Housing Finance Reform: Access and Affordability in Focus

October 26, 2016

By Counselor Antonio Weiss and Assistant Secretary for Economic Policy Karen Dynan

Access to affordable housing serves as a cornerstone of economic security for millions of Americans. The purchase of a home is the largest and most significant financial transaction in the lives of many households. Access to credit and affordable rental housing defines when young adults start their own households and gives growing families options in choosing the quality and location of their homes. Homeownership can be an opportunity to build wealth, placing a college education within reach and helping older Americans attain a secure retirement. Whether they are aware of it or not, some of the most momentous decisions American families make are shaped by how the housing finance system serves them.

Financial reform has sought to reorient financial institutions to their core mission of supporting the real economy. The great unfinished business of financial reform is refocusing the housing finance system toward better meeting the needs of American families. How policymakers address this challenge will be the critical test for any model for housing finance reform. The most fundamental question any future system must answer is this: Are we providing more American households with greater and more sustainable access to affordable homes to rent or own? It is through this lens that we will assess the performance of the current marketplace and evaluate a set of policy considerations for addressing access and affordability in a future system.

The impact of the financial crisis on current borrower access to mortgage credit is evident. Today, the credit score of the typical new mortgage borrower is nearly 40 points higher than the typical borrower in the early 2000s. The average credit score for those obtaining a loan backed by Fannie Mae and Freddie Mac (collectively, the government sponsored enterprises, or GSEs) in conservatorship is nearly 750. The minimum credit score to qualify for a mortgage at the GSEs is 620, yet only 10 percent of all new mortgages originated across the industry are to borrowers with FICO scores below 665. While creditworthiness is certainly a critically important factor, this credit selectivity is especially sobering given the fact that more than 40 percent of all FICO scores nationally fall below 700. While a variety of factors contribute to these outcomes, it is clear that the GSEs and the secondary market can do more to reach a broader swathe of creditworthy households. Constraints on access to affordable credit have ripple effects across the owner-occupied housing market. When a large number of first time homeowners cannot buy a home, established homeowners may face a harder time relocating or moving up in the market.

Behind these statistics are creditworthy families who have not been able to access the wealth-building opportunity of homeownership or enjoy full mobility. This lack of access is particularly acute for minority and low-income families whose homeownership rates are considerably below the national average. While we believe market structure and incentives can go a long way to ensuring the provision of fair housing to consumers, we also continue to support robust enforcement of fair housing laws to help address vulnerabilities for these groups. According to the Urban Institute, minority groups will make up more than half of net new households formed nationally through 2030. As the demographic landscape of our country evolves, finding ways to provide housing opportunities to traditionally underserved communities, including those with limited English proficiency, will become even more critical.

Tight mortgage conditions also strain the rental housing market, with millions of would-be homeowners remaining renters since 2009 due in part to difficulty accessing a mortgage. Rental housing supply, however, has not responded to this increased demand. Between 2000 and 2013, the number of extremely low-income renter households increased 38 percent from 8.2 to 11.3 million, while the number of available and affordable rental homes increased by only 7 percent from 3 to 3.2 million. Reflecting the tight supply of rental housing, rents have outpaced growth in overall income, disproportionately affecting low-income families. This steady increase in rents limits Americans’ ability to save for retirement and delays potential homeownership.

That is why, in 2013, President Obama stressed that any future housing finance system must provide broad access to affordable mortgages and rents. In particular, the President highlighted the need to preserve and promote broad access to safe financing products like the 30-year fixed rate mortgage. While private capital can and should play an important role bearing the majority of mortgage credit risk, a clearly-defined role for government is critical in ensuring the survival of products like the 30-year fixed rate mortgage.

This need for government support in a reformed market, combined with the billions of dollars already provided to stabilize the existing system, makes every taxpayer a participant in the housing finance system. If we are to ask all Americans to contribute to a more robust and sustainable housing system, we must make sure that the system serves all of them fairly.

While there have been a number of legislative attempts at comprehensive housing finance reform to date, no consensus has emerged. Experts and policymakers continue to work on a range of possible models for a future system. As this important public discourse progresses, we must remain mindful that characteristics of market structure and governance affect the achievement of the broader goals of preserving and promoting broad access to good housing options.

The government has made significant changes to strengthen the housing finance system and support home buying. For example, financial reform legislation added safeguards to the mortgage application process, and lenders must now assess a borrower’s ability to repay a mortgage. Additionally, the GSEs, at the Federal Housing Finance Agency’s (FHFA) direction, have taken steps to support access and affordability, including encouraging broader access to credit by clarifying lenders’ legal obligations for the mortgages they originate, introducing new low down payment mortgage products, and working to comply with refined housing goals.

At Treasury, we have, in the past year, allocated $2 billion in additional funds for foreclosure prevention and neighborhood stabilization through the Hardest Hit Fund, and awarded grants through the Capital Magnet Fund (CMF) to promote $900 million in affordable homeownership and rental opportunities. We have also worked to create broader loss mitigation standards for borrowers who face hardship and are unable to make their monthly mortgage payment as our Home Affordable Modification Program (HAMP) sunsets at the end of 2016, and continued our risk-sharing partnership with the Department of Housing and Urban Development (HUD) to support the financing of multifamily properties. However, these targeted improvements and critical additional funds are not sufficient to address the shortfall. Only comprehensive reform will allow a broader range of Americans, including minority communities and middle-class and working families, to further share in the recovery.

This is the first in a series of issue briefs that will focus largely on the GSEs, though we recognize that the GSEs are just one part of the housing market. In future briefs, we will address the need for a future system to support the broader housing market in both good and bad economic times, to create a level playing field for financial institutions and consumers, and to promote robust regulatory oversight to protect the broader system.

Too often, access and affordability are an add-on to discussions of the future of our housing finance system. We explore in this first piece key considerations for constructing a future system that addresses the central challenge that many families in this country face today: accessing affordable housing.

We must address the shortcomings of the existing system while preserving those features that bolster creditworthy individuals’ and families’ access to long-term, consumer-friendly mortgages and affordable rental housing. These key features include (i) incentivizing affordable credit pricing, (ii) implementing duty to serve provisions for underserved markets, (iii) establishing national loss mitigation standards to bolster borrower protections through the cycle, and (iv) providing funds dedicated to affordable housing construction and preservation.

Affordable Credit Pricing

In the current housing finance market structure, the GSEs purchase loans from mortgage lenders, bundle them into securities backed by these loans, and sell mortgage-backed securities (MBS) to investors who hold them as investments or use them as a source of liquidity. The GSEs are “credit guarantors” on their MBS, meaning that the GSEs make on-time payments on these securities to investors even if borrowers fall behind on their mortgage payments. To pay for this credit guarantee, the GSEs charge investors a “guarantee fee.”

This structure, in which investors are shielded from credit risk, has supported the existence of the 30-year, fixed-rate mortgage product. In addition, the scale with which the GSEs purchase and guarantee mortgages has provided them the ability to set the guarantee fee by, in part, blending the cost of providing credit to lower-credit-profile borrowers in pools with higher-credit-profile borrowers. As lenders pass on the guarantee fee to borrowers in the form of higher interest rates, this blending practice, or “average-cost pricing,” allows lower-credit-profile borrowers access to lower interest rates, critical to mortgage affordability.

In a purely competitive secondary housing finance marketplace, there is a risk that mortgage guarantors would focus primarily on consumers with stronger credit profiles, and that borrowers and geographies perceived as lower credit quality would be subject to considerably higher mortgage rates or may be unable to obtain mortgages at all. In contrast, entities with a national market presence and a mandate to serve all markets are likely to be both more resilient than those that guarantee loans from specific geographic areas and better equipped to preserve a healthy level of average-cost pricing. Policymakers should consider how best to create conditions to encourage average-cost pricing in a reformed system.

As the President also set forth in 2013, a reformed housing system should include an explicit government commitment on approved MBS and flexibility to support mortgage lending during times of nationwide economic crisis, such as the Great Recession. Such a catastrophic backstop should help mitigate the “procyclical” impact of mortgage credit, whereby the cost of a mortgage increases in times of market stress. As a condition for being able to issue MBS with a government guarantee, regulated mortgage guarantors should have a mandate to provide credit to all creditworthy borrowers through economic cycles. While such a mandate still requires responsible lending and strong regulatory oversight, it would be an important factor in supporting access to affordable mortgages for the broadest range of eligible borrowers. To further promote broadly affordable pricing of credit, an independent regulator could be invested with specific authorities, including, but not limited to, the review and approval of guarantee fees.

A reformed housing system likely requires more than just a role for average-cost pricing in order to make affordable housing more broadly available. Currently, the GSEs remit an amount equal to 4.2 basis points of annual mortgage acquisitions to government-administered affordable housing funds. This model could be built on and expanded in a reformed system to support affordability programs. The initial impact of these funds is discussed further below.

Duty to Serve Underserved Markets

Treasury supports programs, such as FHFA’s proposed rule mandating a duty to serve underserved housing markets, to incentivize issuers of government-insured MBS to develop secondary markets for products that serve traditionally neglected market segments. Under conservatorship, FHFA has proposed, and is seeking to finalize, a duty to serve rule for three underserved markets: (1) manufactured housing, (2) rural housing, and (3) affordable housing preservation. Data gathered during program implementation will be valuable in informing strategies to achieve broad access in good and bad economic times. We believe that such duty to serve requirements should continue to be statutorily mandated and paired with appropriate incentives and enforcement measures to encourage innovation and service to these, and potentially other, underserved markets.

National Loss Mitigation Standards

In the event a borrower faces a hardship and is unable to pay his or her monthly mortgage payment, he or she should have access to clear information on options offered by the mortgage servicer. Currently, there are no national “loss mitigation” standards for what loan modification options mortgage servicers — those in charge of collecting mortgage payments — should provide to borrowers when they are behind on monthly payments. Appropriate modification options can determine whether a borrower gets to stay in his or her home. A range of housing industry stakeholders have acknowledged the need for broad loss mitigation standards for distressed homeowners similar to the standards established in HAMP. The Consumer Financial Protection Bureau (CFPB) has issued servicing rules for residential mortgages that outline the process servicers must follow if loss mitigation options are offered, which we regard as an important first step for protecting borrowers. We are encouraged by industry efforts to harmonize policies on solutions for delinquent borrowers, including term extensions, rate reductions, principal reduction, and simplifying the documentation needed to complete a loan modification for a distressed borrower.

Treasury has been working with industry stakeholders to coalesce around such national standards, and we will continue to encourage their development. Looking forward, housing finance reform legislation should invest the housing regulatory agency responsible for overseeing any regulated guarantor with the authority to set and oversee loss mitigation standards for government guaranteed and private mortgages. These standards should balance: (1) protecting consumers with fair, transparent, and consistent terms, including those related to housing counseling, loan modifications, and alternatives to foreclosure; and (2) providing investors with clear, consistent loss mitigation rules so they have certainty when evaluating securities, securitization and servicing agreements, and pools of loans; and (3) balancing the need to protect the solvency of the catastrophic insurance fund that supports securities issued by any regulated guarantor.

Multifamily Affordable Rental Housing

Finally, housing reform measures must incorporate ways to support the supply of affordable rental housing for low-income individuals and families, many of whom are currently struggling under onerous rent burdens. Harvard’s Joint Center for Housing Studies reports that more Americans are renting than at any time since the 1960s. Over 43 million families and individuals live in rental housing and the share of all U.S. households that rent rose from 31 percent to 37 percent over the last decade. However the number of affordable units is not keeping up with renter demand, and rental housing affordability has decreased substantially.

Today, multiple government initiatives exist to support affordable rental opportunities, including HUD rental assistance programs, state Housing Finance Agencies’ affordability programs, and Treasury’s multifamily risk-sharing partnership with HUD. The Low Income Housing Tax Credit (LIHTC) underpins the construction and development of much affordable rental housing, and the President’s Budget includes proposals for expansion and refinement of the LIHTC program.

Additionally, Congress created the National Housing Trust Fund (HTF) and the CMF in 2008. These funds are critical to promoting affordable homeownership and rental opportunities, and to broadening the set of policy tools available to address these ongoing needs. With funds received following FHFA’s decision to allow the GSEs to contribute to the CMF, Treasury’s recent CMF awards are expected to fund the development of more than 15,000 affordable rental units and nearly 2,000 affordable homeownership units. Half of these rental units will be developed for very low-income and extremely low-income families earning less than 50 percent of the area median income. HUD also recently announced HTF allocations of $174 million that will further support affordable housing production.

These annual funds serve as a catalyst to help local housing markets take on unique and distinct challenges. But more is needed. A reformed housing finance system should consider making such funds more abundant to address the growing, nationwide shortage in affordable rental housing. 
 
 In addition to these targeted housing affordability programs, multifamily financing — an activity for which the GSEs are a key source of liquidity — supports purchase and refinancing activity for affordable multifamily rental properties. During the crisis, GSE multifamily acquisition volumes increased significantly as other financing sources dried up, highlighting the importance of the government’s role in mitigating a housing market downturn. Reforms to the housing finance system should not focus solely on the provision of mortgage financing support and ignore the importance of financing that expands affordability and access for renters. While single-family reform tends to garner the majority of industry attention, the GSEs’ multifamily businesses are also beneficiaries of taxpayer support and remain critical sources of credit in their own secondary market. Housing finance reform should consider these factors and seek to optimize these secondary market models to further the provision of mortgage credit to support affordable rental housing.

Conclusion

The financial crisis uncovered vast structural weaknesses in our housing finance system and deepened the housing challenges faced by millions of homeowners and renters. The crisis wiped out $13 trillion in household wealth, cost over nine million American families their homes, and left 16 million homeowners with a mortgage balance greater than the value of their home.

Comprehensive housing finance reform provides us an opportunity to reorient the housing system so it better serves all consumers and helps strengthen the broader economy. Addressing the shortcomings of the current system is the most pressing challenge for any model for reform. Taxpayers’ extraordinary and continuing support for the housing system obliges us to seize this challenge and enact reforms that protect and enhance fair and affordable access to a home.