappliedtothesystemasawhole,includingsuccessorstoFannieandFreddie,newentrants,andtheFHA.Suchaparadigmispromisinginourviewbecausetherecentduty-to-serveregulations—whichcurrentlyapplylargelytoruralandmanufacturedhousing—relymoreuponaforward-looking,marketleadershiproleforcreditenhancers.Buildingoffofthiswouldallowforamuchmoredynamicinteractionamongsecondarymarket,primarymarket,andregulator.

Sothatweareclear,tousadutytoservemeansthatalleligiblemortgagesandallcommunitiesshouldfinddirectaccesstothesecondarymarketonanondiscriminatorybasisthroughthebusinesscycleandthatapprovedcreditenhancersshouldberequiredtoshowhowtheyareworkingtomakethisareality.

Adutytoserveinanewsecondarymortgagemarketmeansthataccesstogovernment-backedsecuritizationcarrieswithitaresponsibilitytoserveallborrowersandcommunitieswithinanentity’smarketareaorcharter.Wedonotenvisionthistonecessarilymeanbluntnumericaltargetsbutratherastandingobligationtohave,andcarryout,aprudentbusinessplanthatdemonstratescommitment.Therecentduty-to-serveregulationfromFHFA,whilelimitedbylawtothreetargets—manufacturedhousing,affordable-housingpreservation,andruralhousing—inourviewillustratessuchanapproachandcanbeleveragedtohelpensurethatprivatecreditmarketsareeffectivelyservingallcommunities.Itcanbeexpandeduponasamechanismforbetterreachingandservingallcommunitiesnationally.

Inthecontextofourhousingfinancereformproposal,eachGinnieMaeissueraboveaspecifiedsizewouldhaveadutytoserveallcommunitieswithinitsfootprint,asdescribedintheprecedingparagraph,andareportingrequirementtodocumenthowwellthecommitmentisbeingfulfilledandhowloansareperforming.FHFAwouldberequiredtoworkwithHUDtoensurethattheentiremarketwasbeingserved,includingloansbeinginsuredbytheFHA.

WeenvisionherereportingthatwouldalloweachGinnieissuertobebenchmarkedagainsttheoverallmarketaswellasnarrativereportingontargetedeffortstoenhancecreditavailabilitymorebroadly.Thiscouldincludepilotprogramstoexpandaccessinminorityorruralcommunitiesortoissuesmallerloans,ortoenhancecreditaccessformanufacturedandmicrohousingunits,orotherideasthatsecondarymarketparticipantsdevelop.FHFAandHUDwouldreportonthesamemetricsnationally.

FHFAwouldhavetheresponsibilityforensuringthatanyapprovedcreditenhancementprocesswashelpingtofulfillthisduty.Acreditenhancerfoundtohaveaninadequateplanforresponsiblyfacilitatingbroadaccesstolow-incomecommunitiesortohavefailedtocarryoutaduty-to-serveplan

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wouldneedtotakecorrectiveactionorfacepenalties,includingperhapsthelossoftheabilitytoenhanceloansforGinnieMaesecuritization.

Havingaduty-to-servemandatewouldmakecleartolendersandGinnieMaeissuersthattheycouldnotlimittheirlendingandsecuritizationactivitiestothehighendofthemarketiftheywantedaccesstoGinnieMaesecuritization.Beinginthismarket,withaccesstoGinnieMBSs,requiresprudentlyservingallmarketsatalltimes.ThisisachievablebyrequiringMBSpoolstobe“scalable,repeatable,andgeographicallyandeconomicallydiverse.”Theywouldalsohavearequirementthatthey“notdetractfromthesystem’sabilitytoserveallmarkets.”Byaddingtheserulestostatute,theFHFAwouldhavetokeepthosefactorsinmindwhenapprovinganynewrisksyndicationstructuresornewentrants.Thiscombinationcouldhelpkeeptherightbalanceofmarketinnovation,incentivealignment,andbroadaccesstothesecondarymarketforallcommunities.

Ourobjectivehereistomigratefromstaticgoalsthataresomewhatclunky,thatarereliantonhavingthesecondarymarketfollowingtheprimarymarket,andthatshowahistoryofbeinggamedtowardamoreinteractiveanddynamicsystemthatallowsforinnovativethinking(subjecttoconsumerprotection),aholisticdialoguebetweenprimaryandsecondarymarketsandtheirregulator,andasetofcreditenhancerswhocanprovideleadershipandideastotheprimarymarket.Webelievereplacinggoalswithanexpansionoftherecentduty-to-serveregulationsisapromisingapproachtosuchanend.PayItForwardAninnovationintheCorker-Warnerproposal,alsoutilizedbyJohnson-Crapoandotherhousingfinancereformbills,wasthereplacementofthequota-basedhousinggoalsassignedtoFannieMaeandFreddieMacwithauserfee.AspartofCorker-Warner’sfullfaithandcreditguaranteeonsecuritization,qualifyingmortgagesweretobeassessed10basispoints,withtheproceedsgoingtotrustfundsestablishedin2008tosupporttheproductionandpreservationofaffordablehousing(theNationalHousingTrustFundadministeredbyHUD).Theproceedsalsoweretobeusedtofinancecommunitydevelopmentfinancialinstitutions(CDFIs)andnonprofithousingorganizations(theCapitalMagnetFundadministeredbytheTreasuryDepartment’sCDFIFund).Theideawastoreplacethepoorlytargetedsubsidiesassociatedwiththehousinggoalswithdirectfundingforspecificaffordable-housingprograms.

Likeothers,wesupporttakingthisapproach,butwithcertainrefinements.Weviewthebasicprinciplebehindsuchauserfeeasthis:Notwithstandingalleffortstoreformthesecondarymortgagemarkettobringprivatecapitalandrisk-bearingtothemortgagemarketandtominimizethelikelihoodthegovernment’scatastrophicguaranteewillbeneeded,thereisaresidualbenefitaccruingtoallborrowersfromthefullfaithandcreditguaranteeofMBS.Imposingasmalluserfeeequallyonallmortgagesgoingthroughthissystemisasimplewaytoacknowledgethatfactandtoestablishamechanismtosharethatbenefitwiththelessfortunateinourhousingmarkets.

Auserfeeof10basispointscouldraiseasmuchas$5billionperyear,assumingaGinniemarketof$5trillion(roughlythesizeoftheFannie-Freddiemarkettoday).Whattodowiththeproceedsisacongressionalresponsibility.Congresscouldchoosetofundthetrustfundsortoapplysomeorallofthefundselsewhere.Undertheassumptionthatthefundsshouldsupportcriticalaffordable-housingneeds,

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theycouldbeappliedtothefundingshortfallforrentalvouchersusedbyverylow-incomefamilies,therebyrelievingsomeoftheburdenofextraordinarilyhighrentalpaymentsrelativetoincome.Someportionmightalsobeusedtofunddownpayments,closingcostsorhomebuyingcounselingforlower-incomefirst-timehomebuyers.Anattractivefeatureofthisapproachisthatasstrugglingfamiliessucceedandmoveontohomeownershiptheywouldpaybackintothesystem.Successfulfamilieswould,ineffect,payitforwardtothenextsetoffolkstryingtoachievethesamemeasureofsuccess.Wealsosuggestthatsomeoftheproceedsbeusedtoencouragelendingtomore-marginalborrowers,butinamannerdesignedtoencourageaprudentapproach.Akeyfactorlimitingmortgagecreditavailabilitytoriskierborrowersistheextraordinarycostofdefaultservicing,especiallyinthewakeofthefinancialcrisis.Thischallengeisoftenoverlookedinquestionsabouttoday’screditbox,butitiscertainlyacontributingfactortotheincreaseinaveragecreditscoresofGSEproduction.TheMortgageBankersAssociationreportsthatthecostofservicingadelinquentmortgagehasincreasednearlyfivefoldsincethefinancialcrisis.Significantcostburdensfromservicingdelinquentloansdiscouragelendersfrommakingsomewhatriskierloansinthefirstplace.Iflawmakerswantedtopreservesomesubsidytoencouragecreditavailability,oneoptioncouldbetosubsidizethecostofdefaultservicingontargetedaffordable-housingloans.

Specifically,aswasoftendoneduringthefinancialcrisistopromoteloanmodifications,servicingcostscouldbesubsidizedfordelinquentloansthatmeetapredefinedaffordabilitystandard.Lenderswouldhaveagreaterincentivetomakemoreloans,whilethesubsidypaymentwouldberequiredonlyintheeventofdelinquency.Thepaymentshouldbeforonlyaportionofthecosttokeepservicersproperlymotivated.

Aswedevelopedourhousingfinancereformproposal,wetriedtobemindfulofaligningincentivesandbuildinginbuffers.Webelievetheuserfeebecomesanotherareainwhichincentivealignmentandcountercyclicalbufferscanbeestablished.Specifically,wewouldtiesomeorallofthefundsraisedbythefeetothefinancialconditionoftheMortgageInsuranceFund(MIF)describedinourpreviouspaper.Whiletherearenumerouswaysofdoingthis,andnumerouslevelsatwhichfeesmaybeset,thefollowingexampleillustratesourapproachandmayserveasastartingpointformorediscussion.MIFReserves MIFFee AHUserFee TotalFee0-1percent 10bp 0bp 10bp1-2percent 5bp 5bp 10bpAbove2percent 0 10bp 10bp

Notes:TheMIFismeasuredasapercentofoutstandingMBS.BPisbasispoints,andtheamountreflectstheaddedmonthlyinterestcost,inbasispoints,thatwouldflowfromthemortgagepaymenttofundtheMIFreserveandtothefundingofaffordablehousing(AH).

Sinceourproposal,andmostothercurrentreformproposals,envisionsaMortgageInsuranceFundbackstoppingthemortgagecreditmarket,andbecausesuchafundwouldbestartingfromazerobalance,webelieveitshouldbuildareservethatwouldrapidlyamounttoatleast1percentof

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outstandingMBSandmoreslowlyincreaseto2percent.SinceboththeMIFandtheaffordablehousingfeeeffectivelytaxmortgages,theideaistoavoidthetaxfrombecomingadoubleburdenonhomebuyers.Thus,wewouldprioritizefundingtheMIFforsafetyandsoundnessreasons,alterthemixoncetheMIFhadsomemeasureofreserves,andthencompletelyshifttherevenuestreamtoaffordablehousingoncetheMIFwasfullycapitalized.

Thisapproachcreatesanaturalcountercyclicalbufferbyavoidinganaddedtaxonmortgagesintheeventofcatastrophiclosseslikethoseexperiencedinthelastcrisis.Italsoalignsincentivesinthatadvocatesfortheaffordable-housingrevenuestreamwouldshareaninterestinensuringthatthesystemcontinuedtooperateinaprudentmanner,avoidingexcessiverisk.Anditmeansthatwheneveramortgageisissued,therecipientsaresubjecttothesamefee,creatingequityacrossborrowersovertime.Dependingontheimplementationtiming,thisfeemighthavenolong-termimpactonmortgageratesgiventhatCongressimposeda10-basis-pointfeeonFannieandFreddieMBSbackin2011tofinanceatemporarypayrolltaxholiday;thatfeeexpiresOctober1,2021.DisruptionasaPowerful,PositiveForceWhileFannieMaeandFreddieMachavebeenaccusedofmanythings,beingdynamicandinnovativearenottypicallyhighonanysuchlist.Secondary-marketreformshouldnotjustallowbutencouragedisruptionsandinnovationsthatbenefithomebuyersandexpandaccesstocredit.

Thesecondarymortgagemarketshouldpromotemoreoptionsthanjustthe30-yearfixed-ratemortgage.Productdiversityshouldleadtoborrowershaving,andmaking,choicesthatcanbuildequityfaster.Butanynewproductsshouldmeetconsumerprotectionstandards,includingDodd-Frankability-to-repayrules,andshouldbeaccompaniedbyappropriateborrowereducation.

Tofurtherencouragecompetitionanddisruption,lendersshouldbegivenaccesstotheenormouscacheofloandataaccumulatedbyFannieMaeandFreddieMacduringtheiryearsasagovernment-sponsoredduopoly.Broaddistributionofthedata,someofwhichhasalreadytakenplaceduringtheconservatorships,woulddeepentheknowledgebasefromwhichlendersandthemortgagecreditriskmarketcouldevaluateaffordable-housingmarketsandborrowers.Withknowledgecomestheabilitytoassessandpricerisk,andthewillingnesstodoso.

Disruptionandinnovationalsoopenthedoortomarket-basedresponsestoemergingneeds.Thecomingwaveofbabyboomerretirementssuggeststheneedtobuildmoreseniorhousingandtoretrofitorremodelthehomesofseniorswhodecidetoageinplace.Aflexible,dynamicmortgagemarketshouldbereadytorespondtosuchneedswithanarrayoffinancingtools,includingresponsiblereversemortgageproductsandcommercialfinancingofseniorhousingdevelopments,continuingcareretirementcommunities,andsoon.Ourproposalbeginswithafundamentalpremisethattherearequitelikelygoodloansthatcouldbemadebutthatarenotbecauseofbarriers.Openingthedoortodisruptionwillhelp.

Thecriticalreasonforthis,inourview,isthatFannieMae’sunderwritingsystem,DesktopUnderwriter(DU),hasanearmonopolyondetermininglendingdecisions.DUisusedevenbyFreddielenders,which

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oftenemployittocross-checkloansacceptedbyFreddie’ssystem.Thismeans,ineffect,thatnolendercanoriginateanyloanforsecondarymarketsalethatisoutsideofDU’scomplex(andlargelyblackbox)guidelines.Aworldinwhichacreditenhancercanlookforinnovativewaystoqualifyaborrower—usingcellphonepaymentsorleveragingcertaintypesofcounseling,forexample—isaworldinwhichmoreloanscanbemade.Thisisespeciallyimportantasourcountry’sdemographicsevolverapidly.Onlyacredit-risk-takingenterprisethathasthecapacitytotryoutnewproducts—subjecttoConsumerFinancialProtectionBureau(CFPB)oversightandFHFAapproval—canhelpreallymovetheneedleonenhancingaccessandaffordability.Inaddition,thewayourQualifiedMortgage“patch”workstoday,loanswithgreaterthana43percentdebt-to-incomeratioqualifyforthesafeharboronlyiftheyareapprovedbyDUorbyFreddieMac’sautomatedunderwritingsystem(LoanAdvisor).12Thisisnotarecipeforallowingthemortgagemarkettogrowandevolve.

Themorerigidandrules-drivenourhousingfinancesystem,thesloweritwillbetorespondtothesechangesandthelesscapableitwillbeofrespondingtoemergingneedsandopportunities.Competition,flexibility,andinnovationneedtobecharacteristicsofthenewsecondarymortgagemarket.Affordable Housing: Universal Changes NeededEnhancingtheavailabilityandsustainabilityofmortgagelendingtolower-incomeborrowers,whetherthroughgovernmentprogramssuchastheFHAorthroughprivatemarkets,wouldbeenhancedbypayinggreaterattentiontothreethings:shockabsorbers,accountability,andwealthbuilding.ShockAbsorbersWhilemostunderwritingisfocusedonincomelevel,incomevolatilityisanimportantfactortoconsiderinunderwritingamortgage.Qualifyingforamortgage,whichmeanstheborrowerhastheabilitytorepaytheloan,isnecessary.Butitisnotsufficienttoensureasustainablemortgage.Theunexpectedcanoccur,andsohavingreservesiscritical.Emergingresearchonfinancialchallengesfacinglower-incomefamilieshighlightstheneedforsuchreservesandoffersideasforcreatingsuchbuffers.13Housingpolicythatistrulyconcernedwithsustainablemortgageoutcomesshouldcarefullyconsiderwaystoensuresuchbuffersareavailable.Onesimpleapproachwouldbeasavingsaccounttiedtoamortgagepayment,asoutlinedbyStephanieMoulton,AnyaSamek,andCäziliaLoibl.14

Second,andfollowingfromthefirstpoint,theFHAoriginallywasstructuredasmutualinsurance.Theagencycouldconsidermethodstomutualizethisriskacrossitsborrowerstoaddsomepaymentshockbuffer.Moreover,HUDcouldexamineitsrentalprograms,includingrentalvouchers,forwaysto

12https://www.fanniemae.com/singlefamily/desktop-underwriter#http://www.freddiemac.com/loanadvisorsuite/13See,forexample,MichaelBarr,NoSlack:TheFinancialLivesofLow-IncomeAmericans,BrookingsInstitutionPress,2012;andJ.M.Collins,ed.,AFragileBalance:EmergencySavingsandLiquidResourcesforLow-IncomeConsumers.NewYork:PalgraveMacmillan,2015. 14StephanieMoulton,AnyaSamek,andCäziliaLoibl,“SaveatHome:BuildingEmergencySavingsOneMortgagePaymentataTime,”inAFragileBalance.J.M.Collins,ed.NewYork:PalgraveMacmillan,2015.

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leveragelimiteddollarstoserveasafinancialshockabsorberforlower-incomerentersratherthanasaregular,monthlypaymentsubsidy.15AccountabilityforLong-TermOutcomesAcrossthearrayofideasofferedinthispaper,weemphasizetheneedtomeasurelong-termsuccess.Itisnotgoodenoughtohaveahousingfinancesystemthatprovidesamplecreditiftheresultisahighlevelofdelinquencyanddefault.Wemustconcernourselveswithoutcomes.

Forexample,doesourhousingfinancesystemenablepeopletoaccumulatewealthbybuildingandretainingequityintheirhomesduringtheirworkinglives?Ifaduty-to-servemechanismisestablishedforsecondarymarketentities,arepeoplesimply“gettingloans,”oraretheymakingtimelymortgagepaymentsandbuildingwealth?Weshouldnotstopatmeasuringthenumberofloansmade.Weshouldbeevenmoreconcernedaboutwhetherthoseloanssucceed.

Tomakethisatangiblesetofpolicyrecommendations,inourview,alenderorcreditenhancershouldnotgetpointsinanyduty-to-servereportsfor“serving”acommunitysimplybymakingaloan.Weshouldalsomeasurewhethertheloanwasasuccessorfailureoverareasonableperiod.Yes,loanswillgobadsimplybecauseofachangingeconomyorunforeseencircumstances,andwedonotadvocateacreditboxwherenoonegoesdelinquent.Butnoloanthatgoesintodefaultwithinjustacoupleofyearsofbeingmadeshouldcounttowardfulfillmentofagoal,duty,oranyothernamewewanttogivetotheresponsibilityofservingallcommunitiesequitably.SuchthinkingshouldalsoapplytotheFHAprogram.

Andso,wewouldproposethatwhateverpolicymakerssettleonasitrelatestomanagingandmeasuringthesuccessofdutytoserve,themetricsbebasedonarolling24-monthlookback,notcountingloansastheyaremade.FHFAshouldexaminethesuccessofeachapprovedcredit-enhancersbusinessplanbasednotsimplyonhowwellitwillreachborrowers,butwhetherthoseborrowersperform.Wecallthis“elbowgreaselending.”Therearegoodloansthatcanbemadesuccessfully,buttheymayalsorequireahighertouchstrategyfromtheservicer.Thecreditenhancer—theentityultimatelyonthehookforthesuccessoftheseloans—shouldhaveastrongincentivetofindservicerswhocanhelpborrowerspaydowntheirdebtandstayontopoftheirmortgage.BuildingPathstoHomeownershipandWealthBuildingAlmostalldiscussionofpoliciesencouraginghomeownershipopportunitiesforlow-andmoderate-incomefamiliescitesthelong-termwealth-buildingopportunityastheprimarymotivation.Itbegsthequestionthenastowhetherouraffordable-housingprogramsandhousingpoliciesactuallyleadtowealthbuildingornot.Thatisaninvolvedsetofquestionsthatoneofushastackledinotherpapers.16Wewillsummarizethekeypointshere.

15Thedownwardspiralfacingat-risklow-incomerentersisdocumentedbyMatthewDesmondinEvicted:PovertyandProfitintheAmericanCity.NewYork:CrownPublishing,2016.16EdDeMarco,“Homeownership,WealthCreation,andFinancialStability,”MilkenInstituteReview,FourthQuarter2016.EdwardDeMarco,“CreatingPathwaystoSustainableHomeOwnershipThatBuildsandRetainsWealth,”MilkenInstituteViewpoint,May2017.http://www.milkenreview.org/articles/homeownership-wealth-creation-and-financial-stability?IssueID=17;http://www.milkeninstitute.org/publications/view/863.

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Althoughthepolicymotivationforpromotingownershipopportunitiesiswealthbuilding,thekeyfederalsupportsforhomeownershiparealldeliveredthroughsubsidizingcredit.Theseprograms,themortgageinterestdeduction,theFHAprogram,andthesecondarymarketoperatedthroughFannieMaeandFreddieMac,eachoffersbuyerssubsidiesthataremaximizedbytakingonasmuchdebtaspossible,notbybuildingequity.Ifthegoaliswealthbuilding,onemightthinkthatfederalpolicieswouldbemoreconcernedwithbuildingequity.Yetwepromoteborrowingtobuyahomethatcreatesadegreeofleverage(housingdebtrelativetoequity)thatweoutlawedlongagoforbanks.

Ourfederalhousingpoliciesalsodonotmuchconcernthemselveswithestablishingaprocessforbecomingahomeowner.Instead,theirfocusisonbendingunderwritingstandardstoqualifymoreborrowersevenasdoingsocreatessubstantialriskforthosefamiliesandforthefinancialsystem.Inatimeofrisinghousepricesandstrongemployment,mostpeoplecanwinatthatgame.ButtheGreatRecessiontaughtus(again)howbrutallyfamiliescanbecrushedwhenconditionsturnlessfavorable.

Thisleadsustobelievebothgovernmentlendingprogramsandprivatelendingprograms,aswellasnonprofitsandotherhousingadvocates,shouldspendmoretimedevelopingfamiliestobecomehomeowners.Processesthattookalonger-termviewofpreparingfamiliestobecomesuccessfulhomeownerswouldfocusmoreseriouslyonsavingforadownpaymentaswellassearchingfordownpaymentassistanceratherthansubsidizedcredit.Suchprocesseswouldalsorecognizethedesiretobecomeahomeownerasagoodtimetoassistfamilieswithfinancialeducationandcreditcounseling,notjusttomakethembetterinformedabouttheresponsibilitiesofowningahomeandhavingamortgage,buttoimprovetheiroverallfinancialliteracyandcapacitytomanagefinancialrisk.

Finally,pathwaystohomeownershipmaynotalwaysinvolvegoingdirectlytopurchasingahouseandgettinga30-year,fixed-ratemortgage.New,moreconsumer-friendlyapproachestorent-to-ownandotherfinancialstrategies—subjectofcoursetoCFPBoversight—maybemoreappropriateforcertainhouseholds,andtheyatleastwarrantgreaterattentionandstudy.Andnewmortgageproductsdesignedtobuildequityfasterorcreatesavingsbuffersmayalsoberoutestobothaffordableandsustainablemortgagelending.

ConclusionThissurveyofhousingfinanceissuesforrentalhousingandhomeownershipismeanttostimulatemorethinkinginthedebateoveraccessandaffordability.Acompetitivemarketpromotingeconomicgrowthandopportunitycanproduceaccesstocreditatanaffordableprice.WewillnevermodernizeourhousingmarketnorallowittoreachitsfullpotentialwhenaWashington-basedduopolydominatesalldecisionsinmortgagelending.

Fornewprivate-creditrisk-takers,afocusonsustainablelendingpracticescanreducedefaultrates,improvefamilyfinancialstability,andenhancetheopportunityforhomeownershiptoyieldlong-termwealth-buildingopportunities.Thepathtosuchoutcomesliesinarobustprocessfortransitioningtohomeownership—teachingpotentialhomebuyersaboutcredit,counselingthemonfinancialmanagement,explaininghowamortgageworksandhowequityisbuilt,describingtheresponsibilities

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andpreparednessneededtohandlethebumpsintheroad—andproperlyaligningincentivessothatservicersandcreditenhancersareheldtolong-termoutcomesasmeasuresofsuccess.Andanynewentrantshouldhavetoshowhowitsbusinessplansarehelpingtocreateamortgageecosystemprovidingresponsibleaccessforallcommunities.

Housingfinanceshouldbeproducedinacompetitivemarketthatefficientlyallocatescreditwhilecreatingopportunity.Anewsecondarymortgagemarketthatproducesanenvironmentforthesortofpracticesandinnovationsdescribedhereshouldalsoenhancetheavailabilityofaffordablerentalhousingandtheabilityoffamiliestoaccessthecreditneededtofinancehomepurchasesthatcreateeconomicopportunityratherthaneconomicrisk.

Nineyearsafterthefinancialcrisis,itislongpasttimetotakeaholisticlookatthemechanicsofAmerica’ssecondarymortgagemarketandmakesomeneededchanges.ButforAmericansoutsidetheBeltwayandbeyondWallStreet,thisisnotamechanicalexercise.TheworkwedowillaffecthowandonwhattermsAmericanscanrentorbuyahome.Thus,itisnowonderthatreformhastakensolongtoenact.

Yetitisalsovitalthatwethinkboldlyandbeyondthenarrowscopeofrigidpolicyparametersthathavetrappedourdebateinyearspast.Thepre-2008systemfailed.Meanwhile,today’ssystemisnotworkingaswellasitcould,andsotheimpactonthelivesofAmericansfromthislingeringpolicychallengeisreal.

ItistimethatWashingtonfocusonhousingfinancereformnotonlytomodernizeoursystemofmortgageplumbing,butalsotoresponsiblyopenupeconomicopportunityforthe21stcenturyAmericanrenterandhomeowner.

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About the Authors MichaelBrightisadirectorattheMilkenInstitute’sCenterforFinancialMarkets(CFM),whereheleadsthecenter’shousingprogram.Inadditiontohousingfinance,Brightworksonissuesrelatedtointernationalanddomesticfinancialmarketregulationandpolicy.PriortojoiningtheInstitute,BrightworkedatPennyMac,amortgagefinancefirmfoundedinthewakeofthehousingcrisis.Earlier,hewaswiththeassetmanagementcompanyBlackRock.BrightworkedintheofficeofU.S.Sen.BobCorker,aTennesseeRepublican,forfouryears.HeadvisedonarangeofSenateBankingCommitteeissues,includingmonetarypolicy,Dodd-FrankActimplementation,globalmarketliquidity,U.S.-Chineseeconomicrelationsandhousingfinance.

EdDeMarcoisaseniorfellowinresidenceattheMilkenInstitute.HehasbeennamedpresidentoftheFinancialServicesRoundtable'sHousingPolicyCouncil,effectiveJune1,2017.BeforejoiningtheMilkenInstitute,DeMarcowasa28-yearcivilservant,culminatingwithhisroleasactingdirectoroftheFederalHousingFinanceAgencyfromSeptember2009toJanuary2014.Therehedealtwiththechallengesofmanagingthemega-institutionsFannieMaeandFreddieMac.DeMarcocraftedthe2012FHFAStrategicPlanforEnterpriseConservatorshipsandtheassociatedscorecardsandsetintomotionthecreditrisktransferandcommonsecuritizationinitiativesthatunderpinadministrativeeffortstoday. About the Center for Financial Markets BasedinWashington,D.C.,theMilkenInstituteCenterforFinancialMarketspromotesfinancialmarketunderstandingandworkstoexpandaccesstocapital,strengthen—anddeepen—financialmarkets,anddevelopinnovativefinancialsolutionstothemostpressingglobalchallenges. About the Milken Institute TheMilkenInstituteisanonprofit,nonpartisanthinktankdeterminedtoincreaseglobalprosperitybyadvancingcollaborativesolutionsthatwidenaccesstocapital,createjobs,andimprovehealth.Wedothisthroughindependent,data-drivenresearch,action-orientedmeetings,andmeaningfulpolicyinitiatives.©2017MilkenInstitute.ThisworkismadeavailableunderthetermsoftheCreativeCommonsAttribution-NonCommercial-NoDerivs3.0UnportedLicense,availableatcreativecommons.org/licenses/by