Nuts and Dolts: White House Puff Piece On “Housing Reform”

jesterAND THE AWARD GOES TO… [complimentary drum roll here] Jason Furman and James Stock! [Hereinafter collectively referred to as “J&J.”]  Both economists,[1] apparently shilling for the White House, are calling for the dismemberment of Fannie and Freddie, the government sponsored enterprises, or “GSEs,” with something – anything – else.  They have recently co-authored a puff piece [“The Moment is Right for Housing Reform”] that managed to make it onto the Wall Street Journal opinion page, mercifully “below the fold.”

Both gentlemen appear to have all the right credentials to be comfortably ensconced in the ivory towers of Ivy League academia.  But for all their whiz-bang credentials in economics and statistics [here], one would think this article would contain a little more meat and a little less mush. In fact, the article is so packed with political pablum it ought to carry a warning against reading it without first putting on a bib.  The piece appears to be directed to those folks in the audience who nod knowingly, but know nothing. In other words, J&J’s intent is not to inform, but to influence. To its credit, the article appears to comply with the federal mandates set forth in the “No Idiot Left Behind” learning program for useless information.  Congratulations guys!

Here’s a sampling of what I’m talking about:

QuoteIn the run-up to the Great Recession, Fannie Mae FNMA -3.76% and Freddie MacFMCC -2.26% took on large amounts of risky mortgage debt that resulted in large losses when housing prices collapsed and defaults rose. To stem the spillovers that their failure would have on the economy, the Treasury ultimately put nearly $190 billion into these two government-sponsored enterprises to keep them afloat. They are now in a conservatorship overseen by their regulator, the Federal Housing Finance Agency.

Fact:  Actually, during “…the run-up to the Great Recession…” it was the government’s own policy that mandated Fannie and Freddie’s venture into the subprime market.

Exhibit A: The Community Reinvestment Act (CRA), which required lenders to serve the needs of the “entire” community.  The result was that in 1995:

…the regulators created new rules that sought to establish objective criteria for determining whether a bank was meeting CRA standards. Examiners no longer had the discretion they once had. For banks, simply proving that they were looking for qualified buyers wasn’t enough. Banks now had to show that they had actually made a requisite number of loans to low- and moderate-income (LMI) borrowers. The new regulations also required the use of “innovative or flexible” lending practices to address credit needs of LMI borrowers and neighborhoods. Thus, a law that was originally intended to encourage banks to use safe and sound practices in lending now required them to be “innovative” and “flexible.” In other words, it called for the relaxation of lending standards, and it was the bank regulators who were expected to enforce these relaxed standards. The other is the affordable housing “mission” that the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were charged with fulfilling. [See, 2009 article: The True Origins of This Financial Crisis”]

Exhibit B:  In 1992, the charters of Fannie and Freddie, were changed to include an “affordable housing” mission. [See, 2009 article: The True Origins of This Financial Crisis”]

A 1997 Urban Institute report found that local and regional lenders seemed more willing than the GSEs to serve creditworthy low- to moderate-income and minority applicants. After this, Fannie and Freddie modified their automated underwriting systems to accept loans with characteristics that they had previously rejected. This opened the way for large numbers of nontraditional and sub-prime mortgages. These did not necessarily come from traditional banks, lending under the CRA, but from lenders like Countrywide Financial, the nation’s largest sub-prime and nontraditional mortgage lender and a firm that would become infamous for consistently pushing the envelope on acceptable underwriting standards.


By 1997, Fannie was offering a 97 percent loan-to-value mortgage. By 2001, it was offering mortgages with no down payment at all. By 2007, Fannie and Freddie were required to show that 55 percent of their mortgage purchases were LMI loans and, within that goal, 38 percent of all purchases were to come from underserved areas (usually inner cities) and 25 percent were to be loans to low-income and very-low-income borrowers. Meeting these goals almost certainly required Fannie and Freddie to purchase loans with low down payments and other deficiencies that would mark them as sub-prime or Alt-A. [See, 2009 article: The True Origins of This Financial Crisis”]

Riddle Me This:  Where in the J&J article do they mention that Fannie and Freddie were politically force-fed risky loans? They don’t.  Instead, these two brainiacs ignore the fact that their own employer, the White House, along with other Beltway lemmings, encouraged, cajoled, and persuaded the GSEs to hold their nose and purchase loans from the Rogue’s Gallery of subprime mortgage mills such as Countrywide, WAMU, Long Beach Mortgage, Ameriquest, and a host of others.[2]  Now they suggest that the federal government should get back to being involved in regulating mortgage lending and secondary markets?  Guys, where were you when Obamacare was being rolled out? 

Quote: …further progress will best be advanced by moving beyond what is, in effect, a government-supported duopoly. Today, Fannie and Freddie, supported by U.S. taxpayers, guarantee payments to investors in mortgage-backed securities covering approximately 60% of mortgages. The size of these two giants, and their uncertain future, deter private firms from making the large, long-term investments needed to promote a vibrant, competitive market.

The dominance of Fannie and Freddie in the secondary mortgage market also stifles innovation and puts homeowners, communities and taxpayers at risk for future housing downturns, and is not making transparent sustained contributions to affordable housing. Although there are indications of pent-up demand for homes, uncertainty, including regulatory uncertainty, is placing unnecessary restraints on lending by banks and other mortgage originators. Creditworthy borrowers are being limited in their ability to buy homes, thereby creating fewer jobs and slowing economic growth. To support the recovery and set a firm foundation for the future, now is the time for reform.

Fact: The federal government took over the GSEs in 2008, when the entire financial system nearly collapsed.  They did so because they had no choice.  The private label secondary market [i.e. the investment houses that – aided and abetted by their shills, the ratings agencies – purchased, packaged and pimped subprime and Alt-A loans to hungry institutional investors chasing higher returns] had collapsed.  There was no viable secondary market for conventional loans besides Fannie and Freddie.  If the GSEs disappeared, almost all conventional lending would have ceased [except for credit unions or lenders who retained loans for their own portfolio.]

It’s true that the GSEs needed billions to stay afloat after that. And yes, taxpayer money was used. Again, there was no choice. Fannie and Freddie were, indeed, too big to fail. They received $187 billion in bailout funds.  As of today, they have paid the American taxpayers $192 billion in dividends. [Source: CNN Money, here.]  Hmmm. Where can we find this information in the J&J article?  Wouldn’t this lend a little balance to the article?  J&J make it sound as if Fannie and Freddie caused the housing and credit markets to collapse.  They didn’t, but they were collateral damage, just like Bear Stearns, Lehman Bros, and others.  But don’t waste your time looking for balance. It ain’t there. In fact, this entire piece contains not a single citation, reference, or authoritative third party source to support its conclusions about how great “housing reform” would be.  Like so much that comes from this administration, it contains a not-so-subtle blend of misinformation and fear-mongering.

Fact:  First, Fannie and Freddie are not a “duopoly” – which is fancy work for two monopolies at the same time. Secondly, it is not the GSEs that are in danger today.  Third, while there is “regulatory uncertainty,”  it has less to do with the future of the GSEs, and more to do with the Consumer Finance Protection Bureau’s (“CFPB”) wholesale intrusion into the mortgage and credit markets has caused originating lenders [not secondary market participants] to pull in their horns.

According to the government’s own statistics from HUD [FHA Business Trends – here], commencing in 2008, when the financial crisis hit Wall Street,[3] the FHA began to take on a disproportionate share of secondary market mortgage purchases. According to HUD, it rose from 3.9% in 2007, and ranged between 20% and 32% in the succeeding years to 2012. Only in the first quarter of 2012, did it drop below 20%.  The effect was that FHA, perhaps to its detriment today, took the place of the private label secondary market for subprime loans.  Thus, while housing loans through conventional lenders witnessed a raising of the credit bar, the slack was taken up by FHA, which lowered theirs. The result, unfortunately, is not that the GSEs are financially unstable, but now FHA is.  This is where the focus should be.

As I mentioned above, Fannie and Freddie are actually printing money today.  Why do J&J want to kill the golden goose?  I’ll tell you why; because in the rarified atmosphere of academia, there is always a better way, and By Golly, these economists are the smartest guys in the room. We can’t actually expect them to [ugh!] teach about economic theory and Smith, Keynes, Marx, and Friedman, etc. That would mean they would have to [gasp!] correct papers. Noooo!  That’s what teaching assistants are for!  J&J are far too important to the stability of our nation’s housing market to be back in the classroom.

Perhaps what J&J don’t grasp – actually I take that back – they choose not to grasp – is that it has been the government’s post-crisis hyper-regulation that has caused much of the current uncertainty in the lending markets today.  The regulators and bureaucrats at the CFPB have created some new legal concepts – the “Qualified Mortgage; and new rules – the Ability to Pay Rule.” Together, lenders, especially small lenders, who can ill-afford to hire staff just to read, understand, and explain the new laws, have become fearful of massive regulatory liability if they make a mistake.  This is exacerbated by the unintended consequences of these new laws that the regulators – who never actually succeeded in the private industry they seek to regulate – created without any insight into the long-range consequences.[4]   Together, the smaller lenders have become afraid of their shadow. No wonder there is “regulatory uncertainty” in the lending market.

Lastly, here are a few snippets from the article consisting of time-worn clichés, psychobabble, and non sequiturs, that I cannot resist addressing.  Notice the persistent use of the word ‘should’ when describing the results of their yet-to-be-detailed program that seeks to summarily walk the GSEs off the gangplank for crimes they did not commit.  The word ‘should’ is “government-speak” which gives the authors plausible deniability, so when it doesn’t happen, they can retort: “We didn’t say it would happen. We said “should.” These were just aspirational goals.”

The reformed housing-finance system should enable the dreams of middle-class and aspiring middle-class Americans to own homes by supporting consumer-friendly mortgage products such as the 30-year fixed-rate mortgage.

Comment: Guys, no one disagrees with this! Everyone loves 30-year loans.  The goal isn’t in question. But do you have to dismantle the entire business model and infrastructure of the GSEs?  Remember, they were once privately held corporations, and were hugely successful, until the Franklin Raines era.[5] Shortly after that came the subprime crisis, which caused the GSEs further damage. But there is no reason to believe they cannot become private stock holding companies again.

It should provide help, through narrow and focused programs, to creditworthy first-time borrowers who might otherwise have trouble qualifying for a mortgage; and it should stimulate broad access to mortgages for historically underserved communities.

Comment: Again, no one disagrees. Enough with the pablum. Specifics! We want specifics!  Right now the GSEs “ain’t broke.” Figure out what, if anything, needs to be fixed – then write an article.

Housing has long been one of the most volatile sectors of the economy, and that volatility spills over into other sectors—with all Americans, but especially the most vulnerable and disadvantaged, bearing the brunt of housing-related or magnified recessions.

Comment: I’ve practiced real estate law for 40+ years.  I disagree. I was there; firsthand. Before the Great Recession, the only other crash affecting real estate was in 1979 – 80+. And the cause was not housing or mortgages.  It was the Fed, who jacked up interest rates to 18%+ to fight inflation – primarily in energy, wages and prices.  You don’t sell many homes using 18% mortgages.  It’s true that real estate and finance were hurt, but those industries did not cause the “volatility” J&J refer to, and to my knowledge, none has since.[6] 

Housing-finance reform is a key unfinished piece of business from the financial crisis, and putting all the parts together is a complex undertaking. But the current period of relative economic calm is exactly the right time to do so.

Comment: Great! Just Great! As we experience the most underwhelming, tepid and tentative recovery following any recession, let’s stir up the pot to see if we can’t create more regulations, more bureaucracies, and more power in Washington.  What’s wrong with a little “relative economic calm” for awhile?  

Conclusion: To be clear: My objection to the J&J faux “news article” is that it is nothing of the sort. It is the White House – using a couple of finger puppets – saying to the American public that “We need Housing Reform – We don’t particularly care what it looks like, as long as we get to keep our finger in the pie. And let’s blame it on Fannie and Freddie, they’re an easy target,”  This is what happened with Dodd-Frank and the CFPB.  Once the bureaucracy is created, it’s too late to turn back.

Yes, we want to decouple the GSEs from government ownership. Yes, it would be nice if a private, “first loss” model could be created in the private market. Yes, there still is a place for the government in housing; it’s called the FHA, the VA, and USDA. They can and should fulfill the affordable housing mandate – assume they can do so without requiring another taxpayer bailout. But can you imagine the damage in the process of completely eliminating the GSEs, without creating a viable non-government substitute?  Even Fannie and Freddie, who appear to be writing their own obituaries, are fearful of the process on the drawing board.  

But with the GSEs, the government’s role should be to secure a seamless transition to the private market, perhaps as it existed before the Franklin Raines leadership. The trick is to decide whether there will or will not be a government backstop.  The problem in the past was that investors always assumed that the government provided an “implicit guarantee” to their purchases.  As it turns out, they were right.  The next time around, the answer should be either “yes” or “no.” Quoting The Economist:

Under the new plan, downpayments of as little as 3.5% of the loan value would be permitted. Strewn through the proposed law are words such as “affordable”, “equal access” and “underserved communities”, which suggest that lending decisions will be based on political rather than credit criteria. “The result”, says Edward Pinto of the American Enterprise Institute, a think-tank, “will be risky lending for those least able to cope.”

The underlying problem with the new plan is that, like Fannie and Freddie before it, it tries to reconcile two conflicting goals: protecting the financial system and providing low-cost housing loans to favoured groups. A better approach would be to handle these goals separately and explicitly.

Whether there can ever be a purely “private label” secondary market remains to be seen. Perhaps it would be good for competition, but the question remains whether large investment houses can ever be trusted to securitize residential mortgages loans again.

But it is the height of arrogance to believe that the GSEs need to be entirely dismantled so that we can start all over again.  [See, discussion here.] We know where that will lead; as the government tears down Fannie and Freddie, it will insinuate its way back into what replaces them.  One has to wonder if the 2008/9 financial crisis would have even occurred, i.e. the rampant lending, non-existent underwriting, sloppy securitizations, bogus ratings, and so on, if the Federal Reserve, the Comptroller of the Currency, the Department of Treasury, the Securities and Exchange Commission, and the U.S. Commodities Futures Trading Commission – to name a few – had been doing their job.

The last thing we need is more regulations and regulators. As the history of virtually every financial crisis in the U.S. reminds us, the problem was never a lack of regulationsit was a failure to regulate.[7]

[1] Question: How do you know there’s an economists’ convention in town? Answer:  The hookers take the week off.

[2] Mr. Stock’s bio, states that as a member of the Council of Economic Advisers he “…is responsible for offering the President objective advice on the formulation of economic policy.”  Hmm. Let’s hope his boss doesn’t read this article.  So far, it isn’t overflowing with objectivity. I take that back; the president isn’t really into specifics, unless it’s his golf score. Perhaps one of his speechwriters actually penned this puff piece!

[3] The initial cracks in the private secondary market actually began to occur in late summer, 2007. The reason?  The ratings agencies decided to come clean and admit what they’d been paid to ignore: The packages of subprime loans they’d been rating as spun gold, were actually just straw.  They were not institutional-grade bonds – they were junk, made to appear attractive, like lipstick on pigs. The major three agencies all made mass downgrades in the bonds that investors had purchased in reliance on the ratings. The result was that the private secondary market stopped purchasing the junk, and lenders were left holding the toxic loans. See, discussion here.

[4] The best example is the fact that the new “QM” rules are resulting in lenders, who follow the guidelines and stay “within the box,” are now at risk of being sued by class action lawyers who argue that the banks are guilty of discrimination by “disparate impact.”  But that’s a whole ‘nuther issue.

[5] Here is how the pre-crisis GSEs worked: “The GSEs then provided guarantees of principal and interest payments on these MBS, and markets generally assumed that taxpayers would pick up the tab if the GSEs got into trouble. If only a handful of mortgages backing a Fannie Mae MBS defaulted, Fannie covered investors’ losses out of its own profits. On mortgages that had down payments of at least 20 percent, Fannie covered all the losses. For those home loans with less than a 20 percent down payment, however, the GSEs required private mortgage insurance (PMI). PMI companies, in turn, were typically private insurance companies. In other words, any mortgage with less than 20 percent down in a GSE-issued MBS had at least two sources of private capital to cover losses. The PMI company insured a portion of any mortgage default costs, and the GSEs covered losses not covered by the PMI companies. As long as losses remained “normal” and there was no massive shock to the system, taxpayers were never on the hook for any of these losses.” [Source: The Heritage Foundation]

[6] I am intentionally ignoring the S&L crisis of 1980-82, since that debacle was caused not by the housing industry, or conventional lenders. Rather, it was deregulation and lax oversight of the savings and loan industry by the Federal Home Loan Bank Board (FHLBB), and risky investments by S&Ls. [Source:]

[7] Extra Credit Reading!