Federal agencies generate hundreds if not thousands of press releases every year. Some of these are important and others irrelevant. One of these news items, however, should be of particular concern for mortgage originators and other industry professionals.
On Aug. 18, 2021, the Federal Housing Finance Agency (FHFA) filed a news release outlining the proposed housing goals for Fannie Mae and Freddie Mac from 2022 through 2024. This communication outlined a proposal to increase the benchmark levels for the share of loans that the government-sponsored enterprises (GSEs) purchase that are designed for low-income or very low-income borrowers. It also added new goals to purchase loans in census tracts with a predominance of minority or low-income residents.
These well-meaning goals could lead to calamitous results. The seeds of the Great Recession were sown in 1994 when President Bill Clinton directed HUD Secretary Henry G. Cisneros to expand homeownership.
This was prefaced in June 2021 when President Joe Biden announced that he was firing FHFA director Mark Calabria, who had developed a detailed plan to sufficiently capitalize the GSEs so that they would not depend on another U.S. Treasury bailout. Why should this be a concern for mortgage originators? Because it feels all too similar to something that has happened before.
On Sept. 6, 2008, Fannie Mae and Freddie Mac were deemed insolvent and taken into conservatorship by the federal government. One cause of this action, which often goes overlooked, is that U.S. Department of Housing and Urban Development (HUD) had mandated that the GSEs make more loans to low- and very low-income families. This is precisely what HUD’s successor, the FHFA, has proposed.
Because of its disastrous role in mandating that the GSEs ease their lending standards, HUD’s regulation of Fannie and Freddie ended, and the task was given to FHFA. Its recent proposal increases the share of single-family home loans the GSEs need to make to low-income families from 24% to 28% and the percentage of loans for very low-income families from 6% to 7%.
In addition, Fannie and Freddie were assigned two new goals. One involves census tracts where the population is at least 30% minority while the other is tied to census tracts that are deemed low income. The GSEs are to purchase 10% of their loans in minority census tracts and 4% in low-income tracts. This was in keeping with Biden administration policy and did not get a lot of media attention.
Many government programs have good intentions but also have serious unintended consequences. What happened in 2008 — and what FHFA may be repeating — is one of these unintended consequences.
These well-meaning goals could lead to calamitous results. The seeds of the Great Recession were sown in 1994 when President Bill Clinton directed HUD Secretary Henry G. Cisneros to expand homeownership “to ensure that families currently underrepresented among homeowners — particularly minority families, young families and low-income families — can partake of the American dream.”
In response, HUD formulated the National Homeownership Strategy, which stated the following: “For many potential homebuyers, the lack of cash available to accumulate the required downpayment and closing costs is the major impediment to purchasing a home.” Other households do not have sufficient available income to make the monthly payments on mortgages financed at market interest rates for standard loan terms. Financing strategies, fueled by the creativity and resources of the private and public sectors, should address both of these financial barriers to homeownership.”
In retrospect, these words are incredible — literally asking for loans to be made to people who do not have sufficient available income to make the monthly payments. After Cisneros resigned, Andrew Cuomo (the now disgraced former governor of New York) took over.
During the Cuomo years, mortgage industry officials and housing advocates wanted Fannie Mae and Freddie Mac to purchase higher volumes of riskier loans that were offered to less-creditworthy borrowers. Cuomo’s HUD continued to pressure the agencies to increase the portion of their portfolios consisting of loans to moderate-income borrowers.
In 1999, under Cuomo’s direction, HUD mandated that Fannie and Freddie purchase 50% of their mortgages to benefit low- and moderate-income families. Cuomo applied pressure by having HUD publicly investigate whether the agencies were sufficiently in compliance with the government’s fair-lending standards designed to prevent discrimination.
This disaster had bipartisan support. By 2007, under President George W. Bush’s administration, Fannie and Freddie were required by HUD to show that 55% of their mortgage purchases involved loans made to borrowers with low to moderate income. Moreover, 38% of all purchases had to be from underserved areas, usually in inner cities, while 25% had to be loans made to low-income and very low-income borrowers.
HUD’s mandate that Fannie and Freddie serve a broader set of borrowers ignored the fact that another government agency — the Federal Housing Administration (FHA) — already served borrowers who didn’t qualify for agency loans. FHA had a tested system for underwriting these loans and charging credit-insurance fees commensurate with risk.
Rather than admit that the HUD policy forcing Fannie and Freddie to reduce their lending standards was the cause of these agencies becoming insolvent, the Financial Crisis Inquiry Commission was formed. This body stated that the 2008 crisis was caused by lax regulation, greed on Wall Street and faulty risk management at banks.
The government has been continuously disingenuous about the root cause of the mortgage mess and the Great Recession. One argument is that bureaucracy preserves itself by blaming others for its mistakes. A book that makes a compelling argument about HUD’s role is Peter J. Wallison’s “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again.”
In February 2021, an article in the National Review warned that the Biden administration might make the same policy mistake as Clinton’s. FHFA’s policy change in August 2021 could prove to be the first step toward another government-initiated mortgage disaster. If FHFA stopped with this recent proposal, disaster would not likely ensue. If, however, political capital is the basis for decisionmaking, then the debacle of 2008 may be repeated.
It was not the intention of HUD to destroy Fannie and Freddie, nor is it the intention of FHFA to repeat this episode. Many government programs have good intentions but also have serious unintended consequences. What happened in 2008 — and what FHFA may be repeating — is one of these unintended consequences.
The goal of having low- and middle-income people own homes is excellent, but forcing the GSEs to reduce their underwriting standards destroyed the agencies in 2008. It also resulted in people being encouraged to take out loans that they could not afford. Everyone suffered.
Since there have been steady arguments about whether Fannie and Freddie or private securitization were mainly responsible for the mortgage mess, it would do well to look at some numbers. Losses on loans held by Fannie, Freddie and the FHA totaled some $206 billion. Losses for banks and thrifts were about $217 billion.
Although government-backed and privately held losses were comparable, there was one significant difference. Fannie and Freddie had about $70 billion in shareholder equity while private banks had $1.3 trillion. Although some banks were insolvent, the banking system as a whole was not. Failed banks were readily taken over by healthy ones. Fannie and Freddie, on the other hand, were rendered insolvent by the loan losses they suffered as a result of HUD’s mandate. GSE losses were nearly triple their level of equity.
It is unfortunate that the Biden administration has steered away from former FHFA director Calabria’s plan to add capital to the GSEs. This makes the proposal substantially riskier. It appears that the policy is now, “Let’s make more risky loans but not add sufficient capital to cover that risk.”
FHFA’s proposal should be rejected. It would result in the GSEs weakening their lending standards. The proposal undermines the solvency of the GSEs in favor of political capital. If another disaster occurs, it won’t be surprising if the government and the media blame the mortgage industry for doing what FHFA required. ●