They won't put it this way, of course, but the Obama administration is looking for a return to a more Bush-like approach to regulating the mortgage industry as a way to boost the economy — and it might work. A burst of federal spending or a broad-based temporary tax cut would also likely do the trick, but the current Congress has no intention of agreeing to any form of fiscal stimulus that progressives would find acceptable. The congressional gridlock problem has existed across the board, of course, leading Obama to counter with a series of "we can't wait" executive actions. But on broad economic stimulus, no clear path to such executive action has existed.
Until now, that is, when recently installed Federal Housing Finance Administration chief Mel Watt is prepared to roll out a series of new Fannie Mae and Freddie Mac measures that should give the economy a kick in the pants. The only problem is, they just might lay the groundwork for the next crisis.
Fannie & Freddie, a brief (I promise) history
Decades ago, the government created two agencies, Fannie Mae and Freddie Mac, charged with subsidizing the home mortgage industry. They did this by buying mortgages from banks and then repackaging them. Then in the 1960s, to make the national debt look smaller, the government privatized these companies and turned them into for-profit companies.
But Fannie and Freddie always enjoyed a kind of wink-and-nod federal guarantee, and they remained enmeshed in the political system. This quasi-guarantee served as a subsidy to the whole system — in the event of an unlikely epic collapse in the national housing market, Uncle Sam would pay the tab. Absorbing that tail risk made mortgage interest rates cheaper for everyone. Then came the epic collapse, and then came a bailout.
Since the bailout, the government has not formally taken ownership of Fannie and Freddie. But they are effectively controlled by a regulator — the FHFA — set up by the Bush administration. All of Fannie and Freddie's profits are "swept" into the Treasury.
If the White House had a free hand in budgetary matters, those profits might go to finance useful spending. But given congressional gridlock, they simply make the deficit smaller than it might otherwise be at a time when the deficit is not a problem. For a long time, the FHFA had no confirmed director and was led instead by Edward DeMarco, a career civil servant who took the narrow view that his job was to protect the government's financial investment in Fannie and Freddie. But since January of this year, Watt — a former Democratic member of Congress from North Carolina who has ties to House liberals but also to the banking industry — has been running the show. And on October 20, he gave a really important speech.
The significance of the speech is that the FHFA is going to be less of a tight-ass in a number of regards, essentially upping the level of subsidy that is provided to mortgage lenders. This will make it cheaper for some wannabe home buyers to buy homes, it will increase the value of some existing homeowners' houses, and it will generate plenty of profit-seeking opportunities for realtors and banks.
One important change relates to mortgage buybacks. If a bank sells a mortgage to Fannie or Freddie and then it turns out not to meet Fannie/Freddie standards, the banks can be made to buy the loan back. Generally speaking, however, this can only happen within a 3-year window. But there is an exception for cases of fraud, an exception that's cost banks billions during recent litigation. Watt said he will be "setting a minimum number of loans that must be identified with misrepresentations or data inaccuracies to trigger the life-of-loan exclusion." In other words, a small number of fishy loans will be written off as just an innocent mistake. It's only a really big stack of misrepresentations that will lead to action. Watt also wants Fannie and Freddie to start buying riskier loans — loans with down payments as low as 3 percent, a move bolstered by similar action from other regulators.
In both cases, the boost to the economy, though modest, should be real. By assuming the financial risk if things go bad in the future, Fannie and Freddie will increase the onward rush of funds in the present. Best of all, it can be done purely through executive action. At a time when the unemployment rate remains elevated and inflation is complacent, it's an attractive proposition.
A dysfunctional housing policy
Unfortunately, it's also a proposition that exacerbates and entrenches everything that's wrong with the past generation of housing policy. There are two real ways to make houses more affordable. One is rising wages, and the other is greater abundance of housing supply. Tinkering with credit policy offers a short-term boost, but doesn't do anything to address the underlying issues.
At the same time, it's an awfully odd way to give the economy a short-term boost. If the government wants to subsidize new home purchases, it could offer a $1,000 rebate check to anyone who buys a new home. Even better, we could offer a $1,000 check to everyone and let them buy whatever they want with it. The difference is that cutting checks would require a new spending authorization, while Watt's actions are "free."
But "free" in this case simply means that the costs are hidden. If you let banks pass on the costs of improperly documented or excessively risky loans, that simply means the US government is assuming those costs. In any given year the odds of a giant house price crash are low, so no actual costs will be incurred. But every once in a while these things do blow up, and the bailout bill arrives.
This hide-the-ball approach to goosing the economy has some political appeal. But it also creates lots of opportunities for bankers and other industry players to ride high on the hog during the good times, and pass the buck for their own misbehavior during the bad. The particular actions announced this week aren't going to fully bring "the bad old days" back, but they do reflect the exact same mentality that governed Bush-era housing policy — let credit flow at all costs and don't worry about the rest.