The past month has yielded a host of negative news about housing. And despite the range of federal programs to save the housing market, we are currently faced with five big problems:(1) housing prices—I say they are still unsustainably inflated, others say they are too low; (2) supply glut of homes, both new and existing houses; (3) a shadow inventory of homes that has yet to hit the market, distorting supply and price indicators; (4) an attack on mortgage servicers by vindictive regulators and state Attorneys General, though some say it is the mortgage servicers who are the problem, but either way this unresolved issue is clogging the foreclosure pipeline and distorting supply and price signals; and (5) Fannie Mae and Freddie Mac support 90% of new mortgages today, continue to be a leach on the taxpayers, and are years away from being appropriately dealt with by Congress.
Addressing all of that is a tall order to say the least, so on one level it is understandable why the government hasn't "fixed" all our problems. But there still needs to be a solution (so GOP Presidential candidates, heads up).
What would the free market approach be to robust reform for the housing market in America? There are a number of moving parts but here is a basic overview.
First, put Fannie and Freddie on a five year path towards sunsetting their charters. This would eliminate the governments support for 90% of mortgages originated today and allow the private sector back into the market. It would remove government subsidies for mortgages meaning there would likely be an increase in mortgage prices. However, mortgage prices saw a 100 basis point swing last year without the world ending. And with prices so low today, it is highly unlikely they would reset beyond their 30-year average. See this article and my congressional testimony for more details available on how this would work.
Second, end Making Home Affordable Programs (including HAMP) to declog the foreclosure pipeline and unwind the shadow inventory of homes. This would mean in the near term an uptick in the number of foreclosures, but the failure of HAMP has just spaced out those foreclosures over the past several years. Having those homes go through foreclosure and out onto the market would impact price by changing the supply of homes available and yield a more free market price.
Third, end the Fed's artificially low interest rate policy to let the cost of mortgages rise to their actual market pricing. This would cause housing prices to dip further, but lower prices mean more sales. It also would mean more homes would be underwater. This is only a problem in the near-term if people start to abandon their homes. But if homes were overpaid for and homeowners are going to abandon their homes when the real price is reflected in their purchase, better have it out now rather than dragged out because prices either are going to get back to their historical norm and grow stably from there, or we are going to have another price bubble.
Fourth, end the Mortgage Interest Deduction and capital gains exemption for housing investment returns. These tax code issues have distorted housing demand, done little to promote homeownership, and have been a massive cost burden on the taxpayers as a whole.
Fifth, pass legislation that would allow a covered bonds market to function in the U.S., as well as other new forms of mortgage financing. This could help private capital start flowing back to the mortgage finance market and turn the ship around.
Sixth, have state AGs finish their investigation of mortgage servicers, levy a fine on companies that improperly foreclosed on families without legal standing, fine companies that violated terms in their contracts for communication with customers on refinances and modifications, and then be done with the investigation. They should cease efforts to create a uniform mortgage servicing code and they should not attempt to use this as a chance to extract a pound of flesh from financial institutions that participated in causing the economic crisis..
Seventh, create a market-organized Mortgage Underwriting Standards Board (MUSB) on a model like FASB to have the industry establish guidelines and definitions for types of mortgages and securitization so that investors have better awareness of what they are purchasing when buying mortgage securities (and so the government doesn't try to define mortgage quality itself, like it is trying to do through QRMs).
In the spirit of clarity, here is what I foresee the housing market looking like over the next year if all seven of these steps were put in place today: we would see a surge in foreclosures, an increase in mortgage prices (though how much is really unclear, it probably wouldn't be greater than the 30-year average), and lower housing prices (though they are still well above the historical norm anyway, and that historical norm included subsidies so further declines are a good thing for future stability).
In short, a free market reform of the housing market means felling all the pain now that is scheduled to be inflicted on us over the next 10 years, so we can get down to stable and sustainable growth. It may not sound like a winning agenda for most any politician—particularly because means pulling back government programs and letting the market adjust itself (cliche recognized)—but it is the bulk of how we get the housing sector back on its feet.
P.s. We probably also have to fix Dodd-Frank and the bankruptcy code so TBTF really is dead. But that is a broader question of which housing finance is just a part.