Targeted Mortgage Lending - Who Pays?

Edward DeMarco, the boss at FHFA made the following statement recently:

For many decades the federal government has sought to affect housing finance in ways that promoted the availability of credit for low-and moderate-income homeowners and renters. Under the current structure, the many subsidies granted the Enterprises were exchanged for various requirements, including housing goals, to ensure the Enterprises did not ignore these segments of the marketplace. Going forward, policymakers may consider alternative approaches to defining and targeting subsidies to achieve public policy objectives. For instance, subsidies intended to support the financing of affordable rental units or to assist first-time homebuyers could be more efficiently targeted through down payment assistance or other measures than by a general subsidy provided to all types of mortgage credit.

DeMarco has articulated something that I have not seen proposed before. It is important to analyze the implications of his words.

Administration after administration has used the Washington mortgage lenders as tools of social policy. The agency's respective charters confirm this. Part of their mission statements’ is to advance the nations housing objectives. This was a lovely marriage of interests for many years. It worked because RE value almost always went up. There weren’t significant losses until 2008 happened. Mixing high-octane credit with social objectives was a way of creating Federal off balance sheet financing. It was a contributor to the bubble in housing. We are paying a big price today for social policy choices that were made years ago.

Demarco has said that that policy has not worked and needs to be changed. That is a very significant acknowledgement of failure. That he goes on to propose that down payment assistance instead of 100% mortgage financing must be considered has potentially far reaching impacts.

For DeMarco to comment like this confirms that Fannie and Freddie have a lot of underwater mortgages that are tied to social housing goals. The question is, “How big is this problem?” There is no published information that breaks this out. A starting place for an estimate comes from a minor announcement from FHFA’s sister in law FHA. The announcement confirms that the “favored lending” status (Targeted Lending Initiative or ("TLI") for areas of Louisiana that were impacted by hurricane Katrina would be extended.

From that document comes the following graph. The FHA proudly points out that it has made 900,000 loans totaling $111 billion dollars that fall under their definition of a social objective mortgage. That comes to 15% of their total book.

If one uses that percentage as a proxy for all or the $7.3 trillion of D.C. mortgages it implies that the social side of this is approximately $1.1 Trillion. If this level of social lending is to be sustained and DeMarco’s suggestion that down payment assistance should replace bad lending standards then is would require an on budget expense of $50 billion a year forever.

That is not in the cards. Not by a long shot. The days where ‘social mortgages’ are made without equity are coming to an end. At some point in the future if you want a D.C. mortgage, you will have to put up 20% of the purchase price. You will have to get that from savings, friends or family. You might even get it from your Uncle Sam if you’re lucky, but don't count on it.

The long-term implications of this on the housing market will be significant. More important will be the social implications. We are not going to pay for the next Katrina with low-interest, no money down mortgages. We will have to pay up front.

It is good that DeMarco put this in front of the Senators. Now that it is out it will be difficult to withdraw. Something will have to change. The lending Agencies have been geese laying golden eggs for years. Then they morphed into a Black Swan. We are going to wish we had those geese back.



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