CQ: Roskam On Housing Policy
House Financial Services Chairman Barney Frank unexpectedly turned up the heat on a Friday morning in late January. In the middle of an otherwise desultory hearing of his committee focused on the compensation of financial executives, Frank suddenly switched gears and in an aside remarked that he wanted to abolish Fannie Mae and Freddie Mac. Just like that. Throw them away and start over with a whole new structure for financing housing in the United States.
For a time, the bombshell upset bond markets that had already been shaken by enormous losses posted quarter after quarter by the two mortgage giants. And it reverberated through congressional offices, even as it sounded like a trial balloon coming from a man often regarded as the biggest supporter of Fannie and Freddie on Capitol Hill.
Even before the peak of the real estate boom, the Massachusetts Democrat had pushed to expand the role the two companies play in affordable housing for both renters and owners. In the midst of the financial crisis, he defended them as essential backstops for the home loan market.
But that was before the two institutions admitted they had bought a huge volume of risky loans, fueling the irresponsible lending spree that ended up undermining the entire economy, and potentially costing taxpayers as much as $200 billion.
Frank's seemingly offhand remark in January has since grown into a full-throated call to overhaul all the federal institutions involved with the real estate market, from the Federal Housing Administration to the Federal Home Loan Banks and beyond.
"Clearly, we have to change things," he said last week. "We need a new model, and not just for Fannie and Freddie."
After decades of lauding homeownership as a central and unquestioned part of the American Dream, public officials are starting to re-examine just how far they want to push that goal. From some quarters, there are appeals for a much greater retrenchment. Regional planners and economists on both the left and the right of the political spectrum say the crisis exposed a dangerous policy bias toward homeownership that has tilted way out of balance. And many call for a complete re-examination of the federal government's support for the residential real estate market.
Signs of this changing perspective are beginning to crop up in concrete proposals.
Frank is planning to open hearings on the federal role in housing finance this month, a first step, he says, on the road to determine how to promote "responsible homeownership." Meanwhile, President Obama has proposed a near-heresy in each of his first two budget requests: raising revenue by scaling back the heretofore inviolate mortgage interest deduction and denying it to the wealthiest taxpayers. And the Federal Reserve is set this month to start removing one of the pillars of the mortgage market. The central bank will start winding down its $1.25 trillion investment in mortgage-backed securities -- an unprecedented commitment of capital it made over the past year -- with some uncertainty whether private investors will be willing or able to pick up the slack.
"Now is the right time, in this little economic window, to reset our housing policies for the next generation or two," said Arthur C. Nelson, a professor of city and metropolitan planning at the University of Utah, who has been critical of federal subsidies that he says create an oversupply of single-family house construction and make it difficult for low-income families to find affordable rental apartments.
Federal support for the homebuilding and sales industries started as a way to help middle-class families purchase modest homes. But those industries have mushroomed to the point that the economy turns on real estate.
The federal government, and the entities it implicitly backs, have for decades propped up ownership through tax, spending and interest rate policies. The upshot is that the private market is totally distorted by -- and dependent upon -- federal support. And some say those subsidies are to blame for the real estate bubble that fueled irresponsible lending in the first place.
"As the housing boom gathered steam in this decade, there is little doubt that large-scale government housing subsidies only encouraged more residential investment," Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, told the congressionally created Financial Crisis Inquiry Commission at a recent hearing. "These policies amplified the boom as well as the resulting bust."
Critics of the federal role in the housing market note that this overemphasis on homeownership isn't a recent phenomenon. It has been building over decades, fueled by demand from consumers, lenders and the construction industry, a housing-industrial complex so politically strong that it has become impossible to get rid of or scale back programs it favors.
"Who will stand up to say they are against homeownership?" Bair said.
It will be hard to unwind seven decades or more of federal policy support for housing. But critics of the current situation hope the aftermath of the financial crisis will provide the momentum necessary at least to re-establish a balance between real estate and other areas of the economy, and between homeownership and renting.
"My goal, if I were in the government, would be to encourage people to make the correct decision on whether they should own or rent, and not just subsidize owning the way we have in the past," said Joseph Gyourko, chairman of the real estate department at the University of Pennsylvania's Wharton School of Business. "I think now we're seeing the costs of excessive support for owning. If you subsidize something as much as we did, you're going to have problems."
Supporters of the housing industry note that ownership still has an important role to play in the national economy and in creating personal wealth, which makes it worthy of federal investment.
"We'll continue to need some government support for the mortgage market for the very reason we're in the situation we're in right now," said David Crowe, chief economist at the National Association of Home Builders. "There is always the potential that the wheels will come off the financial system, and so many people are dependent on mortgages for where they live and for drawing equity out to go to college and do all the things they do with their home equity."
At the same time, Crowe said, studies have linked homeownership to family stability and positive social outcomes. "The government has a social justification for being involved," he said.
The trick, Frank says, is to be sure the government draws the line in the right place. "I'm very skeptical of the government's artificially helping people buy homes who not only can't afford it but can't manage it," he said. "If you're living on the margins and you've got a lot of stress in your life, owning a home is hard."
All Good Intentions
In the early part of the 20th century, before the federal government became so heavily involved in the mortgage market, roughly 46 percent of American families owned their homes. By 2004, the homeownership rate reached an all-time high of 69.2 percent.
In the intervening years, federal policy played a central role in making residential loans cheaper and easier to get -- and in encouraging people to buy houses in the first place.
The shift started during the Great Depression, when Congress and the administration of President Franklin D. Roosevelt responded to a wave of foreclosures by establishing the Federal Housing Administration to insure mortgages and Fannie Mae (then known as the National Mortgage Association of Washington) to stimulate lending by buying mortgages from lenders.
The FHA transformed the mortgage industry, and made financing available and affordable for more people, by requiring relatively long terms and fixed rates for the loans it covered. Fannie Mae, which became a shareholder-owned company in the late 1960s, provided lenders with the cash they needed to originate more mortgages.
Other government efforts, such as allowing homebuyers to deduct mortgage interest payments from their federal income taxes, have propped up homebuying for the better part of a century. As federal policy fueled borrowing and residential construction, homeownership became an entrenched goal. People wanted bigger and bigger houses, and were willing and able to go deeper into debt to get them.
Because owning property could also help low-income families build assets, expanding ownership became a political goal shared by Democrats and Republicans. President George W. Bush declared in June 2002 that he wanted to expand the number of minority homeowners by 5.5 million by 2010.
"It is essential that we make it easier for people to buy a home, not harder," Bush told employees of the Department of Housing and Urban Development during a speech in celebration of National Homeownership Month. But Bush's ideal, which would have pushed the ownership rate to about 75 percent, was never realized. Instead, in the middle of the past decade, many new owners began defaulting on loans they couldn't afford.
"It may be that one thing we've learned is that the homeownership rate was an illusion," said Alexander von Hoffman, a senior fellow at the Joint Center for Housing Studies at Harvard University. "The people who were counted were unable to sustain the payments."
There were many reasons why the real estate industry and the entire economy reached a tipping point in 2007. But many experts now contend that federal government policies were a principal cause.
At the beginning of the decade, after the economic shocks caused by the terrorist attacks and the bursting of a bubble in technology stocks, the Federal Reserve kept interest rates consistently low. Federal regulation of loans, especially a new class of subprime mortgages aimed at borrowers with poor credit histories, was lax. In this environment, Fannie and Freddie bought up hundreds of billions of dollars of risky mortgages, feeding the market for them.
"Definitely, we can make the case that we overcooked the housing market by having massive government intervention into it," said Anthony B. Sanders, professor of real estate finance at George Mason University.
Warping the Economy
Even without the excesses that led to the financial crisis, experts say, a strong policy bias toward owner-occupied housing warps the economy and diverts resources from other types of investments.
"This crisis represents the culmination of a decades-long process by which our national policies have distorted economic activity away from savings and toward consumption, away from our industrial base and public infrastructure and toward housing, away from the real sectors of our economy and toward the financial sector," Bair told the financial crisis commission.
Such critics as Bair contend that Wall Street trading, much of it involving housing-related financial instruments, now generates too large a share of the nation's corporate profits, supplanting Wall Street's traditional role of allocating capital toward productive enterprises.
Investment in new housing and remodeling has averaged about 4.8 percent of overall economic output since the beginning of record-keeping in 1947. By the end of 2005 -- just before the bubble burst -- residential investment spending reached 6.3 percent of gross domestic product. This reflected, in part, a new reality driven by skyrocketing house prices: People began to see houses as a way to get rich rather than as a place to live.
"In history, the notion of homeownership was something you took very seriously, and the house was the focus of your life," von Hoffmann said. "The idea that you'd use the house as an ATM machine was completely foreign. But a couple of years ago, you started to hear upper-middle-class people talking about flipping properties, which used to be very disreputable."
Indeed, those who contend that the United States is overinvested in housing point out that federal policies have disproportionately benefited the wealthy. In certain high-cost neighborhoods, borrowers with mortgages as large as $730,000 enjoy relatively low interest rates because their loans qualify for purchase by Fannie and Freddie. Moreover, taxpayers who earn more than $100,000 claim more than two-fifths of the billions of dollars in tax breaks for the mortgage interest deduction, which applies to loans as large as $1 million.
The National Association of Realtors reported that in 2005 -- the peak year for housing speculation -- two out of every five sales were for second homes. Some analysts say this makes no economic sense.
"I frankly think there is no reason to subsidize the middle-class and upper-income mortgage market," Gyourko said. "I would phase them out. Essentially, what we should retain as part of public policy is a low-income support system."
Advocates for low-income families say the mortgage interest deduction also encourages disproportionately high prices. "Some of our policies have made the homeownership situation worse by encouraging house price increases, which of course puts more homeownership out of the reach of modest-income people," said Ellen Seidman, a senior research fellow at the New America Foundation.
But altering that piece of the tax code, which has existed since creation of the modern income tax in 1913, would be extremely difficult, because it is widely viewed as an essential element of the U.S. economy.
"It is money well spent, and a vibrant housing market is the key to high employment as well as a good economy," said Sen. Johnny Isakson, a Georgia Republican who used to own a real estate brokerage.
Meanwhile, some critics of U.S. housing finance policies argue that the government rewards investment in ever-larger homes in far-flung suburbs, exacerbating sprawl and adding to environmental and social costs.
In 1950, when the residential building boom took off, the average single-family house contained about 1,000 square feet of living space, and the country's outstanding mortgage debt totaled about 15 percent of GDP. Today, new houses have ballooned to an average of 2,500 square feet, and mortgage debt has risen to 101 percent of GDP.
And as houses have gotten bigger, the average U.S. household size has declined to 2.6 persons in 2007 from 3.1 in 1970, according to the Census Bureau.
"Historically, the interesting thing is that homeownership was not always the big thing that it's become," von Hoffman said. "In the last 50 years, we've just built our economy and society on ever more dispersed houses, ever more cars and roads."
David Goldstein, energy program co-director for the Natural Resources Defense Council in San Francisco, has called for "location efficiency" and "energy efficiency" mortgages that incorporate transportation and energy costs in loan repayment calculations.
In a study released by the council in January, high transportation costs due to housing situated far from employment centers led to a significant increase in mortgage default rates. The study showed that homebuyers with the same credit scores, debt-to-income ratios and loan-to-value ratios had very different default rates based on the ease of their commutes.
In Chicago, Goldstein said, every dollar saved in transportation costs allowed a family to spend more than $3 more on mortgage payments, with no higher probability of default.
Others have tried to address what they contend are energy-inefficient "McMansions" by advocating a cap on the size of houses eligible for the tax deduction. In 2007, Democratic Rep. John D. Dingell of Michigan proposed ending the deduction for all houses larger than 3,000 square feet, though his idea went nowhere. Such houses represent roughly 15 percent of the nation's housing stock, according to the realtors association.
Too Much Supply
While they acknowledge the need to stabilize credit markets during the financial crisis, many planners, economists and other experts say they are dismayed that aspects of the government's response may be further subsidizing the housing market and enriching lenders and investors, while delaying an inevitable reckoning.
An example is the first-time homebuyer tax credit that Congress enacted as part of the 2009 stimulus law and then extended into this year.
"What are we doing? We are rewarding the developer community for oversupplying the market relative to demand," said Nelson of the University of Utah. He suggested that an oversupply of houses, coupled with policies promoting ownership, has primed demand beyond sustainable levels.
"The homeownership bias forces more people into buying homes than probably would want to if the supply of rental housing was truly competitive," Nelson said.
Still, Isakson and other supporters of the homebuyer tax credit say declining inventories of houses for sale are an indication that the credit has worked. It has particularly helped, he said, in areas where speculators drove up prices in recent years by buying houses in which they had no intention of living. The most significant price declines have come in states such as Florida, where in some places as many as half of all properties were purchased by speculators.
But the credit, which goes only to buyers who plan to live in their homes, has helped stabilize the market, said Isakson. "It was designed to absorb some of the inventory that was out there and bring back some legitimate buyers to the market to balance out the draconian amount of foreclosures and short sales," he said. "I think it's been proven to have done that."
Meanwhile, federal efforts to prop up housing finance have benefited banks and investors in mortgage-backed securities, but loan workout programs for homeowners in danger of foreclosure have largely failed to help those who owe more than their houses are worth.
Efforts such as the Obama administration's Home Affordable Modification Program lower payments by stretching out the term of loans but haven't required investors to reduce the amount still owed.
Dean Baker, co-director of the liberal Center for Economic and Policy Research, says this forces homeowners to pay far more than they would in the rental market or to walk away and ruin their credit.
"More than ever, I've really been disgusted with the policy here," Baker said. "We've pursued a policy where the idea is to keep people in their homes, but we have people paying $500 or $1,000 more than they would be renting."
Baker favors a solution that would allow families to rent the homes they are in danger of losing to foreclosure. Others say there simply needs to be much more emphasis generally on policies that help renters.
Tax breaks that favor ownership, including the mortgage interest deduction, were projected to cost $127 billion in forgone revenue in fiscal 2009. Spending for loan guarantees and other housing programs was projected to add $100 billion.
By comparison, federal support for renters, including all of the government's public housing programs for the extremely poor, was expected to cost only about $50 billion.
Even with all of this potential revenue in play and the lessons learned from the housing bubble, Congress isn't likely to back away from its longstanding support for tax breaks. Obama's proposal to cap the mortgage interest deduction has received an unenthusiastic reception from members of both parties on the House Ways and Means Committee.
The deduction "is really foundational in terms of our housing policy in this country, and particularly in this housing market I think it would be a real setback and not helpful" to cap it, said Illinois Republican Peter Roskam, a member of the panel.
And when Sens. Ron Wyden, an Oregon Democrat, and Judd Gregg, a New Hampshire Republican, unveiled their tax simplification plan last month -- including the repeal of dozens of tax breaks -- the mortgage interest deduction was left intact.
Why? "Political reality," Gregg said.
Wyden warned that "the housing sector is so fragile" that eliminating the deduction might lead to real economic harm.
But, like Barney Frank and the Federal Reserve, many are starting to talk about stepping back from government domination of the mortgage business.
Counting Fannie, Freddie -- which for decades have held the special status of government-sponsored enterprises (GSEs) -- and the FHA, the government now buys or guarantees about 85 percent of residential mortgages, according to the research publication Inside Mortgage Finance. Right now, said George Mason's Sanders, government involvement is completely supplanting the private market.
If Fannie, Freddie and the Fed stopped buying mortgage debt, "we would probably see the banks stepping in and making loans again," Sanders said. "It's very similar to a drug addiction problem. As long as the banks know they can unload all the mortgages off on the GSEs, why return to lending and expose themselves to risk?"
Yet even critics concede that there will probably be some federal involvement in lending, if only because of the need for a safety net in emergencies, Seidman said.
At the same time, she insisted, there needs to be equilibrium in federal policies.
"We need to put homeownership back into context," Seidman said. "It is a very valuable element of life, and it can be a really good asset-builder, if it's done well, even for modest-income people. But it's not the solution to everybody's problems."