Mel Watt, President Obama’s new Federal Housing Finance Agency (FHFA) director, has broken his silence and has left no doubt that he will break with his predecessor’s policy of shrinking government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac’s footprint in the mortgage market.
Watt issued further clarification on when Fannie and Freddie will force banks to buy back “bad” loans they previously sold to the GSEs. However, these “put-back” rules are actually updated versions of proposed rules from 2012. The FHFA updated the rules because banks felt the agency’s original proposals didn’t offer lenders enough protection.
Based on the 2012 rules, banks implemented credit standards that were tougher than those set by Fannie and Freddie because they didn’t want to buy back even more loans. Of course, this strategy meant that banks tightened their credit standards.
According to The Wall Street Journal:
Mr. Watt said that he hoped that the changes would “substantially reduce” credit barriers, “and that lenders will start operating more inside the credit box that Fannie and Freddie” provide.
Lower credit standards for mortgages purchased by the GSEs? That sounds an awful lot like the government policies responsible for inflating the housing bubble by “bending financial markets.”
What’s even stranger is that these latest changes conflict with the supposedly tough approach taken by the Dodd–Frank financial regulation bill.
Dodd–Frank imposed the “ability to repay” rule and the qualified mortgage to ostensibly prevent banks from using lax credit standards. And it required federal banking agencies to jointly develop a rule requiring banks to retain at least a 5 percent interest in any mortgages they sell into the secondary market.
In their initial proposed rule, the agencies increased the percentage to 20 percent, but that rate was met with a “huge outcry from lawmakers, affordable-housing groups and the real-estate industry.” So the agencies revised their proposal in 2013 and went all the way down to the 5 percent retention rule. (The agencies are expected to issue “final” rules in the next few weeks.)
All of these issues highlight what should be the focal point of housing finance reform: U.S. housing policy should stop shifting risk from lenders to taxpayers. Far from removing risk from the economy, these policies tend to compound the risk in financial markets and contribute to housing and credit crises.
Congress should provide a framework that gives lenders the correct incentives to assess and price risk without any special taxpayer-backed protections. Removing this federal backstop may result in less mortgage debt in the short run, but it will likely lead to more stable homeownership in the end.