There are two different conversations taking place about housing. One happens in the world of housing advocacy. In this conversation, housing prices are seen as too high, and so the conversation tends to focus on how to bring housing prices down. The other conversation takes place in the world of finance. In that space, high housing prices are a feature, not a flaw. The financial conversation focuses on finding more ways for people to access debt.
It is my observation that the housing conversation tends to
demonstrate a rather unsophisticated understanding of the financial
conversation. That is the case with the simplistic supply/demand assertion that
we can build our way to falling home prices. It also shows up in the widespread
assertion that developer greed is the primary source of rising prices. While I
share a lot of the same underlying motivations, I have personally struggled to
engage with the housing conversation because I find it internally incoherent.
That is not the case with the financial conversation. The
financial world, a world of predator and prey, is very coherent when it comes
to housing. And very sophisticated. Those in the financial world see themselves
as the predators. Those seeking housing are the prey. The sophistication comes
with how the predators construct and market their financial products to the
prey, as well as to the various mediators, go-betweens, and overseers that
foster these transactions.
For example, in the 1990s, the Clinton administration created a
collaboration called the National Partners in Homeownership (NPH). It was an
unprecedented collaboration of regulators and the regulated: federal
departments like the Treasury and the FDIC and private sector organizations
like the Mortgage Bankers Association and America’s Community Bankers. The goal
of this initiative was to increase home ownership levels by making homes more
affordable for more people.
To that end, they merely expanded the playbook first developed
in the Great Depression and then redeployed during the first decades of the
postwar Suburban Experiment. For example, NPH called for a reduction of down
payments. Fannie Mae—at that time a privately-owned Government Sponsored Entity
(a private business with government backing)—responded by reducing down payment
requirements from 10% to 3%. In 2001, Fannie Mae entirely eliminated the need
for a down payment on mortgages they purchased.
Obviously, lower down payments mean less skin in the game for
home purchasers, which means greater risk for lenders. The NPH called on the
insurance market to address this risk by expanding the use of private mortgage
insurance. Insurers such as American International Group (AIG) stepped up their
issuance of these policies. (Spoiler: That didn’t end well for AIG or for the
federal government.)
Another NPH innovation was the credit score. Up to this point,
qualifying for a mortgage meant meeting with a banker for a very intimate and
very intense underwriting process. With one human sitting in judgment of
another human’s ability to assume a mortgage, all of the human failings—all of
the -isms—crept into the process. An algorithm that calculated a credit
score for each borrower was considered a much cleaner way to evaluate
worthiness.
Conveniently, it was also a great way to issue more debt,
especially to poorer people. Frank Raines, who was the chairman of Fannie Mae
at the time, claimed that “lower-income families have credit histories that are
just as strong as wealthier families.” LOL. Raines put Fannie Mae’s
(government-backed) money where his mouth was by increasing the amount of
ultra-low down payment mortgages Fannie Mae purchased by 40 times in the
1990s.
With others joining in, the
housing market soared, both in terms of the number of people who purchased
homes (goal achieved) and the price of that housing (goal achieved). Here’s the
Case Shiller home price index from 1995 through the start of 2008.
This
orgy of debt and price appreciation didn’t end well for Fannie Mae. Or, perhaps
it did. In September 2008, as one part of the larger subprime housing crisis,
Fannie Mae was rescued/nationalized and placed under the control of the federal
government. It has remained nationalized for more than 15 years now.
Last month, Fannie Mae
announced the launch of a “Single-Family Social Bond Framework,” a
set of criteria used to create a financial product they call a Social MBS. This
is marketing to investors, letting them know that they can feel good about
putting their money where their heart is. By investing in Fannie Mae’s Social
MBS, investors are helping allocate more credit in support of affordable
housing so that “more people have better access to credit.” Fannie Mae’s
marketing suggests they are working on the challenges of the housing market,
especially those challenges “that disproportionately burden lower- and
moderate-income borrowers and renters.”
This is the kind of thing you’d
see in a Super Bowl commercial, complete with a compelling profile of the
family being assisted by Fannie Mae’s lending program. It is also the kind of
marketing that soothes the concerns of many housing advocates, just enough to
keep the focus elsewhere (like those greedy developers). Show me the numbers,
Fannie Mae, and they responded with a Social Index Score
that does just that. It’s great marketing.
Want
a real commercial—not the kind you’ll see during the Super Bowl, but the kind
experienced in cities all across North America?
In Detroit, there is a house occupied by a family paying rent to
a landlord. That landlord acquired the house through the tax foreclosure
process. The landlord may have paid $15,000 for it at a tax auction; the family
now pays $700 a month to live there. It is likely that the same family paying
rent now was living there when the prior landlord—whose business plan included
not paying their taxes—defaulted and lost the home in tax foreclosure, a
process that takes five years in Michigan (in this instance, not paying your
taxes for five years is simply a wise business strategy).
Take the $15,000 purchase price and divide by $700 per month in rent. That’s a tad more than 21 months, less than two years. The family living in that house could have owned it outright in less than two years had they been the ones to purchase it. So, why didn’t they?
The
answer is simple: there is no financial product to facilitate that transaction.
Fannie Mae, despite the marketing of a Social Good MBS, is not going to
purchase that mortgage. The margins are just too small. They won’t purchase it
and so nobody originates it; that’s how vertically oriented local banks are.
There are hundreds of thousands, perhaps millions, of these transactions that
could happen—all of them profitable and socially beneficial—but Fannie Mae has
no real financial incentive to bundle them up, securitize them, and create a
secondary market for their purchase. So, they don’t happen.
Not only are the margins too small, but a proliferation of this
product (an entry-level housing product at a much lower price point) undermines
the entire foundation of housing finance and, by extension, the entire
foundation of our banking system (because securitized mortgages make up such a
large percentage of bank reserves). It undermines everything because such a
broadly affordable product will slow, perhaps even reverse, housing price
appreciation. That is also bad for Fannie Mae.
Fannie Mae, and all the other purveyors of centralized capital,
are not interested in pursuing strategies that make housing broadly affordable.
In fact, they will oppose any policy that actually makes prices go down. They
are happy to provide more loans to more people, to increase the amount of debt
we consume as a society because that makes housing prices go up, which is what
centralized capital requires.
They are happy to listen to the housing advocacy
conversation if only to discern just how to market their financial products in
the most socially affirming way possible.
This whole thing won’t change until that Detroit family can
easily finance the $15,000 foreclosed home they are paying rent on, a
transaction that requires less capital than most auto loans. This is not a
liquidity problem. It won’t be solved by lowering interest rates or printing
more money. It can’t be fixed by originating more mortgages to securitize, by
lowering down payments, or by extending terms to riskier borrowers.
This is a structural problem. It is the result of a social, political, and financial system that is centralized and top-down. The next Strong Towns book, Escaping the Housing Trap, comes out on April 23. With it comes a transformative conversation about the power of bottom-up action to change the way housing is done in North America.
https://www.strongtowns.org/journal/2024/3/4/how-fannie-mae-puts-a-chokehold