Housing, Housing Finance, and Public Policy

1
Housing, Housing Finance, and Public Policy

• Lawrence J. White
• Stern School of Business
• New York University
• Lwhite_at_stern.nyu.edu
• Presentation at the Hudson Institutes discussion
  on Where Did the Risk Go?, Washington, DC, May
  3, 2007

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Summary

• Housing and home ownership
• Overview of residential mortgage finance
• Sub-prime lending
• Over-arching questions
• Conclusion

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Housing and home ownership
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Housing policy

• Widespread subsidy of housing consumption
• Income tax deductions and exemptions
• Tax breaks and subsidies for rental
• GSEs (Fannie Mae, Freddie Mac, FHLBs)
• FHA, VA, Ginnie Mae
• Direct provision (public housing)
• Too much is never enough!

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Home ownership

• Encouraging home ownership is a major goal of
  housing policy
• There are genuine positive externalities from
  home ownership
• But home ownership is not for everyone
• Rental subsidies do not encourage home ownership

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Housing policy consequences

• Much of the subsidy encourages larger, better
  appointed homes on larger lots, second homes,
  etc.
• The U.S. invests too much in housing and not
  enough in other productive assets
• The tax advantages mostly benefit higher income
  households
• Housing policy is not especially well focused on
  encouraging greater home ownership

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Overview of Residential Mortgage Finance
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The components of residential mortgage finance

• Originate mortgages
• Service mortgages
• Collect the savings for funding the mortgages
• Issue deposits or liabilities to funders
• Guarantee deposits or liabilities

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Traditional portfolio lender vs. securitization
summary

• Traditional portfolio lender
• Vertically integrated (bundled) components, by
  banks thrifts
• Securitization
• Vertically dis-integrated (unbundled) components,
  by a wider variety of specialized parties

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Traditional portfolio lender vs. securitization
(1)

• Originate mortgages
• Trad Thrifts banks
• Sec Thrifts banks mortgage banks
• Service mortgages
• Trad Thrifts banks
• Sec Thrifts banks mortgage banks

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Traditional portfolio lender vs. securitization
(2)

• Collect savings for funding mortgages
• Trad Thrifts banks
• Sec Thrifts banks insurance cos. pension
  funds mutual funds hedge funds
• Issue deposits or liabilities to funders
• Trad Thrifts banks
• Sec Thrifts banks Fannie Mae Freddie Mac
  Ginnie Mae private label issuers

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Traditional portfolio lender vs. securitization
(3)

• Guarantee deposits or liabilities
• Trad FDIC (FSLIC)
• Sec Ginnie Mae Fannie Mae (?) Freddie Mac
  (?) FHLBs (?) private label senior/sub
  structures

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An extra element

• In the 1990s (and through 2003) Fannie Mae and
  Freddie Mac greatly expanded their portfolio
  holdings of residential mortgages

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FFs recent growth

• Residential Mortgages and MBS
• Fannie Freddie Tot Mkt
• Year Mtgs MBS Mtgs MBS
• 1980 56B 0 5 17 1,100
• 1990 114 288 22 316 2,903
• 2000 608 707 385 576 5,514
• 2002 821 1,040 590 730 6,856
• 2003 920 1,301 661 752
  7,725
• 2004 925 1,408 665 852 8,847
• 2005 727 1,598 710 974
  10,046
• 2006 724 1,784 701 1,123 10,921

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The forces driving securitization

• Efficiencies of the MBS process
• The revolution in data processing and
  transmission
• Differential capital requirements
• Banks and thrifts need 4 capital to hold a
  mortgage, but only 1.6 capital to hold MBS
• Aggressive portfolio growth by Fannie and Freddie
  since 1990
• Advantageous funding costs
• Freddie went fully public in 1989
• Differential capital requirements Fannie
  Freddie need 2.5 capital to hold a mortgage
  specialist thrifts are constrained by the 5
  leverage requirement

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The pluses and minuses of securitization

• Securitization provides access to more sources
  of funding, allows more parties to invest in
  residential mortgages diversification
• Securitization allows more customization of risk
• But securitization (because of the vertical
  unbundling) increases the problems of asymmetric
  information

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Sub-prime lending
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The expansion of sub-prime lending

• Partly due to the revolution in data processing
  and transmission
• Partly due to expanded securitization
• Partly due to pursuit of the American dream
• Partly due to the recent history of rising home
  prices

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The debacle in sub-prime lending

• Partly due to excessive optimism about rising
  home prices
• Partly due to securitization (asymmetric
  information, moral hazard)
• Partly due to poor borrower information

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A new focus for public attention sympathy

• The focus is on the borrowers, not on the lenders
• Because of securitization, lender losses will be
  wide but not especially deep
• In foreclosures, borrowers lose downpayments
  transactions costs credit reputation

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Overarching questions
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Housing (1)

• To what extent should home ownership be
  subsidized?
• What are the best ways of subsidizing home
  ownership?
• Beyond encouraging homeownership, should housing
  consumption itself be subsidized?
• Is too much is never enough a sensible policy
  standard?

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Housing (2)

• How can the transactions costs of house
  buying/selling be reduced?
• What to do about RESPA?
• What to do about real estate brokerage?

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Housing finance (1)

• With mortgage securitization now a well-developed
  technology and with mortgage finance now a
  national market, is there still a need for the
  special status of Fannie Freddie the FHLBs?
• With commercial banks now as the dominant
  portfolio lenders, to what extent does deposit
  insurance subsidize banks mortgage lending (any
  more than it subsidizes banks other loans)?

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Housing finance (2)

• Are the large portfolios of Fannie Freddie a
  potential systemic problem?
• How necessary are these large portfolios to their
  efficient operation?
• Is the 30-year fixed rate mortgage a necessary
  fixture in American mortgage markets?
• Does all of the prepayment risk have to be borne
  by lenders (i.e., no prepayment fees)?

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Housing finance (3)

• What can/should be done for current borrowers in
  distress?
• What should be done in sub-prime for the future?
• Should there be a suitability requirement placed
  on originators?
• How deep into the unbundled chain should
  responsibility be placed?
• Is there a role for greater education of
  borrowers?

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Conclusion

• Housing and housing finance issues are important
• They are likely to be with us for a long time