The next hous­ing cri­sis: No one can af­ford a place to live

Jour­nal­ist Bethany McLean says gov­ern­ment-backed mort­gage lenders are aw­ful — and es­sen­tial

The Washington Post Sunday - - OUTLOOK - Bethany McLean is a con­tribut­ing editor at Van­ity Fair and the author of “Shaky Ground: The Strange Saga of the U.S. Mort­gage Gi­ants.” Twit­ter: @bethany­mac12

If there’s one thing with which most of Wash­ing­ton has long agreed, it’s this: Fan­nie and Fred­die must die. That’s Fan­nie Mae and Fred­die Mac, the mort­gage gi­ants that prop up much of the Amer­i­can hous­ing mar­ket and have been op­er­at­ing un­der gov­ern­ment con­trol since the financial cri­sis seven years ago. “There’s a ma­jor­ity of peo­ple here that be­lieve that they should be wound down and re­placed so that the tax­pay­ers are not back­ing them up as they are to­day,” is how Sen. Bob Corker (R-Tenn.) put it last week. In one of his few men­tions of the topic, Pres­i­dent Obama de­scribed Fan­nie and Fred­die’s busi­ness model as “heads [they] win, tails tax­pay­ers lose,” mean­ing that al­though their ex­ec­u­tives and share­hold­ers prof­ited in the good times, the im­plicit be­lief that the gov­ern­ment stood be­hind them — which was the core of their busi­ness model — would force tax­pay­ers to cover the losses in a cri­sis. Which we did.

The crit­ics are right about the flaws of both in­sti­tu­tions: Fan­nie and Fred­die ac­crued too much po­lit­i­cal power be­fore they went bust, and their drive for mar­ket share dur­ing the hous­ing boom early in the past decade left tax­pay­ers on the hook to bail them out.

But we still need Fan­nie and Fred­die, even more now than be­fore.

They own or guar­an­tee the pay­ments on more than $5 tril­lion in Amer­i­can mort­gages, or about 60 per­cent of the to­tal. In the years since the financial col­lapse, they have been the ma­jor source of credit for most peo­ple who got mort­gages, and the only source of credit for less-than-pris­tine bor­row­ers. Wash­ing­ton is par­a­lyzed. Even Corker, when pressed, backed away from his call to elim­i­nate them, be­cause de­spite the ha­tred of the hous­ing gi­ants, col­lec­tively known as “gov­ern­ment-sup­ported en­ti­ties,” or GSEs, no one wants to see what would hap­pen with­out them, and no one can agree on how to re­place them.

As a re­sult, there’s no plan for how the United States will fi­nance hous­ing in the fu­ture. With­out a hous­ing fi­nance pol­icy, there is no hous­ing pol­icy. And that’s a huge prob­lem, be­cause an­other cri­sis — about how peo­ple will af­ford a place to live — is brew­ing.

Since 2008, while Fan­nie and Fred­die have sat in limbo, home­own­er­ship has plunged. This sum­mer, the Cen­sus Bureau re­ported that the home­own­er­ship rate had fallen to 63.4 per­cent, the low­est level in 48 years. (It had peaked at 69 per­cent, in 2004.) “Renter na­tion,” one blog called the United States. The de­cline is par­tic­u­larly pro­nounced in mi­nor­ity com­mu­ni­ties. At the Con­gres­sional Black Cau­cus Foundation’s an­nual leg­isla­tive con­fer­ence this year, hous­ing ad­vo­cates pointed out that the home­own­er­ship rate for the black pop­u­la­tion has de­creased from nearly 50 per­cent in 2004 to about 43 per­cent, its low­est level in 20 years. It’s pro­jected to con­tinue to drop.

Pun­dits have ar­gued that the home­own­er­ship rate was, and maybe still is, too high, be­cause too many peo­ple were get­ting mort­gages they couldn’t af­ford. But if peo­ple don’t own (and don’t sleep on the street), they rent — and rents have been steadily ris­ing since 2000, while in­comes have not kept pace. In the third quar­ter of this year, rents in­creased by 5.7 per­cent year over year, ac­cord­ing to Morn­ingstar, and they rose at a dou­ble-digit clip in some large ci­ties such as San Fran­cisco and Den­ver. (Rents in Wash­ing­ton were up just 1.44 per­cent year over year, ac­cord­ing to the on­line real es­tate data­base Zil­low, in part be­cause of in­creased sup­ply.) The Wall Street Jour­nal re­cently noted that a pend­ing merger of two com­pa­nies that own sin­gle-fam­ily rental homes is pred­i­cated on rents con­tin­u­ing their rise.

Stan Humphries, the chief an­a­lyt­ics of­fi­cer at Zil­low, has called what’s com­ing a “rental cri­sis.” Ac­cord­ing to Zil­low’s data, while home­own­ers with a mort­gage can ex­pect to spend about 15.3 per­cent of their in­come on monthly hous­ing bills, renters must plan to set aside al­most dou­ble that share. As rents rise, it gets harder to save for the down pay­ment re­quired to buy a home. Add in the bur­den of stu­dent loans, and financial chal­lenges in­crease. Ac­cord­ing to an anal­y­sis by En­ter­prise Com­mu­nity Part­ners and the Har­vard Joint Cen­ter for Hous­ing Stud­ies, since the start of the 2000s, the num­ber of se­verely cost-bur­dened renters in the United States — mean­ing those who pay more than half their in­come in rent — has risen sub­stan­tially, from 7 mil­lion in 2000 to 11.3 mil­lion in 2013. The num­ber is ex­pected to keep in­creas­ing.

There’s a log­i­cal re­sponse to this, which is to use Fan­nie and Fred­die for what they were de­signed to do: sup­port home­own­er­ship for those who can af­ford it, and sup­port the fi­nanc­ing of multi-fam­ily hous­ing that work­ing peo­ple can af­ford.

In Wash­ing­ton pol­icy cir­cles, re­viv­ing the GSEs is con­sid­ered some­thing that shouldn’t be dis­cussed in po­lite com­pany. The com­plaints about their pre-cri­sis busi­ness model are ac­cu­rate — but some of the other crit­i­cisms are wrong, and even con­tra­dic­tory.

One ar­gu­ment is that in their pre­vi­ous in­car­na­tion, Fan­nie and Fred­die caused the financial cri­sis by help­ing un­qual­i­fied peo­ple buy homes, in the name of fol­low­ing man­dates from Congress to meet hous­ing af­ford­abil­ity goals. But the financial cri­sis wasn’t caused by putting peo­ple in homes. It was caused by peo­ple of all in­come lev­els spec­u­lat­ing on homes as in­vest­ment prop­er­ties, and us­ing their homes as credit cards, ex­tract­ing money from them via cash-out re­fi­nanc­ing. Ac­cord­ing to Ja­son Thomas, the di­rec­tor of re­search at the Car­lyle Group, only about a third of sub­prime mort­gages that were turned into mort­gage-backed se­cu­ri­ties be­tween 2000 and 2007 were used to buy homes. And a study pub­lished by the Na­tional Bureau of Eco­nomic Re­search in early 2014 found that the wealth­i­est 40 per­cent of bor­row­ers ob­tained 55 per­cent of the new loans in 2006 — the peak year of the bub­ble — and that over the next three years, they were re­spon­si­ble for nearly 60 per­cent of delin­quen­cies.

An­other old crit­i­cism con­tra­dicts that one: In the 1990s, crit­ics — from ac­tivists on the left, to Amer­i­can En­ter­prise In­sti­tute scholar Pe­ter Wal­li­son on the right, to the Con­gres­sional Bud­get Of­fice — ar­gued that Fan­nie and Fred­die never did much to fos­ter home­own­er­ship or lower mort­gage rates. Maybe this was true in the golden years of the 1990s, when there was no short­age of pri­vate cap­i­tal to be lent for real es­tate. But we cer­tainly needed Fan­nie and Fred­die in the wake of the cri­sis. And al­though there is a lot of anal­y­sis about what a mar­ket with­out gov­ern­ment sup­port would look like, the sim­ple truth is that Fan­nie has been around for al­most 80 years. Any­one pro­ject­ing how the hous­ing mar­ket would ap­pear with­out it is just guess­ing.

Still, there is fairly wide­spread agree­ment that some things we take for granted, such as a 30-year, fixed-rate, pre-payable mort­gage, wouldn’t ex­ist with­out a gov­ern­ment back­stop. In­vestors sim­ply don’t want that risk. That’s part of the rea­son Congress has done noth­ing with the in­sti­tu­tions since the gov­ern­ment took them over. With­out the gov­ern­ment sup­port, not much would change for the very wealthy. But most an­a­lysts agree that a great swath of the mid­dle and lower class prob­a­bly would get five- to 15-year mort­gages with float­ing rates, rates that would vary sig­nif­i­cantly de­pend­ing on in­come and ge­og­ra­phy. Mort­gage cap­i­tal might be hard to come by in times of stress. Home prices prob­a­bly would de­crease. With an af­ford­able-hous­ing cri­sis in the works, and when even the Wall Street Jour­nal is pub­lish­ing es­says about the squeeze on the mid­dle class, it is prob­a­bly not po­lit­i­cally fea­si­ble or wise to ex­per­i­ment if you care about the so­cial fab­ric of the coun­try.

Most sup­pos­edly “free mar­ket” so­lu­tions as­sume that the big banks would take greater con­trol of the mort­gage mar­ket with­out Fan­nie and Fred­die. But the big banks were bailed out in 2008, too. The Dodd-Frank financial re­form leg­is­la­tion may have fixed the “too big to fail” is­sue. (That’s de­bat­able, but give it the ben­e­fit of the doubt.) If banks con­trol the na­tion’s mort­gage mar­ket, does any­one think they’ll be al­lowed to fail in the next cri­sis? In which case, how are they not gov­ern­ment-sup­ported en­ti­ties, as well?

One le­git­i­mate com­plaint about the old Fan­nie and Fred­die was the way they gar­nered po­lit­i­cal clout through their pro­mo­tion of home­own­er­ship. In their hey­day, it was im­mense and ugly. (“Fan­nie has this grand­moth­erly im­age, but they will cas­trate you, de­cap­i­tate you, tie you up, and throw you in the Po­tomac,” a con­gres­sional source told the In­ter­na­tional Econ­omy in the late 1990s. “They are ab­so­lutely ruth­less.”) That would pale next to the po­lit­i­cal clout of a big bank that also con­trolled the mort­gage mar­ket, and what­ever evils grew out of the GSEs’ need to please politi­cians, there could be worse. Imag­ine the con­ver­sa­tion in a back room be­tween the politi­cians and the bank ex­ec­u­tives, where they agree that if the bank will loosen up credit in their states, the politi­cians will go easy on, say, de­riv­a­tives reg­u­la­tion. It al­most makes the old Fan­nie and Fred­die look pure.

Fan­nie and Fred­die have le­git­i­mate prob­lems. As Obama said, theirs was a flawed busi­ness model in which the drive for prof­its ul­ti­mately led to their fail­ure. Many econ­o­mists also ar­gue that any sub­sidy even­tu­ally leads to cor­rup­tion. But there are ways to mit­i­gate th­ese is­sues. Reg­u­late Fan­nie and Fred­die like util­i­ties, with lim­its on the re­turns they can make. Cre­ate in­cen­tives that en­cour­age them to pull back from the mar­ket when it’s over­heat­ing, in­stead of chas­ing mar­ket share. Give them as com­pe­tent a reg­u­la­tor as pos­si­ble. En­cour­age Fan­nie and Fred­die to get pri­vate cap­i­tal to bear risk ahead of them, which they are try­ing to do, and which is how their ex­ist­ing multi-fam­ily busi­nesses op­er­ate.

None of this would sat­isfy the Fan­nie and Fred­die blood­lust. Nor would it be per­fect. But if per­fect is out there some­where, it’s time to pro­pose it. We need a hous­ing pol­icy.

Since 2008, while Fan­nie and Fred­die have sat in limbo, home­own­er­ship has plunged.

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