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Three years into the nationalization of housing finance by government-sponsored entities Fannie Mae, Freddie Mac, and the Federal Housing Authority (FHA), it is time to start reducing their footprints. This is not an easy task, for as Ronald Reagan observed in 1964, “A government bureau is the nearest thing to eternal life we’ll ever see on this earth.” The same might be said for temporary legislative enactments.
Currently, American taxpayers guarantee some 95 percent of new mortgage loans made each month thanks to their backing of Fannie, Freddie, and FHA. In its February 2011 white paper on housing finance reform, the Obama administration recognized that no private-sector market for financing mortgages will be able to fully develop until competition from these three entities is reduced. The administration recommended that FHA be retargeted to its original mission and Fannie and Freddie be eliminated over time.
To this end, the administration suggested, as a first step, allowing the temporary loan limits that were put in place in 2008 to expire on September 30, 2011. On October 1 the GSEs’ loan limit for high cost areas dropped from $729,750 to $625,500, with the general loan limit remaining unchanged at $417,000. To put these numbers in perspective, the median priced U.S. home sells for $172,000 and the median priced home in the most expensive metro area (San Jose-Sunnyvale-Santa Clara, California) sells for $610,000. Also, the $417,000 general loan limit was first put in place in 2006, when housing prices were 20 percent higher than they are today. FHA’s loan limits were also reduced from unprecedented temporary levels on October 1.
American taxpayers guarantee some 95 percent of new mortgage loans made each month thanks to their backing of Fannie, Freddie, and FHA.
Rather that leaving well enough alone, on Thursday October 20 the U.S. Senate approved an amendment that would restore these expired maximum loan limits. This amendment, sponsored by Senators Bob Menendez (D-New Jersey) and Johnny Isakson (R-Georgia), passed 60-38. It allows affluent homeowners to continue receiving a federal subsidy to qualify for mortgage financing costs upwards of $1 million provided they have an annual income of $200,000. This has never been, nor should it be, the mission of Fannie or Freddie, much less FHA.
In addition to raising the limits, the amendment also imposes a new “premium fee” paid by the homeowner on conventional loans that are above the $625,000 limit (up to $729,000) applicable to Fannie and Freddie, but not FHA. While some argue that these fees help protect the taxpayers from further exposure to Fannie and Freddie, a more likely outcome is that much of this risk merely shifts to FHA. In essence, the amendment raises the cost of loans originating in the private sector, further overextending the already stressed FHA, which provides a 100 percent government-backed guarantee should the loan default.
The Senate’s vote to increase the subsidy to $729,750 now shifts to the House of Representatives. The House should keep these policy points in mind as members consider this issue:
• The loan limits fell with no significant impact on the housing market.
In the short time since the loan limits were lowered, there has been no real evidence of adverse impacts on the housing market. To the contrary, the pace of home sales actually increased in September, despite the fact that lenders had already begun conforming to the lower loan limits back in July. Furthermore, the Federal Reserve reported recently that the lower limits would have impacted about 3 percent of purchase mortgages last year. This does not mean these loans would not have been made: Many of these high cost homes could have been financed at somewhat higher rates or with a larger down payment.
• While the housing lobby presents this issue as “now is simply not the time,” the real question is: if not now, when?
The housing lobby has resisted commonsense reforms for many decades. Let us not forget that Fannie and Freddie collapsed in 2008. For 15 years the housing lobby’s efforts to stop reform allowed these too-big-to-fail entities to spread moral hazard around the world. Congress needs to focus on fundamental reform and end its fixation on subsidizing rates by 0.25 or 0.5 percent. Just over the last 12 months mortgage rates have varied by 1 percent. Stop focusing on the trees when the entire forest is at risk as a result of the nationalization of housing finance.
• The proposal to raise the Fannie/Freddie/FHA loan limits is using data from before the burst of the housing bubble.
For example, the Menendez amendment would calculate local FHA loan limit maximums using a formula based on 2008 area median home prices. However, home prices have dropped dramatically since that time (17-23 percent), meaning those loan limits simply do not reflect the current state of the market. This poses a particular risk for FHA given its much riskier loan profile. For example, the average down payment on FHA loans used to purchase a home is about 4 percent. Add the fact that over the last two years an estimated 20-25 percent of FHA’s dollar volume has been from California. Raising FHA’s limit ensures that FHA can continue to use government backing to insure home loans that are well beyond the size of an average home.
• Senators are blocking the Obama administration’s goal of reducing the government’s footprint in the housing market.
The Senate vote puts it at odds with the Obama administration, which has repeatedly called for the federal government to shrink the size of its footprint on the national housing market. In its February white paper, the administration called for the reduction of loan limits as part of the greater effort to allow “private capital to play the predominant role in housing finance.” In the paper, the administration recommended that Congress allow the temporary increase in limits to expire as scheduled and as a result, “larger loans for more expensive homes will once again be funded only through the private market.” The private sector responds to market needs, but this is virtually impossible if the government continues to crowd out any private competition.
• The FHA is already dangerously overextended.
FHA’s market share of total originations going into the crisis was only about 2.5 percent. Now, its market share has ballooned to approximately 30 percent. Moreover, FHA’s third-quarter fiscal 2011 report to Congress showed that its Capital Reserve Account has been drained from $19.6 billion just two years ago to a low of $2.8 billion at the end of June 2011 due to rising defaults.
While the reduction in loan limits affects few loans, reversing that reduction would be a devastating signal to the housing finance market that even the Republican House is not serious about beginning the process of bringing back private sector involvement. Weaning off the Fannie and Freddie addiction will be a long process—let’s hope House Republicans don’t start with a step backwards.
Edward Pinto is a resident fellow at the American Enterprise Institute.
Congress should allow Fannie, Freddie, and FHA’s loan limits to drop.
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