As the U.S. emerges from the housing crisis, the fundamental architecture of mortgage markets is being decided. Although it is sometimes hard for community developers to think about topics as seemingly abstract as the future of secondary mortgage markets when they have so many pressing matters to deal with, few other issues will have so profound an effect on housing and neighborhoods.
The latest proposal is the Johnson-Crapo bill, whose sponsors are the leaders of the Senate Banking Committee. Fundamentally, the bill resembles many earlier proposals, including last year’s Corker-Warner bill and several by groups like the Bipartisan Policy Center and the Center for American Progress, as well as one by Moody’s, the Milken Institute, and the Urban Institute. While there are some important distinctions between these plans—including some improvements in Johnson-Crapo in terms of funding for affordable housing—they start with a common premise: a goal of relying primarily on private risk capital to fund mortgages and minimizing the role of the public sector in the funding process. Some plans suggest that a strong regulatory system is needed to accompany the greater role of private capital, but they rarely acknowledge that vigorous regulations may be hard to maintain over the long run.
Fundamentally, most proposals rely on some sort of “enhanced” system of private-label securitization, with government providing a form of secondary insurance to a system dominated by Wall Street-based issuers of private mortgage-backed securities. (Remember these? They were the primary source of funding for subprime mortgages.) These securities would be insured, or rely on another form of enhancement that reduced risks to the investors. The firms providing the insurance would be funded first with private capital, but would have access to some form of “catastrophic” federal insurance, similar to what the FDIC provides for bank failures. This Federal Mortgage Insurance Corporation, as it is called in the Johnson-Crapo bill, would also be charged with regulating the bond insurers and other parties involved in the system, although how strong and transparent such regulation would be is highly uncertain.
Many inside-the-beltway think tanks and advocacy groups appear to support Johnson-Crapo, in part because the bill calls for some modest funding streams for affordable housing and community development. There has been remarkably little dissension on this general architecture coming from progressive groups. In fact, the major opposition has been from the libertarian right, led by House Republican Jeb Henserling, who last year introduced the PATH Act, which called for completely privatized financing via essentially unregulated private-label securitization, accompanied by a severe cutback of the Federal Housing Administration. Supporters of the PATH Act are particularly cynical because while they argue for the primacy of private finance markets, which rely on regulation, they are also working to gut the 2010 Dodd-Frank Act and the Consumer Financial Protection Bureau. This would leave the nation’s mortgage market dominated by private mortgage-backed securities without any regulatory capacity to rein in reckless behavior.
The questionable long-term robustness of Dodd-Frank, stronger securities regulation, and the CFPB should lead us to question a housing finance architecture that provides for a small federal role in the mortgage market. With limited—and likely diminishing—regulatory power, is it reasonable to assume that the FMIC will actually be able to control the risk in what will primarily be a system of private, Wall Street-dominated secondary markets? Will bond insurers and securities issuers lobby for weak regulation while they benefit from federal insurance? Will they, as banks do with the FDIC, lobby for lower insurance rates during good times, only later to need a bailout when excessive risk brings the system down? Might a system dominated by private issuers lead to a more highly segmented mortgage market where wealthier borrowers receive low-cost, long-term, fixed-rate mortgages, while less affluent homeowners and communities are served more by lenders specializing in higher-cost, often adjustable-rate, riskier products? These are questions that need to be answered by supporters of the dominant proposals.
From a progressive perspective, the basic architecture proposed in Johnson-Crapo relies too heavily on vigorous regulation, despite the fact that the Dodd-Frank and the CFPB are under constant attack. It is too likely that issuers will—at least over time—take the bulk of the gains while still benefitting from downside protection via federal insurance. Thus, right-wing opponents like Henserling argue for a system in which the private sector takes all of the gains but also accepting the full losses. We have seen, however, that this is naïve. The housing market is too big—and intertwined with the broader economy—to fail. If it collapses, the federal government will, and should, step in.
A better system would be one where the public sector receives a major share of the upside when times are good, recognizing that the public sector will have to step up in the event of crisis. Moreover, more direct federal involvement with more of the moving parts of secondary markets would reduce many of the risks inherent in the labyrinths of private-label securitization. Perhaps the political train has left the station, as housing groups and financial services lobbies seem to have coalesced around a Johnson-Crapo-type system. However, it is important to recognize that this may simply reflect political viability overwhelming good policy.
Some of my community development friends ask me to get real, and they wonder, given the potential inevitability of a Johnson-Crapo system, whether there are things that they should advocate for in such a system. Certainly there are. Community developers will—and should—care about the level of support such bills give to affordable housing and community development. Johnson-Crapo is a modest improvement in this regard over Corker-Warner, and includes more attention to financing of affordable multifamily rental housing. A few additional basis points (of the aggregate securitization insured by the FMIC) devoted to affordable housing or community development could mean hundreds of millions more in funding for lower-income communities. Moreover, advocates should pay attention to the “duty to serve” provisions in all proposals (again, somewhat strengthened in Johnson-Crapo), making sure that issuers and insurers are not able to effectively redline or discriminate among families or communities. Finally, working hard to ensure that the FMIC is as strong a regulator as possible is perhaps the most important task of all.
Like it or not, housing finance markets are much more socially and politically constructed than most other markets. Contrary to some right-wing rhetoric, mortgage market policy is—and has to be—housing policy. They cannot be separated. This is true in all advanced industrialized countries. Housing finance shapes how families are sheltered, their school choices, and a wide set of other opportunity structures. Community developers ignore bills like Johnson-Crapo at their peril, and at the peril of low- and moderate-income communities more broadly.
(Photo by Vijay Gunda CC BY-NC-SA)