Administration’s proposals for reforming US housing finance system a disturbing signal

By Jillian Olinger, Research Associate with the Kirwan Institute for the Study of Race and Ethnicity

The jointly issued “Report to Congress” issued in February by the Treasury and the Department of Housing and Urban Development caught many in the civil rights community by surprise. The Report laid out three paths, none of which appears to lead to a robust government role in securing equitable access to affordable rental and owner-occupied housing. Regardless of the path taken, the Report recommends that the federal government ultimately wind down Fannie and Freddie, withdraw from active involvement in housing finance, and step aside for private capital to fill the vacuum. One way to respond to this unexpected development is not to treat it as a literal policy recommendation but instead as a signal to Congress and the public of the Administration’s current thinking on housing finance broadly.

The signal is, frankly, disturbing to those of us who have fought for fair housing and fair lending. The Report is nothing less than the dismantling, through privatization, of key parts of the New Deal, which expanded home ownership partly in the service of dependable individual and community asset building for families who previously could not dream of home ownership. In direct opposition to this democratic vision, the privatization of housing finance has the potential to deepen the dual credit market, create a nation of (few) white homeowners and (many) renters of color, and freeze out all but the largest lenders from the housing finance market. Although these developments are the logical effects of housing finance privatization, the Report offers no guidance on how, exactly, low- and middle-income Americans are supposed to build wealth once access to affordable homeownership decreases. The lack of an affirmative vision for asset-building is especially troubling for low- and middle-income people of color, who are already disproportionately exposed to credit market discrimination and the toxic effects of years of subprime lending.

The Administration’s report enumerates repeated and costly failures of the private market, including “poor consumer protections [that] allowed low-quality mortgage products and predatory lending,” “inadequate and outdated” regulations, a securitization chain that allowed brokers and originators to profit without regard to mortgage loans’ future performance, inadequate capital in the system, and a poorly performing servicing industry.  While the Administration faults Fannie and Freddie for serious errors, the report clarifies that affordability goals did not drive the failure of the GSEs.  In fact, the report notes that private market security performance was often lousier than that of Fannie and Freddie portfolio, even without affordability goals: “delinquency rates on many PLS securities and other loans held by banks and other private market institutions were far higher than on the loans held by Fannie Mae and Freddie Mac, including loans qualifying for the affordability goals.”

Rather than drawing the conclusion from its own evidence that an unrestricted private market naturally inclines to low-quality products, predatory lending, and inflated mortgage prices (The Wall Street Journal reported in 2007 that in 2005, 55% of people with subprime mortgages had credit scores high enough to qualify for conventional loans  — in 2006; it was 61%) the federal response seems to be a “hair of the dog” response: the report recommends that the primary source of mortgage credit for the American people should now come from private markets.

One of the more worrisome statements in the report is: “This does not mean all Americans should become homeowners.  Instead, we should make sure that all Americans who have the credit history, financial capacity, and desire to own a home have the opportunity to take that step.” Unfortunately, this approach can disproportionately harm people of color and low-income and immigrant populations, who often lack credit experience and have little intergenerational wealth to rely on for down payments. In fact, we have already seen a “new redlining” in credit and insurance and prime credit is already receding in neighborhoods of color.

In addition, the report fails to note that during 1998 – 2006 only 9% of all subprime loans went to first time homebuyers.  The majority were refinance loans, loans that were disproportionately marketed to African American neighborhoods. The White Paper does, however, include a problematic and erroneous discourse on bad borrowers taking on more debt than they could afford (without the caveat that they were often steered toward it) and using their home equity “like an ATM.”  In point of fact, the top three reasons people took out home equity loans, according to the literature, were to send kids to college, pay medical bills, or pay down other consumer debts, indicating that home equity was actually providing credit where it was truly needed and unavailable elsewhere. The report then seems to endorse the idea of taking money out of housing, i.e. by restricting home loan availability, “more capital will flow into other areas of the economy, potentially leading to more long-run economic growth and reducing the inflationary pressure on housing assets,” and without submitting any evidence for this position.  Our view is that this exercise has been run; it was called predatory equity refinancing.

Lastly, the White Paper seems to have a bizarre head-in-the-sand regarding the history of the government role in housing finance, when it states that “Under normal market conditions, the essential components of housing finance – buying houses, lending money, determining how best to invest capital, and bearing credit risk – are fundamentally private sector activities.”  By “normal market conditions,” do they mean the pre-Depression era, when only a handful of very wealthy people could afford homes?

We are not arguing for a return to the housing and credit system pre-crisis or even the reinstitution of Fannie and Freddie as they once were. That did not serve marginalized communities and borrowers equitably. We do agree that we need housing finance reform. But we take issue with the fact that debates have largely been advancing to the detriment of communities of color that have for too long been exploited or neglected—at times by the government’s own policies—in the housing and credit systems. And the recent round of proposals promises to lock out many middle class borrowers as well. Housing finance reform cannot be about isolating affordable housing through the FHA. It cannot be about sustaining a dual, unequal credit delivery system. And it cannot be done on the backs of marginalized communities and borrowers. Period.