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The U.S. Starts to Rebuild its Housing Finance Market

Last week I wrote about Canada’s real estate market and its financial underpinnings; the take away from the article was that, because of a cautious and conservative banking and regulatory approach, the Canadian real property market has remained stable – indeed growing slightly—during our “Great Recession”. Any direct comparison, of course, must be tempered by the fact that Canada’s population and economy is only about 10% of that of the U.S. (around 34 million to 310 million citizens, and $1.5T to $14.2T GDP). Nevertheless, it is clear that the U.S. mortgage finance system is broken, and the Congress and Administration are debating how to fix it. Even in the current partisan political climate, some outlines of the end result are now emerging. And the end result will certainly not look like the system we knew in the past.

First, let’s look at how the U.S. residential real estate market is doing currently.

In spite of easing a bit this month, U.S. mortgage rates are slightly above those of this time last year (but only about .05%), and home prices continue to fall. Zillow calculates the decrease to be 2.6% nationally in the last quarter, but NAR calculates a very slight increase. However, because of the statistical methods NAR uses to calculate sales, there is currently some discussion that their figures may be skewed in dramatically falling markets – like the ones we are experiencing now. According to the latest Case-Schiller model, U.S. home prices fell about 4.1% over last year. Foreclosures, according to RealtyTrac were up in January, increasing 12 percent compared to the previous month but down 11 percent from a year ago; banks foreclosed on over 78,000 houses in January.

Regardless of the statistics chosen, however, Moody’s home affordability index has fallen to levels comparable to pre 2003 levels. This, combined with continuing low interest rates should spur home sales, except for the still weak economy, high unemployment, and low consumer sentiment which are clearly holding down any upsurge. Another drag on home sales is the uncertainty in the lending market.  Banks are simply not clear what the rules are going to be regarding the initiation, processing, and selling or securitization of mortgage loans; this, combined with uncertainties regarding their current liabilities arising out of past mortgages (and mortgage pools or securities) has created an atmosphere which is not conducive to lending. Those loans which are being made are tightly underwritten, or are backed by the federal government.

The traditional buyers of mortgages, the GSEs (Fannie Mae and Freddy Mac) are in federal receivership, i.e., they are owned by the government, and are regulated by the newly created Federal Housing Finance Administration (FHFA). Both GSEs continue to lose billions in assets as the value of the mortgages they own or guarantee continues to fall; it is the taxpayer who is picking up much of the losses. The GSEs continue to buy loans, though.

The federal government’s most active participant in the housing finance market these days is the FHA program, which was originally designed to help low income and first time buyers purchase homes. It does this by mandating strict underwriting standards, then guaranteeing the loans. The FHA suffered losses, too, as the market went south, but traditionally its exposure, because of the underwriting standards and low mortgage limits, was less than the GSEs. However, the FHA has become at least in part a substitute for the GSEs in the current lending market, and the maximum mortgages it will guarantee has been substantially increased to reflect prices in the different market areas; in 2005 the largest mortgage it would guarantee was about $360K, currently it is about $730K. Needless to say, it has incurred losses as the maximum amounts have increased while house values have plummeted.

No one believes that the current situation is acceptable or sustainable, but like every thorny issue, everyone has an opinion on how to fix it, many of which are wildly contradictory. Here are what I believe are the contenders.

First, there have recently been studies of the FHA system which suggest that it is not necessary for that agency to guarantee such large mortgages in order to fulfill its mandate. The latest and one of the best was done by the George Washington University School of Business and can be found at Basically it takes the position that the FHA should only lend up to $100K over the local median market price, and that it should increase down payment requirements to at least 5%. What makes this article emphatic is that it shows that the FHA, as currently operated and funded, will not be able to anchor the U.S. mortgage market, and that further expansion risks the same meltdown as just occurred with the GSEs.

Any changes of FHA requirements need to be approved by Congress, which is unlikely to make dramatic modifications until the larger issue of housing finance is settled upon. To that end, the U.S. Treasury Department recently presented its analysis and proposals regarding the restructure of the GSEs. The document, entitled Reforming America’s Housing Finance Market, can be found at  The report presents several alternatives, but recommends that the GSEs be at least partially privatized, and that the only government entities that should offer mortgage guarantees should be the FHA, Department of Agriculture, and Department of Veterans Affairs.  

The Treasury report does discuss the option of some limited federal mortgage guarantees, including a backup guarantee for hard economic times, it discusses the need to increase bank capital requirements to cover future real estate fluctuations, and it discusses the option of adding increased guarantee costs and higher down payments to house purchases in order to buttress the paper against economic jolts. A final option, according to the Treasury would be to continue with federal mortgage guarantees, with the costs passed on the purchaser, lender, or both.

Of course the Treasury report contains a detailed analysis of the failings of the GSEs, as well as its recitation of policy options; a good summary of the technical analysis can be found at

While most observers seem to accept the demise of the GSEs as publicly backed entities, there is opposition from many constituencies, including community banks that use GSE products to back mortgages they make, and even from housing organizations representing low income buyers and minorities. This opposition will likely provoke a sharp fight in Congress, and may shape the final legislation to include some future government participation.

Interestingly, the NAR takes the position that some government participation in the GSEs is necessary in the secondary market as the GSEs are wound down, and even afterwards to ensure capital flows to the mortgage market in periods of economic downturn. It has other recommendations, too, all of which can be found at

Washington is by definition a political town, and the current period is as partisan as it has been in a long time. Nevertheless, it seems clear that the Congress will soon address the real estate finance market, and more likely than not it will at least partially privatize the GSEs. The inevitable result will be that the costs of mortgages will go up, but that money will become more available for home purchases. When the end result will become a reality, however, is anyone’s guess. Personally, I would not bet on it happening anytime soon, but would not be surprised if we do not see some bipartisan legislation by the end of the year or the first of next year.

The bottom line for the domestic employee mobility industry is that current policies regarding home sales, home purchases, and their options will most likely not need to be changed this year. However, all those involved in home sale policies should keep informed of what the Congress is up to since a dramatic change in housing finance will have an effect on real estate sales, in one way or another.


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