November 7, 2017
House Financial Services – Housing and Insurance Subcommittee “Sustainable Housing Finance: Private Sector Perspectives on Housing Finance Reform, Part III”
Key Topics & Takeaways
- Government Guarantee: Several of the witnesses endorsed a catastrophic government guarantee on qualifying mortgage-backed securities as necessary to preserve access to mortgage credit and preserve the 30-year fixed rate mortgage. However, Wallison endorsed (and several Republican members seemed open to) pushing all credit risk in to the private market. Several Republicans noted that the jumbo loan market does not have a government guarantee, though other witnesses noted that the jumbo loan market has unique and not-universal characteristics.
- Private Capital: Republicans used the hearing as an opportunity to draw attention to the need to expand private sector involvement in housing finance, while Democrats argued that the private sector is unable to meet the demands of the market. Zandi noted that his research indicated a 1% increase in rates for the median borrower in a fully-privatized system, with a larger impact felt by individuals with worse credit.
- Mortgage Interest Deduction (MID): There was lengthy discussion throughout the hearing on the proposed mortgage interest deduction cap in the House Republican tax bill. Democrats attacked the cap for not being indexed or for considering regional variations in home prices.
- Peter Wallison, Senior Fellow, American Enterprise Institute
- Mark Zandi, Chief Economist, Moody’s Analytics
- Michael Lea, Cardiff Consulting Services
- Alanna McCargo, Co-Director, Housing Finance Policy Center, Urban Institute
- The Honorable Theodore “Ted” Tozer, Senior Fellow, Milken Institute
Subcommittee Chairman Sean Duffy (R-Wis.)
In his opening statement, Duffy discussed the importance of the housing market to the broader economy and said his priority as Subcommittee Chairman was to protect homebuyers and prevent a repeat of the 2008 crisis. He also introduced the panel, which he described as consisting of representatives from “think tank” world.
Subcommittee Ranking Member Emanuel Cleaver (D-Mo.)
In his opening statement, Cleaver described the subcommittee as “serious” about passing housing finance reform legislation and tsaid hat he appreciated the opportunity to gather feedback from industry stakeholders through this series of hearings. Cleaver called on the committee to preserve the 30-year fixed rate mortgage, which he said would require a government guarantee of some kind, and to use housing finance reform legislation to improve access to affordable housing. Cleaver also discussed the proposal in HR 1, the Tax Cuts and Jobs Act, to cap the mortgage interest deduction (MID) at the $500K level, and noted that many stakeholders are concerned this would have a detrimental impact on homeownership and the middle class.
Peter Wallison, Senior Fellow, American Enterprise Institute (AEI)
In his testimony, Wallison argued that the “best” path forward for the housing finance system is to eliminate the federal government’s role in the industry by eliminating Fannie Mae and Freddie Mac (collectively, the GSEs). Wallison said that the private sector is capable of offering mortgages with lower interest rates than the GSEs, as well as offering 30-year fixed rate loans, without a government guarantee. Wallison criticized the GSEs practices as putting “upward pressure” on home prices while doing little to help middle income Americans buy homes. Wallison specifically criticized the GSEs for only dedicating 11% of their activities to helping people buy homes worth less than $250K, and engaging heavily in refinancing activities, financing second homes, and financing home purchases for rental units. Wallison argued that the GSEs have been ineffective at boosting homeownership rates. Wallison closed by arguing that purchases of agency mortgage backed securities (MBS) increases borrowing costs for the Treasury by reducing demand for federal government debt.
Mark Zandi, Chief Economist, Moody’s Analytics
In his testimony, Zandi called for an explicit, catastrophic government guarantee on mortgage-backed securities (MBS) that is fully paid for by borrowers. Zandi described the guarantee as a “necessary ingredient” for any future housing finance system and that absent a guarantee, mortgage interest rates will be “measurably higher” than they are today, possibly as high as 100 bps higher for the typical borrower (or 1%), and even higher for those at the bottom of the credit box. Zandi also praised a multiple guarantor model, saying that having more than two guarantors would eliminate the too big to fail (TBTF) issue for the GSEs and encourage innovation in mortgage credit allocation.
Michael Lea, Cardiff Consulting Services
In his testimony, Lea discussed differences between the housing industries of Australia, German, Canada, Denmark, the United Kingdom, and the US. Lea noted that these six countries have some notable commonalities, including similar amounts of house price increases since 2008, similar homeownership rates, and similar mortgage interest rates. Lea noted that only Denmark and the US offer a mortgage interest tax deduction, and that there are significant differences across the countries for origination of loans, the length of loans, and the treatment of interest rates. Specifically, the US market is dominated by securitization, reflecting the domination of fixed-rate mortgages backed by a government guarantee, while European countries have large covered bonds markets, which are corporate-bank issued bonds backed by ring-fenced mortgage loans. Lea noted that underwriting standards are stricter in other countries, and that other countries do not have many 30-year fixed rate mortgages, as these are not suitable for bank financing.
Alanna McCargo, Co-Director, Housing Finance Policy Center, Urban Institute
In her testimony, McCargo discussed the US’s growing wealth gap and said that boosting homeownership rates in minority communities will help ameliorate this, as homeownership is the primary mechanism used to build wealth. McCargo noted that the homeownership rate for black Americans is at the pre-Fair Housing Act level of 42%. McCargo also called on Congress to expand the credit box to safe borrowers with lower traditional credit scores and to consider alternative credit scoring models. McCargo closed by calling on Congress to 1) preserve access to long-term fixed rate products; 2) protect taxpayers and ensure capital is available for mortgage lending even in economic downturns, and 3) fund the Federal Housing Administration (FHA) so it can support affordable housing creation and first-time homebuyers.
The Honorable Theodore “Ted” Tozer, Senior Fellow, Milken Institute
In his testimony, Tozer argued that the GSEs current duopoly is slowing down innovation in mortgage lending and hurting access to credit, and said that a reformed system should encourage innovation and competition in the market for loans. Tozer also discussed the Milken Institutes proposal for housing finance reform, with its focus on expanding the role Ginnie Mae plays in the market, and noted that the number of Ginnie Mae-approved issuers has expanded dramatically, and that this diversified issuer base is a source of strength.
Question & Answer
Rep. Keith Rothfus (R-Pa.) asked Wallison if the 30-year fixed rate jumbo market has a government backstop, and Wallison replied that it does not, and that this is evidence that government backstop is not needed to ensure access to 30-year fixed-rate products. Zandi, later in the hearing, noted that the jumbo market is dominated by large financial institutions, and that jumbo loan borrowers have excellent credit and low debt-to-income ratios. Rothfus also asked if it would be possible to quantify the necessary size of a catastrophic backstop, and Zandi said that the government should be prepared to step in after the private market absorbs the first 5% of losses. Zandi noted that the GSEs, even in 2008, did not take losses that heavy, and that underwriting standards have only improved since the crisis.
Duffy asked the panel how to price the government guarantee, and how Congress should ensure that it is collecting enough money to pay for it. Zandi conceded that there was “not a good answer” to the question but endorsed a mortgage insurance fund (MIF) along the lines of the FDIC’s deposit insurance fund, with a 10 bps fee on every insured mortgage. Zandi said this system would raise enormous amounts of money over the long term and that Congress should simply let the MIF grow. Wallison said that the private mortgage insurance industry was best equipped to set premiums, as it would require riskier mortgages with low downpayments and borrowers with low FICO scores to pay appropriately priced premiums.
Private Sector Capital
Republicans used the hearing as an opportunity to draw attention to the need to expand private sector involvement in housing finance, while Democrats argued that the private sector is unable to meet the demands of the market. Cleaver asked Zandi to describe the drawbacks of a largely privatized mortgage finance industry, and Zandi argued that such an structure would lead to higher borrowing costs, especially for borrowers with lower credit scores (Zandi used the HR 2767, the Protecting Homeowners and Taxpayers or ‘PATH’ Act of 2013 as a baseline for this discussion). Zandi also argued that because of events in 2008, the market now believes that the government would step in to support the housing market in another major downturn and so this belief ought to be formalized. McCargo argued that the lack of an explicit guarantee would disproportionately hurt rural communities.
Rep. Dennis Ross (R-Fla.) said he believes that the private sector is willing to insure mortgages, but that the last two housing hearings in the subcommittee have featured panels that believe a government backstop is necessary. Ross asked if a private market for mortgage insurance would “self-regulate” because it would be unwilling to take on enormous risks. Wallison argued that there is a “trade-off between underwriting standards and housing prices” and that smaller downpayments translate to more credit risk and drive up housing prices. Zandi argued that a catastrophic guarantee is still necessary because otherwise interest rates on fixed rate loans will still increase.
Rep. Michael Capuano (D-Mass.) criticized Republicans for entertaining a private-only mortgage lending industry and dared them to put such a proposal on the House floor for a vote. Tozer discussed servicing regulations and said that some entity needs to oversee servicers to ensure that servicers are on the hook for losses, not the end investors. Tozer also endorsed having an efficient credit risk transfer market.
Status of the GSEs
Duffy asked the panel for its thoughts on the various proposals for housing finance reform currently circulating. Zandi said he supported a multiple guarantor system because it would use the existing infrastructure and build on the reforms that the GSEs have enacted since the conservatorship began.
Rep. Randy Hultgren (R-Ill.) asked Zandi for his thoughts on recap and release proposals for the GSEs, and Zandi was sharply critical, noting that without reforms the GSEs will face the same risks they faced in the runup to 2008, and as private entities they will be forced to raise interest rates.
Mortgage Interest Deduction (MID)
The hearing also featured lengthy discussion of HR 1, the Tax Cuts and Jobs Act, and the proposed cap on the mortgage interest deduction in particular. Duffy defended the cap on MID, while many Democrats attacked the cap, saying the lack of an index for the cap, combined with regional variations in housing prices, mean that the cap would harm middle-class borrowers. Rep. Brad Sherman (D-Calif.) asked Zandi about the market impact of the proposed MID cap, and Zandi said that his analysis showed the cap would create a 3-5% decline in nationwide housing prices, with a sharper, potentially double-digit decline in prices in large suburbs and in metropolitan areas. Reps. Michael Capuano (D-Mass.) and Joyce Beatty (D-Ohio) also attacked the proposed cap.
Credit Risk Transfer
Rep. Ed Royce (R-Calif.) asked the panel if there was “any reason” the government should not try to maximize credit risk transfers to the private market. Tozer agreed that the government should try to transfer as much credit risk as possible.
Private Activity Bonds (PABs)
Beatty criticized a provision of HR 1 that would eliminate PABs because of the impact of that provision on affordable housing creation. She entered this Politico article into the record.
Qualified Mortgage (QM) Rule and Underwriting Standards
Duffy noted that while the QM rule requires a 43% debt-to-income (DTI) ratio on loans, the GSEs themselves are insuring loans with up to 50% DTI. Wallison responded to his comment that financial institutions would not make loans with a 50% DTI, as these loans are too risky and vulnerable to a fall in housing prices.
Sherman asked the panel how to prevent a “race to the bottom” in underwriting standards in a multiple guarantor system, and Tozer argued that if guarantors are required to offload credit risk to private markets, these third-parties will require good underwriting standards and will demand premiums on riskier insured mortgages.
Several Democrats used the hearing to draw attention to affordable housing issues in the US and asked the panel for how to boost the nation’s stock of affordable housing. McCargo said the best way to do this would be require the GSEs to have affordable housing targets, including supporting the renovation of older affordable housing.
Several Representatives asked Lea to describe similarities and differences between the US housing market and housing markets abroad. Rep. Ted Budd specifically asked for comparisons between the US and Canadian markets, and Lea noted that Canada also provides a government guarantee on qualified MBS, a 45% DTI, several policy provisions in place to prevent defaults, and an upper limit to the size of loans that can be guaranteed. Lea noted that the US has the largest percent of its mortgage market guaranteed by the government, and that the other countries in his analysis (Canada, Australia, Germany, Denmark, and the UK) do not come close to reaching the US level.
Rothfus noted that the other countries in Lea’s analysis have similar homeownership rates despite significant differences in mortgage terms, and asked Lea “how important” the 30-year fixed rate mortgage is in encouraging homeownership. Lea said that other countries have fewer 30-year fixed rates because of the large credit and interest rate risk, and these countries have decided that borrowers can be exposed to more interest rate risk, while in the US, the government guarantee is necessary to support 30-year fixed rates.
For more information on this hearing, please click here.