A discussion by housing analysts in front of the Senate Committee on Banking, Housing and Urban Affairs makes two things very clear: demand for private capital to fund more of the mortgage finance system is there, and the underlying issue that must be addressed is the market’s ongoing unwillingness to price the risk associated with subprime mortgages up front.
The only question is how far should the market swing to ensure safety, while still trying to appease the nation’s ongoing commitment to homeownership?
As the Federal Housing Finance Agency continues to work through the creation of a future securitization platform and the inevitable end of the GSEs comes, the remaining question is how far will the nation go in pricing risk ahead of time and what will the market look like after that shift?
There are two distinct viewpoints in the matter.
The Senate Committee featured testimony from Janneke Ratcliffe, a senior fellow for the Center for American Progress Action Fund, who warned that some type of government back-stop is needed to keep mortgage lending affordable.
"A completely private market would mean a smaller market and a riskier one, and one that would not meet the fundamental requirements of stability and liquidity to support a robust housing market in this country," Ratcliffe told the Committee.
"History has shown us that a housing finance system that relies on private risk-taking will be subject to a level of volatility that is not systemically tolerable, given the importance of housing to the economy and the American family."
Yet, fears over affordability may have created some of the risks that ended up creating a bubble and the subsequent wipe out of trillions of dollars in equity, according to Peter Wallison with the American Enterprise Institute.
"The reason such a large bubble developed is that housing bubbles tend to suppress delinquencies and defaults," said Wallison.
"As long as housing prices are rising, people who are in danger of default can refinance or sell the home for more than the amount of the mortgage. As weaker and weaker mortgages do not seem to be producing more delinquencies and defaults, lenders go further and further out on the risk curve and investors in MBS do not get the signals that should tell them their risks are increasing."
With this in mind, Wallison told the Committee only prime loans should be securitized in the future housing finance system. He believes subprime mortgages should only be made by firms that understand the risks and who are willing to keep those loans on private balance sheets.
As to where the problem lies, Wallison suggests true lending costs are artificially deflated by special interests groups. And he says this construction inevitably resurfaces every time a special interest group wins out in the shaping of housing policy.
He suggested that Fannie and Freddie were stable when they only bought prime mortgages.
"Let’s be clear where the problem lies," Wallison said. "Community activists, realtors and homebuilders want loose underwriting standards. Loose standards mean more people can buy homes, but none of these groups suffer the losses when the market collapses as it did in 2008. Who is visiting congressional offices asking for tighter mortgage underwriting standards? The answer is no one."
Even as those testifying pushed for at least some type of government guarantee or back-stop, the handwriting is on the wall. To ensure the risk of lending is at least priced appropriately, prices will have to shift to a model where the assumption is a private actor takes the hit of risk first. The end result of this shift is a pricing model that quantifies the risk, forcing borrowers to pay a bit more.
Mel Martinez, co-chair of the Bipartisan Policy Center's Housing Commission, pushed for some type of government guarantor, but said protecting the taxpayers from loss means "the protection will come at the cost of higher mortgage rates for borrowers."
For starters, private credit enhancers will charge fees to cover the risk of default and any type of public guarantor of mortgages will be forced to charge an unsubsidized fee to cover the risk.