The Long Road Backwards: Prelude to Another Housing Meltdown?

Those Who’s are at it again. Pursuant to the Supreme Court’s decision in Collins v. Yellen, which ruled that the requirement that the head of the Executive agency the Federal Housing Finance Agency (FHFA) can only be removed by the President for cause represents a violation of separation of powers, the Biden Administration has moved to terminate Director Mark Calabria. FHFA was the agency created by Congress to oversee Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac in the wake of 2008’s crash of the housing market. One of the agency’s first decisions was to place the GSEs into conservatorship, to ensure that they retained the financial assets necessary to continue to serve as the de facto guarantor for the mortgage market.

Calabria, a former Director of Financial Regulation Studies at the Cato Institute, was a Trump appointee who wished to impose financial responsibility on the GSEs in order to minimize the rate of mortgage defaults. This did not sit well with Biden, who wishes for FHFA to play an active role in making housing affordable for those with the lowest incomes. It seems as if we have been here before, at this poisoned nexus between credibly good intentions and discreditably ignoring predictable outcomes. This is shades of 2002 McCulley and Krugman, calling for a housing bubble to artificially bolster an artificially dampened economy.  There are times I believe that those who fail to learn from history are doomed to become policymakers.

There are those, such as Duke’s Manuel Adelino, who point out that subprime mortgages didn’t cause the crash, and they would be correct. The percentage of subprime defaults among the morass of toxic assets wasn’t enough to bring the house of cards a-tumblin’ down. The majority of those defaulting assets were owned by mid-to-higher income buyers, many of whom purchased homes for speculative purposes. This bears acknowledgment, but we simply cannot disregard the subprime market as a proximate cause. Private mortgage securitization was largely the result of the expansion of risky mortgages, as the inherent risk in such instruments came with the promise of higher yields. In this case, securitization also allowed financial institutions to play fast and loose with capital reserve requirements, encouraging profligacy by everyone involved, including the GSEs tasked with acting as a backstop against such behavior via their own, ostensibly safer, mortgage-backed securities.

I can agree with the Constitutional reasons behind the Court’s ruling while being given pause by the reasons behind Mr. Calabria’s firing. Taking the shackles, so to speak, off FHFA will simply allow policy pressures to be exerted upon Fannie Mae and Freddie Mac that result in baggage and bailouts. Prior to the housing bubble, Fannie Mae’s annual losses averaged around 4 basis points. During the crises, those annual losses averaged 52 basis points. That is simply not acceptable for an institution designed to inject stability into the market. The duty of FHFA regulated GSEs should be, as publicly traded institutions, to their shareholders, and not the policy wishes of any given President.

Of course, in a truly free and liberal society, how we handle the least among us says much about our health moving forward. There are any number of ways to encourage the availability of homeownership to those of lowest income without allowing public policy to hijack the market in potentially disastrous fashion:

1. Encourage states to loosen occupational licensing requirements: The major deterrent to homeownership for the poor is the lack of income needed to properly qualify for non-subprime mortgages. For many workers who don’t possess high-paying skillsets, entrepreneurship is the best path to raising their income level. Occupational licensing laws serve as an unnecessary barrier to entry, creating a ceiling to upward mobility. I am entirely in favor of, say, the barber industry creating their own internal standards and certifications to assess practitioner skill and quality. I don’t see the need for barbers to be licensed.
2. End the Drug War: The job prospects of individuals with prison records is severely limited. This creates poverty that is often intergenerational in scope. Nonviolent drug offenses should simply not be a barrier to upward mobility. This paradigm becomes increasingly harder for policymakers to justify as in increasing number of state legislatures are not only legalizing marijuana but collecting taxes and getting into the dispensary business themselves. Drug prohibition benefits no one except those whose income is derived from creating criminals. It’s time for this paradigm to end.
3. Let the market market: There are any number of nonprofits and private organizations, such as the Neighborhood Assistance Corporation of America (NACA) which exist solely to extend the possibility of homeownership to low-income Americans. These organizations generally also provide financial counseling, credit repair, and other similar services that assist their clients in improving their financial health beyond purchasing a home.
4. Provide tax incentives for rent-to-own programs: I am generally in favor of lowering taxes for any reason, and this would benefit both landlord and renter. Allowing a portion, or even all, of the amount of rent received as part of a rent-to-own contract to be written off would potentially incentivize owners of rental houses to engage in more of such contracts. Additionally, allowing a tax break for improvements made by renters engaged in such a living arrangement would both lower their tax bill and increase the value of the property once they have taken ownership. As an additional caveat to mitigate predatory landlords, if they fail, without cause, to execute the contract allowing the renter to purchase the home, they might be made subject to penalties covering both the tax breaks they received, and the improvements made by the tenant.

Ultimately, the purpose of securitization is to spread and mitigate risk, and if government owned mortgage guarantors are to exist, they must operate solely within the parameters of this purpose. As fairly recent history has demonstrated, when Freddie and Fannie act irresponsibly, it provides a signal to market actors that the government approves of irresponsible securitizations, insurance schemes and risk, and will bail out bad actors. We simply cannot afford to travel this long road backwards.