By Richard K. Green , Anthony W. Orlando, and Susan M. Wachter
One of the few bright spots of the COVID-19 recession has been the mortgage market, the epicenter of the last economic catastrophe. In the midst of this crisis, mortgage lending is humming along quietly and steadfastly. Like Arthur Conan Doyle’s dog that did not bark, there is much to learn from a mortgage market that does not crash.
In this case, the clues all point to Fannie Mae /zigman2/quotes/208846331/composite FNMA +1.66% and Freddie Mac /zigman2/quotes/202741363/composite FMCC +0.56% , the once-private companies that the government took into conservatorship in the fall of 2008. Today, Fannie and Freddie and the government agency Ginnie Mae provide more than 80% of the financing for home mortgages at record-low rates.
The private-label securitization market, which recklessly provided trillions of dollars in pre-crash funding and then imploded a decade ago, now has a very small footprint. In its place is a market dominated by safe, affordable products for which lenders charge appropriate rates for the level of risk, thanks to reforms adopted by Fannie and Freddie.
This success is why it is so concerning to read reports that Mark Calabria, director of the Federal Housing Finance Agency, and Treasury Secretary Steven Mnuchin are considering fully privatizing Fannie and Freddie before President-elect Biden takes office. Without reforms locked in, we view such a change to be disruptive now and destabilizing in the long run. .
Currently, Fannie and Freddie own 45% of the country’s $11 trillion of residential mortgages. In the second quarter of this year, they purchased more than 65% of new residential mortgages. In the depths of the COVID-19 recession, it is no exaggeration to say they, along with Ginnie, are keeping home loans flowing. Americans are locking in all-time-low interest rates with 30-year mortgages—quite a change from the risky loans securitized by the private-label market in the run-up to the Great Recession.
These activities provide a large stimulus to housing demand and the overall economy. Moreover, they enable lenders to forbear on mortgage payments for those who have lost their jobs, enabling millions to stay in their homes. And unlike fully private lenders, they have the capacity to await repayment of the forborne loans until the end of their terms.
After the 2008 financial crisis, we saw what happens without this support. The housing and mortgage market cratered. Housing prices fell over 30%, and housing starts fell over 40%, with feedback effects on the entire economy. The lesson was clear: A housing crisis is a recipe for economic disaster.
Consider, in contrast, what happened this year.
After a brief scare at the beginning of the pandemic, mortgage rates plummeted to all-time lows because the Federal Reserve was able to purchase the safe mortgage-backed securities issued by Fannie and Freddie. Mortgage applications rebounded to highs not seen in over a decade and mortgage refinancings put money in pockets of consumers. Housing prices have risen across the country. A housing crisis has been averted. With Fannie- and Freddie-sanctioned forbearance, families can stay in their homes, even if they have lost their jobs due to COVID-19.
After years in the wilderness, these twin mortgage titans redeemed themselves by doing what they struggled to do the last time: They stabilized the market. They made lending more affordable in a challenging time. They fulfilled their mission.
When jobless claims are rising, when businesses are shuttering, when COVID cases are soaring to unprecedented heights, what good can it do to undermine this mission?
Private corporations do not exist to promote stability or affordability. Their mission is profits. They work for shareholders. When crisis approaches, their first thought is not to save the economy but rather to save themselves.
But let us imagine this plan being proposed by Mnuchin and Calabria has succeeded. Fannie and Freddie are back in the hands of private investors. What then will prevent a return to the mistakes of the past? What will stop shareholders from demanding higher profits at all costs—including issuing mortgage-backed securities that fund dangerous loans? When the defaults start rolling in, will we tell them to file for bankruptcy, that the era of “too big to fail” is over, that bailouts are a thing of the past? Would they believe us if we did?
There are ways to avoid “privatized gains and socialized losses.” This is not one of them.
At the heart of this effort are worthy goals: to relieve taxpayers of the liabilities on their balance sheets and to restore the discipline of private capital and the competitive pressure for innovation. And Fannie and Freddie have been forced to deliver most of their profits to the Treasury rather than rebuild equity.
But without government oversight and support, these benefits will not endure. They will not resist the excesses of booms, and they will not withstand the temptation to abandon the market in crises.
The best outcome for potential homeowners and taxpayers alike is to allow these companies to continue supporting our mortgage market as they have done so ably throughout this world-altering pandemic, with public oversight that maintains the reforms that have been put into place. Setting them on a path away from this mission jeopardizes all the stability and affordability that they have created with the aid of our tax-funded conservatorship.
Richard K. Green is a professor at the University of Southern California in Los Angeles and the director and chair of the USC Lusk Center for Real Estate. <STRONG>Anthony W. Orlando</STRONG> is an assistant professor in the finance, real estate, & law department at California State Polytechnic University, Pomona. Susan M. Wachter is the Albert Sussman Professor of Real Estate, a professor of finance at The Wharton School, and the co-director of the Penn Institute for Urban Research at the University of Pennsylvania in Philadelphia.