Credit Where It's Not Due
February 10, 2004
By Howard Husock
When the Senate Banking Committee holds its hearings today on regulation of Fannie Mae and Freddie Mac, members should keep foremost in mind the determination by a December Federal Reserve study that the secondary mortgage giants provide little or no benefit to homebuyers, while costing taxpayers billions.
This must now serve as the first argument for their eventual privatization. But it is not the only argument. Public support has not only enriched stockholders at taxpayer expense but has provided the rationale for a system of regulatory mandates which seek to use the vast mortgage capital pool as an instrument of unwise social policy. In the name of expanding home-ownership and assisting low-income and inner city households, these mandates risk undermining the crucial habits of thrift and frugality so important to upward mobility -- and replacing them with the fools' gold of easy credit.
Here's how the system works. In exchange for their status as "government-sponsored enterprises" -- and the credit market advantages which come from the perception that the government will not allow them to fail -- Fannie and Freddie are subject to so-called "affordable housing goals." These mortgage purchase quotas, set by the Department of Housing and Urban Development (HUD), require that no less than 50% of the mortgages purchased by Fannie and Freddie be for low and moderate-income households, that 20% be specifically for those of low income, and that 31% come from "geographically targeted underserved areas." These figures represent substantial increases adopted in the waning days of the Clinton administration.
What could be wrong with what seem to be laudable goals? A great deal. They are based in a big lie which a national coalition of anti-banking groups has circulated for years: that the private mortgage markets would, left to their own devices, deny credit to those of modest means in less than affluent neighborhoods -- a charge known as red-lining when it first surfaced in the 1970s. The best that can be said for this is that there was a time, before the bank deregulation of the early '80s, when banks had little incentive to serve riskier markets and often did not. But that is ancient history in the mortgage industry -- which now uses computerized credit scoring, flexible interest rates and mortgage-backed securities to serve almost anyone. The advent of sub-prime -- read higher-interest -- lending has brought credit to higher-risk households once outside the mainstream financial system. They have helped push up the American rate of home-ownership to its record high of 68.4%. Indeed, between 1993 and 2001, 1.4 million Americans bought homes with sub-prime loans.
But the bank-haters -- including activist groups like ACORN, the Greenlining Institute, and National Community Reinvestment Coalition, whose collective raison d'etre lies in the supposed market failure of the mortgage lending industry -- don't see all this as an advance at all. With HUD oversight, they pressure Fannie and Freddie not to purchase sub-prime loans, which are denounced as "predatory." They have pushed a wave of "anti-predatory" lending legislation through state legislatures, based in such vague criteria that rating agencies, fearful of potential liability, have said they can't rate the risk of mortgage bonds which include sub-prime loans. Were it not for the courageous decision by Comptroller of the Currency John Hawke to exempt nationally chartered banks from these state laws, sub-prime mortgage lending might well dry up. Mr. Hawke was undeterred by threats of lawsuits by Eliot Spitzer, and his Connecticut counterpart Richard Blumenthal.
The agenda here is a demand for credit on easy terms for areas and households which are, in the liberal imagination, uniformly victims of an unjust economic system -- rather than being seen as individuals, some of whom deserve credit on favorable terms, some of whom don't. With HUD pressure to meet the affordable housing goals, and high-interest loans castigated as predatory, both the banks -- which want to sell mortgages to Fannie and Freddie -- and the secondary giants themselves, which want to retain government support, have reason to let easy credit flow, willy-nilly, to target populations.
Therein lies the real danger of the affordable housing goals. They provide a powerful incentive to say yes to mortgage applications to which it might be better for lenders to say no. It is, after all, better to say no when a household has not saved a sufficient down payment or lacks a reliable income stream. "No," under such circumstances -- and said with an explanation -- is a way of saying, If you improve your creditworthiness, you can get a mortgage. Saying no is also a protection for those who already own homes in a neighborhood. Foreclosures -- the bitter fruit of easy credit -- are bad news for neighboring homeowners who are making their mortgage payments and hoping the value of their home will increase. This is the virtuous circle that arises from traditional credit criteria, and is threatened by "affordable housing goals."
That's been the story with another easy-credit mortgage program, that of the Federal Housing Administration, notable for their "flexible qualifying guidelines" designed to help low-income households. Down payments are 3% or less, with loans insured by the federal government. The delinquency rates for FHA loans runs over 12%, more than four times the 2.93% rate for prime rate loans. And problematic FHA loans have been shown to be concentrated in lower-income urban neighborhoods.
The Fed has found that higher-than-conventional foreclosure rates also typify so-called Community Reinvestment Act (CRA) "special lending programs" -- a geographically targeted program which banks adopt to fulfill the Act's lending mandates. Like the Fannie and Freddie affordable housing goals, the CRA is built on the false premise of an anti-poor conspiracy by the financial industry; and it allows non-profit mortgage lenders like the Neighborhood Assistance Corporation of America to gain the right to administer huge pools of mortgage money on behalf of fearful banks.
It's true that the delinquency rates for sub-prime mortgages are also high (11+%); but at least these loans hold the prospect of encouraging households to learn from their mistakes and qualify for better credit rates next time. The easy credit of the Fannie and Freddie affordable housing goals breaks the link between personal habits and creditworthiness. Public subsidy for Fannie and Freddie merely gives those who would pervert mortgage markets the chance to make credit seem like an entitlement.
Mr. Husock, a contributing editor to City Journal, is the author of "America's Trillion-Dollar Housing Mistake" (Ivan Dee, 2003).
©2004 The Wall Street Journal
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