Across the country, we continue to see stories that indicate a decline of a cornerstone of the American dream: homeownership. Whether it be that millennials are opting out of purchasing a home or that minority borrowers suffer disproportionately from tight credit conditions in the mortgage market, it is clear that more must be done to better promote homeownership across the board.
Unfortunately, two of the greatest tools at our disposal – Fannie Mae and Freddie Mac – find themselves bound by limitations that are no longer applicable in today’s market; limitations that are not only preventing them from servicing communities in need but which are also endangering their long-term survival should another economic crisis occur. We must enact reforms to address the issues that led to their conservatorship and allow them to do their jobs.
A 2015 study found that 84 percent still believe that homeownership is an important part of the American dream, yet only 63.1 percent of the population of Rhode Island owns their own home.
So why are we handcuffing two major financial institutions that are required, by their charters, to service underserved communities?
Fannie and Freddie are operating with very thin capital levels, as mandated by the Treasury Department, through the third amendment of the Senior Preferred Stock Purchase Agreements. The SPSPAs third amendment mandates that the government-sponsored enterprises pay their entire quarterly earnings, each quarter, in perpetuity, to the Treasury. With this schedule, by 2018, Fannie and Freddie will have reduced the capital they hold to zero. A zero-capital level leaves Fannie and Freddie vulnerable to fluctuations in the housing market, which leaves the enterprises dependent on the U.S. government.
What does this mean for Rhode Islanders and the average American? The continued dwindling capital buffers raise the likelihood that any loss by the GSEs could lead to a taxpayer bailout. As it currently stands, not allowing them to keep their earnings could result in up to an estimated $126 billion bailout should another financial crisis occur. It is irresponsible to continue to withhold their capital and leave taxpayers on the hook, especially when a fix is possible.
Not only that, but the current state of affairs is making credit more expensive, especially for those who need it the most and could benefit from a stronger Fannie and Freddie. A zero-capital level, in addition to making Fannie and Freddie vulnerable to adverse quarterly financial developments, also creates uncertainty in the housing market; that in turn leads to a restriction on the availability of credit, particularly to low and moderate-income, creditworthy borrowers.
Allowing the GSEs to retain capital gives them the means and independence to strike a prudent balance of risk with availability of credit, particularly to less-affluent borrowers. Weak or nonexistent capital causes institutions to constrict their credit standards and make credit available only to more affluent borrowers in order to avoid risk.
The two largest mortgage credit intermediaries in the U.S. – Fannie and Freddie – find themselves in the latter, meaning they have less mortgage credit available for lower and more moderate income borrowers seeking to become homeowners.
Further exacerbating the problem is that the Federal Housing Finance Agency has required the two institutions to enter into risk-sharing arrangements.
Fannie and Freddie have primarily done “back-end” risk sharing to date, in which they solicit offers from investors to share the risk on loans already purchased and securitized by Fannie and Freddie. It can be done on a cost-effective basis, with investors bidding against each other so Fannie and Freddie can achieve their risk sharing at the lowest cost obtainable in the market.
The FHFA is now proposing that they engage in front-end risk sharing, where Fannie and Freddie buy loans where the originating lender or a third party agree to share any losses on the loan due to a borrower default. Front-end risk sharing is much more expensive and deprives Fannie and Freddie of considerably more income. It also worsens availability of credit, as front-end risk sharing encourages lending only to affluent borrowers with high credit scores. First-time buyers, lower and moderate-income borrowers and minority borrowers who need affordable mortgages to purchase a home are left out in the cold.
Clearly, what is needed – and quickly – is action by the FHFA and Congress. While it awaits congressional actions, FHFA must allow Fannie and Freddie to retain their quarterly earnings and build a capital cushion. Such a cushion would do two things: make them less vulnerable to market fluctuations – protect taxpayers – and permit them to responsibly adjust their credit requirements for lower and moderate income borrowers.
Owning a home continues to be a vital asset to expanding opportunity and creating economic stability. The FHFA must do everything in its power to plug the dam until Congress can act on fixing its infrastructure and avoid a potential flooding. •
Glen Corso is the executive director of the Community Mortgage Lenders of America.
