Building a New System of Housing Finance

The JCHS research team is busy these days, putting the finishing touches on the 2013 State of the Nation's Housing report, which will be released via live webcast on Wednesday, June 26.  In the meantime, we’re pleased to share another guest blog. Recently, we held a symposium entitled Homeownership Built to Last: Lessons from the Housing Crisis on Sustaining Homeownership for Low-Income and Minority Families. At the event, Sarah Rosen Wartell, President of the Urban Institute, delivered the following remarks to the assembled group of policymakers and members of industry, the nonprofit community, and academia. 

by Sarah Rosen Wartell
Urban Institute

Over the last 75 years, housing has been a critical component of the physical security, psychological identity, and economic opportunity of millions of Americans—although we have not yet achieved equitable access to those benefits, something to which I know those in this room are committed.

Today we are building a new system of housing finance from the ashes of the system that crumbled in the last decade.  Yet, we began this endeavor before we had a blueprint completed—we have laid pieces of the foundation before we know the design of the first floor, let alone the shape of the roofline. What is more, to over-extend the metaphor, the ground upon which we are building is shifting. As a consequence, I don’t think we will have a grand reform moment, but rather a series of discussions and incremental change.

As part of those discussions, we must continuously ask: in this new system, will homeownership continue to offer the advantages of physical security and psychological identity? Will it continue to offer economic opportunity—the opportunity to build wealth and assets that make so much else possible? And, if so, who among us will gain those benefits?

I fear we are expecting homeownership to accomplish too much: we’re asking it to close gaps in incomes and opportunities, and to address economic volatility—challenges that have deeper roots than housing. Homeownership cannot be the route to overcoming growing inequality and its persistence along racial lines. But if the new system cannot erase these inequalities, it is imperative to ask if it will exacerbate them—if it will calcify the divisions between the “asset haves” and “asset have nots,” and the “income haves” and “income have nots.”

I wish I could tell you what the future will bring, but you should be highly skeptical of anyone who has great confidence about how sweeping policy change and shifting socio-economic factors will combine to determine the future, as we are in a period of profound policy change. Underway now are the implementation of new Basel capital standards, which are changing financial institution behavior; the implementation of hundreds of Dodd-Frank provisions (most relevant QM and QRM, but inevitably others) that will also have consequences we cannot predict; efforts to restore the FHA Fund’s capital levels, which will either strengthen or hobble FHA; and the creation of a new “architecture”—including servicing standards and a new securities platform to segregate the MBS issuance and credit risk functions. The elephant in the room is the impact of what comes after Fannie and Freddie as they are (as the Administration likes to say) “unwound.”

As the principal focus of policymaking right now is on avoiding excess leverage and systemic risk, and not principally about ensuring affordability and access to credit, a key question is how access and affordability will be pursued in the new framework. Some mechanism will be politically necessary, but will they be sufficient? Will they be a fig leaf? Can access be done in a non-distorting way?

Beyond the future housing finance system, what will be the consequences of changes, if any, to the Mortgage Interest Deduction and broader tax reform? And what about likely further reductions in domestic discretionary spending?

The U.S. is also experiencing transformational socioeconomic and demographic shifts that will fundamentally affect housing demand and the effectiveness and desirability of housing as a wealth-building tool. As the Joint Center and some of my own colleagues at the Urban Institute and the Bipartisan Policy Center have so ably documented, household formation patterns are changing, our senior population is exploding, and our immigrant population is both increasing and suburbanizing.

For example, children are increasingly born into non-marital families: 40 percent of births are to unmarried moms, and these percentages vary dramatically by race. And while in some of those cases, a second adult is present, absent marriage, co-habitation doesn’t usually last.  The result for homeownership could be profound, as single-earner households face a narrower set of housing choices.

We are also seeing significant generational differences in wealth accumulation. Just last month, Urban Institute scholars including Signe-Mary McKernan, Gene Steuerle, and others published work showing that even with the Great Recession, over the last forty years, people are wealthier than their parents’ generation—unless they were under forty.  Today’s young people, in particular the cohort in their thirties, have accumulated far less wealth than their parents over a comparable period of time.  Some of that stems from coming of age in the era that led to the housing collapse, but not all. Another challenge is that younger people without college degrees have less predictable earnings.

Sadly, that same economic volatility affects many of those with a college degree in the 21st century economy.  Employment is far less secure. And deeper trends in the economy suggest that middle skill workers will not see any end to the wage stagnation of the last few decades, giving rise to questions about the ability of more of the workforce to sustain homeownership.

Minorities—who historically have had lower levels of educational attainment and thus incomes—make up a growing share of the U.S. population. While educational attainment is increasing, it is unclear whether these rising levels will overtake the effects of shifting population composition, or if the housing market demand will be shaped by lower-income consumers in the long term.

And an additional challenge is the aging of the population and its consequences for demand for different kinds of housing units.  We just don’t know how all of these trends will intersect with policy change.

There are also three trends in the mortgage market – partly policy-driven, but not exclusively – that keep me up at night: underwriting rigidity, the cost of credit, and the role of down payments.

In terms of underwriting, we have gone backwards.  We now have limited flexibility with little consideration for compensating factors.  Rigid rules have replaced rules of reason.  This change, which falls disproportionately on lower income households, recent immigrants, retired Americans and the self-employed, comes from a confluence of regulatory policy and private sector incentives.  Well-intentioned individuals who committed to avoiding the mistakes of the bubble years are overshooting. One statistic stands out: I am told the average loan that is turned away by GSE automated underwriting systems has an average credit scores well north of 700 and average LTV below 80.  Manual underwriting is a shallow promise in the era of rep and warranty concerns.  So we see overlays based on rigid ratios not only on GSE loans, but also FHA.

A second issue is that we haven’t really absorbed the extent to which the cost of credit is going to rise in the years ahead.  When we fully price the value of the guarantee – especially as there will be pressure to price it for another “100-year flood” or, in this case, financial catastrophe, the real cost of credit is going to rise A LOT.

There is also pressure in Congress to change the rules of how we estimate what credit costs taxpayers.  “Fair value accounting” will make the accounting for government credit risk more expensive, which will lead to higher premiums and guarantee fees. Even today, before these changes, despite low interest rates, the cost of credit is not as inexpensive as it seems.  Today, the primary-secondary market spread is 50 to 100 bps higher than its historic levels.

And then there are risk-based premiums. We’ve always had pooling of risk, but we can expect much less in the future. While we have traditionally had price banding—pooling of risks but not a single pool, we are moving toward more granular pricing, some at the expense of credit-impaired borrowers.  

A real challenge for those who care about affordability is managing in a world of greater risk-based pricing.  We have built a financial system that prices credit based on risk, yet pools or average prices prepayment risk.  Low-wealth individuals are the losers on both sides of these trades.  We need more research to provide greater transparency on the consequences of risk based pricing.

I am also concerned about learning the wrong lessons about consumer leverage and downpayments.  I accept that loss severity is greater with lower equity, but am less convinced that proclivity to default is affected by LTV.  Further, there is a difference between what drove the crisis and what may have exacerbated the losses suffered: when unemployment rises so dramatically and prices fall 50 percent, does it matter whether current LTV is 190 or 180?

Going forward, we need to understand how combinations of factors influence performance and create prudent regimes that allow for other factors to compensate for lower equity. I also am attracted to testing the concepts discussed yesterday that build in savings, first in the lead up to ownership with a promise of mortgage at the end, and throughout ownership to provide the necessary cushion against unexpected costs of loss of income.

We also need a way to lower the cost of capital for innovation, to provide additional credit enhancement for innovative products and services. The Center for American Progress’ and Mortgage Finance Working Group’s reform paper has a concept known as the “Market Access Fund” which we would fund out of an assessment on all MBS – guaranteed or not—and that can be delivered through a combination of high performing state and local HFAs and competitive allocations to innovative products by MIs, CDFIs, or other nonprofit and private capital providers.  Some will say, isn’t that FHA’s role?  I have long hoped it would be so.  But I think we need an additional strategy – a nimbler and more flexible tool – as I have little confidence Congress will ever stop writing FHA underwriting standards in statute.

Finally, we face a pressing need for better information – particularly, more analysis and quick learning that connects the seemingly disparate macro and micro economic forces that determine a household’s ability to purchase a home and save.  In addition, much of the impact on families and communities is determined by capital markets, secondary markets, and financial institution regulatory policy, and not the retail consumer and mortgage issues that advocates for affordable housing typically focus on. Yet the gulf between the two worlds is so great, and the language of analysis is so different. If we could manage to better translate between the two, and create a body of shared knowledge, I am confident we would be in a much better position to reimagine and build our housing system of the future.

In closing, we have only just begun to reconstruct our national housing finance system, and we face tremendous uncertainty around the forces that will affect it. Will homeownership continue to serve the critical asset-building role it has for 75 years? And if so, how do we create a system that enables access to it in the face of volatile economic and social dynamics? We need to show how we can do access without increasing risk to the system.

If anyone can determine the best way forward, it is the minds assembled here today. You all have not only the brainpower, but the commitment to affordability and access. Thanks again to Eric, the Joint Center, the Ford Foundation, NeighborWorks America, and Bank of America for bringing us together today.

Foreclosures: The Great Untold Story

by Chris Arnold
Guest Blogger

From time to time, Housing Perspectives features posts by guest bloggers. Today's post, written by NPR Housing and Economics Correspondent Chris Arnold, reflects thoughts from a panel he moderated at the Harvard Kennedy School on March 26, 2013. The panel was entitled "Foreclosures: The Great Untold Story" and included panelists Mike Calhoun (Center for Responsible Lending), Gary Klein (Klein Kavanagh Costello, LLP), and Bruce Marks (Neighborhood Assistance Corporation of America)


People know there’s a foreclosure crisis.  Yes, the housing market crashed and lots of people are losing their homes.  But most people don’t realize that about half of foreclosures don’t need to happen. 

That is, about half the time, when a homeowner falls behind on their mortgage payments, there is a better alternative that will keep the homeowner in their house and result in a smaller loss for the lender (often investors in RMBS).  

When president Obama came into office, in the spring of 2009, he started the Home Affordable Modification Program (HAMP.)  The goal was to prevent 4 million foreclosures by modifying the terms of people’s mortgages in cases where lowering a borrowers interest rate, and perhaps forgiving some principal, would be “NPV Positive” for the lenders.  In other words, the goal was to modify loans in cases where it made better business sense for the lender to keep people in their homes instead of foreclosing.  This also helps the housing market and the broader economy by reducing the overall numbers of foreclosures and the losses associated with them.

The problem is, while many economists thought that 4 million people estimate was a pretty good one, 4 years later the program has only reached about 1 million people.  There have also been 3.4 million non-HAMP mods over this period but data on the quality of these mods remains murky.

Meanwhile, according to recent data compiled by the JCHS (State of the Nation's Housing, 2012, Figure 20) there are still roughly 3 million seriously delinquent loans in (or heading into) the foreclosure pipeline.  

The JCHS recently hosted a panel of people working on the front lines to prevent foreclosures.  All are strong advocates for increasing the number of loan modifications in order to help housing markets.  They said there are still serious problems implementing the HAMP program, and that if some changes were made, there is still time to prevent tens, and perhaps hundreds of thousands of unnecessary foreclosures.  

The Panelists were (pictured above, right to left):

• Gary Klein, Partner, Klein Kavanagh Costello, LLP 
• Mike Calhoun, President, Center for Responsible Lending
• Bruce Marks, CEO, NACA (Neighborhood Assistance Corporation of America)

I hosted the panel, and these are the highlights of the recommendations from the group.  

Gary Klein has been suing the nation's largest banks for their alleged failure to provide loan modifications for people who should qualify for HAMP.  Often, he said, the major banks that “service” the mortgages on behalf of investors (the banks are responsible for qualifying homeowners for HAMP) drag out the process for far too long.  Homeowners can stay stuck in limbo trying to qualify for the program for 6 months, 9 months, sometimes for more than a year.  Klein says the HAMP agreement/contract documents signed by the banks and the homeowners state that the bank has 3 months to make a decision.  This agreement is struck when a homeowner begins the “trial period” of the HAMP program and starts making lower monthly payments.  Klein recommended that if a homeowner stays current, making payments, for those 3 months, and the bank has yet to make a decision, the homeowner should be automatically qualified for HAMP and receive a permanent loan modification through the program.  Currently there are more than 59,000 active HAMP trial mods according to the Treasury Department.  So Klein would like to see many of those automatically converted to permanent loan mods.  

Mike Calhoun has been studying the foreclosure crisis for years now at the Center For Responsible Lending.  He urged the regulator for Fannie Mae and Freddie Mac (the FHFA) to allow for loan modifications involving principal write-downs.  Loans not backed by Fannie and Freddie have been receiving principal write-downs more frequently as private investors calculate that it can make good business sense to avoid a foreclosure this way.  Calhoun urged Fannie and Freddie to follow suit.  

Calhoun also suggested expanding the administration’s HARP II refinancing program.  He’d like HARP II to permit delinquent borrowers (who are currently not eligible) to refinance into today’s low market interest rates.  In many cases, Calhoun said, just cutting a homeowner’s interest rate to what is currently available on the market can be enough to prevent a foreclosure. 

Bruce Marks’s organization NACA has been functioning essentially as an outsourced loan modification “qualifier” for all of the nation’s largest banks/ loan servicers.  Marks said NACA has enabled more than 200,000 homeowners to avoid foreclosure with a loan mod.  Like Calhoun, Marks would like to see more principal write-downs to avoid foreclosures.  Marks also said he wished that bankruptcy judges had been allowed to help rewrite the terms of mortgages (this was proposed by federal lawmakers in recent years but couldn’t get approval in Congress). 

One hopeful sign, Mike Calhoun said, is that the quality of the loan modifications done by loan servicers outside of the HAMP program appears to be improving.  But the panelists said the exact terms of many of those modifications remain unclear.  

Momentum Building for Home Improvement Activity

by Abbe Will
Research Analyst

Spending by homeowners on improvement projects is expected to accelerate as the year progresses, according to our latest Leading Indicator of Remodeling Activity (LIRA).  On top of the almost 10% growth reflected in U.S. Census Bureau figures for 2012, the LIRA projects strong gains in homeowner remodeling spending continuing throughout 2013, with some moderation in the pace of growth toward the end of the year.

Existing home sales were up almost 9% last year, and house prices are increasing in most markets across the country. This has increased the home equity levels for most homeowners, encouraging them to reinvest in their homes.

The strong growth that we’ve seen recently is putting pressure on the current capacity of the home improvement industry. Contractors and subcontractors are having more difficulty finding skilled labor, and building materials costs are unusually volatile for this stage of a recovery.

For more information about the LIRA, including how it is calculated, visit the Joint Center website.

Childless Households Have Become the Norm

by George Masnick
Fellow

In 1960 almost half of all households were families with children under 18.  Since then, the number has fallen to under 30 percent (Figure 1).  By definition, the declining share of family households with children exists because households without children have increased more rapidly (Figure 2).  There are many reasons for this trend: delayed age at marriage and later age at childbearing, smaller family sizes, higher divorce rates, and more couples choosing not to have children (Table 1).  The changes in each of these measures over the last few decades are quite striking. In 1960 the median age at first marriage was 22.8 for men and 20.3 for women, compared to 28.6 and 26.6 in 2012.  The share of households with four or more people in 1960 was over 40 percent, falling to just under 23 percent in 2012.  Women who were 25 in 1960 ended their childbearing years in the mid 1980s with only 8.5 percent of them remaining childless. Women born in 1960 finished childbearing in 2010 with nearly twice as many of them childless (16.3 percent). In 1960, only 13 percent of all households were single persons, but by 2012 that percentage had risen to 28. All of these trends result in households having fewer children and fewer households having any children at all. (Click charts to enlarge.)

Source: Current Population Survey March and annual Social and Economic Supplement, 2012 and earlier. Table FM-1.  Minor children numbers from Census Bureau's population estimates for July 1 of each year.

Source: Current Population Survey March and annual Social and Economic Supplement, 2012and earlier. Table FM-1

Source: Census Bureau Current Population Survey historical tables.

The interesting aspect of this long-term trend is that it continued in spite of the strong upswing in the sheer number of American children, which grew after 1990 (also Figure 1).  That increase is due to the largest baby boomers having their own children (the echo boom) and to childbearing by the flood of immigrants who arrived between 1985 and 2005.  (Note that in 2012, fully 87.5 percent of children under the age of 18 who have an immigrant parent were themselves born in this country.) 

To be sure, baby boomer and immigrant childbearing did increase the actual number of households with children.  For example, the number of households with children under the age of 18 increased from 33.3 million in 1985 to 38.6 million in 2012. This 5.3 million increase was far less than the 11.3 million increase in total number of children in the population over this period because many households with children contained two or more children under the age of 18.  More importantly, however, the increase in households without children surpassed the 5.3 million growth of households with children by a considerable margin.

Two key reasons for the recent increase in childless households have been the aging of the population and increasing longevity. The large baby boom generation (age 45-64 in 2010) is now entering the empty nest stage (at least regarding children under 18). Between 2002 and 2012, households with at least one child, headed by today’s 45-64 year old cohort, declined by 12.3 million. There are still 11.5 million 45-64 year old headed households with children, and most will become households without children over the next decade.  Furthermore, empty nest households headed by those over the age of 65 are surviving longer and longer, making it likely that the trend in the decline of households with children will continue well into the future.

Significantly, the decline in the number of households with children accelerated after 2007.  Much of the decline can be explained by the sharp drop in the number of births. Annual births rose from just over 4 million in 2001 to over 4.3 million in 2007, the highest on historical record, but then fell to just below 4 million in 2011.  The total fertility rate (births per 1000 women age 15-44) fell from 69.5  (a 17 year high) to 64.4, a decline of 7.3 percent over this same period. Both the decline in births and the drop in the fertility rate are linked to the decline in immigration that followed the Great Recession. Because newly arrived immigrants are concentrated in the childbearing ages, and because immigrants have higher fertility than the native born, the loss of immigrants has had a disproportional effect on declining fertility.  The effect of the Great Recession on lowering fertility among the native born is also of importance, but this decline could be temporary.  The echo boom generation began to turn 25 in 2010, and has most of its childbearing years yet ahead of it. A return to higher levels of immigration and/or a rebound in fertility could reverse the decline in number of births and ease the long-term decline in the share of households with children, but will not likely reverse it.

How Much Did LTVs Actually Rise During the Housing Boom?

by Chris Herbert
Research Director

The rise in housing prices that appears to be taking hold in many parts of the country is an important sign of recovery in the market. Among the many ways the upturn in prices is helping the housing market heal is by turning back the tide on the 100-year flood of underwater mortgages.  Still, even as reports from CoreLogic and Zillow document the progress in reducing the inventory of homes with negative equity, these same reports remind us that despite recent improvements there are still millions of housing units saddled with mortgage debt exceeding the value of the home. These homes serve as a warning about the risks of excessive loan to value ratios (LTVs) that are assumed to have become commonplace among homeowners during the housing boom. However, a review of data from the Survey of Consumer Finances (SCF) from the last 20 years finds that there was actually relatively little change in the distribution of LTVs through the boom years.  While outstanding mortgage debt did increase substantially, it essentially kept pace with the rise in home prices. The flood of underwater owners was thus less the result of a greater share of owners having little equity cushion and more the result of the tremendous collapse in housing prices.

Figure 1 shows  trends in the distribution of LTVs among all homeowners between 1989 and 2010, based on a comparison of total outstanding mortgage debt to owners’ estimates of the value of their principal residence. As shown, there was a fairly substantial increase in the average LTV between 1989 and 1995 from 27 percent to 34 percent. This rise reflects a combination of factors, including the greater tendency of households to hold mortgage debt in the wake of the 1986 Tax Act that gave preferential treatment to mortgage interest payments, the sharp fall in house prices in some areas of the country, and an expansion of mortgage lending that occurred as the economic boom of the 1990s began. However, between 1998 and 2007 the average remained largely unchanged at about 37 percent. Average mortgage debt did increase sharply over this period, from $67,000 to $111,000 (in constant 2010 dollars) but the average house value also increased substantially from $185,000 to $317,000. Even at the peak of the boom, the vast majority of owners still had fairly low LTVs.

Source: Joint Center tabulations of Survey of Consumer Finances.

Of course, these averages include a large share of households that continued to hold little or no mortgage debt. The stable average may result from a rise in high LTVs among some owners that is counterbalanced by plunging LTVs for those who did not tap their growing home equity. But there was also little change in the level of LTVs at the upper end of the distribution. As Figure 1 illustrates, at the 75^th percentile of owners LTVs also remained largely unchanged between 1998 and 2007 at roughly 67 percent. Even at the 90^th percentile of the distribution LTVs held steady at 86 percent.  Thus, even at the height of the housing boom the vast majority of homeowners had at least a 15 percent equity cushion, as they had continuously since the mid 1990s.

The data in Figure 1 includes homeowners of all ages, but it might be expected that highly leveraged homeownership was becoming more common among younger households who were more likely to buy homes during the boom years and take advantage of more liberal lending. Figure 2 shows the same distributions of LTVs for homeowners under age 30. While there is more sampling variability for this subgroup, there does appear to be more of a rise in average LTVs among this group than is true of all households. Between 1995 and 2001 the average LTV was generally a little above 60 percent, but rose to more than 65 percent in 2004 and 2007. A similar increase was evident at the 75^th percentile where LTVs reached about 90 percent during the boom years after having been closer to 85 percent during the 1990s. Still, the vast majority of young homeowners had at least 10 percent equity invested in their homes even when lending standards were most relaxed. There was more stability at the 90^th percentile of the distribution, where young homeowners had LTVs of between 95 and 98 percent consistently since 1989. At this upper point of the distribution young homeowners did have little equity in their home, but this was no different during the boom than it was 20 years ago.

Source: Joint Center tabulations of Survey of Consumer Finances.

As both Figures 1 and 2 illustrate, when the bottom fell out of the housing market after 2007 LTVs among homeowners shot up.  According to estimates from the SCF, 9 percent of all homeowners were underwater on their principal residence as of 2010, with the rate more than twice as high among those under age 30. But this sharp rise in LTVs was the result of the unprecedented fall in house prices and not due to an expansion of excessively high LTVs during the boom.

Still, there is no question that homeowners took on much more debt than was prudent during the boom. While outstanding mortgage debt may have been keeping pace with house prices, the level of debt was greatly outracing trends in incomes. This great expansion of credit decoupled from borrowers’ incomes certainly played a role in helping to inflate the housing bubble. The new Qualified Mortgage (QM) standard is designed to avoid this problem in the future by establishing an ability to pay standard for mortgage lending. Notably, the QM standard did not include restrictions on LTVs. However, the still to be announced rules defining the Qualified Residential Mortgage (QRM) may introduce limits on LTVs. While it is true that a greater equity cushion would have helped both homeowners and lenders avoid losses during the housing crash, the housing market has long been characterized by fairly high LTVs at the upper end of the distribution. These higher LTVs were not problematic as long as house prices were not subject to extreme swings. Imposing more stringent LTV requirements are of concern as they will curtail the ability of young households to get a start as homeowners—particularly the growing share of young minority households who have not benefited to the same degree from having parents build wealth through homeownership. Given these concerns, it may be best to have regulatory efforts focus on ensuring that borrowers can afford their mortgages as a means of introducing more stability in the mortgage system, rather than on setting standards for LTVs meant to withstand the next 100-year flood.