Housing Finance Policy and the Coming Recession: Time to use current system to lower mortgage payments!

Devajyoti “Doc” Ghose, Advisor, Kah Capital Management; Treasurer (Retired) Freddie Mac

Edward Golding, Executive Director MIT Golub Center for Finance and Policy; Former Head of FHA

Housing finance policy has been built during and for times of crisis. Just look at the long list of government actions related to the financing of housing: Homestead Act of 1862 during the Civil War, the Federal Home Loan Bank Act of 1932, the National Housing Act of 1934 that created FHA and FSLIC and amended in 1938 to establish Fannie Mae during the Great Depression, and even the Emergency Home Finance Act of 1970 that created Freddie Mac. Today we face another crisis ─ a health crisis that now threatens the economy and financial markets. We offer some thoughts on what this portends for housing finance.

First, as long-term rates plummet with 10-year Treasuries hovering at 1 percent and mortgages near 3 percent, mortgage refinances will skyrocket, with refinance volume potentially pushing mortgage origination to levels not seen since the 2003 peak of $3.9 Trillion. The system is built to handle higher volumes, although bottlenecks and the disruptions caused by COVID-19 are slowing the origination process and temporarily raising mortgage rates. The good news is that each $1 trillion of refinancing with an average lower mortgage rate of 1.5% will put $15 billion more in the pockets of homeowners each year. Here the Fed has just taken an important step by announcing that it will buy mortgage-backed securities (MBS), ensuring that the yield on MBS remains low, thereby allowing homeowners to benefit from the low rates. More action is also needed to remove impediments on the origination side.

Second, many homeowners are losing their jobs and won’t be able to refinance. For these homeowners, FHA and the GSEs are offering 12-month forbearance. While the details of forbearance are handled on a case-by-case basis, in general, those having difficulty making mortgage payments can cease making payments for up to a year with no adverse consequences during that year. Then the forgone payments are typically added to the mortgage balance, although that amount can be forgiven in a loan modification.

We suggest it is time to be bolder. These borrowers will not benefit from today’s low interest rates in the market and face uncertainty as to what happens in a year. Refinance them into a mortgage that has no principal and interest payments for a year, then becomes a 30-year fixed rate mortgage. We estimate that the GSEs could offer this mortgage to current GSE borrowers at a fixed rate of 3.5 to 3.75%. (This estimate takes into account that the GSEs already have the default risk on the current mortgage.)  Homeowners would have certainty as to their payments, pay nothing for a year, and still have a lower rate in the out years. One lesson from the 2008 financial crisis was that we put too many impediments initially in the HARP program. We should not do this again.

FHA will have a harder time offering a similar product and will need legislative flexibility to offer more assistance to unemployed borrowers. Furthermore, the non-qualified mortgages that were securitized, while not many, will unfortunately face many of the same problems we saw in the 2008 financial crisis.

Third, the GSEs need the caps on their portfolios lifted in order to offer this consumer-friendly refi mortgage and other innovative products. It takes too long to build an MBS market for new products. Allowing the GSEs to purchase these mortgages for their own portfolio will speed time to market.  

An added benefit of lifting the caps on the GSE portfolios is that it would increase demand for MBS and reduce mortgage rates. While the Federal Reserve announced that it will buy MBS, the GSEs have a better infrastructure for buying, holding and hedging MBS – expertise that should be put to work in this crisis.

Fourth, the market for credit risk transfer (CRT) bonds is unravelling. Bonds that had a yield of 4 percent three months ago now require yields of over 15 percent, if available at all. And with lower interest rates, many of the outstanding bonds will be paid down as the stronger borrowers refinance their loans and exit the pool. Just as many critics argued, this protection is available only in good times. In bad times, this business model runs counter to the purposes of the GSEs to stabilize housing finance. The CRT bonds that are in circulation today were priced for risk but did not include a sufficient premium for uncorrelated uncertainty such as a one-in-a-hundred-year pandemic. The experience of CRTs in this market should be incorporated into any future decisions on the housing finance system, which brings us to our last point.

Fifth, housing finance reform plans, both administrative and legislative reforms, will be postponed indefinitely. We have a system built to handle crises. We have a crisis. Use the institutions we have that actually have worked and can again.

In good times, almost any housing finance system will suffice. In times of crises, we need a system that can rise to the occasion. We have a fairly good system built over past crises and we suggest ways that this system needs to respond boldly for today’s crisis. Give all homeowners the benefit of lower mortgage rates available in the market and defer mortgage payments for those who have been adversely affected by enabling innovative products.  

One reason why COVID-19 is so virulent in its impact on the economy is that nobody knows who has the virus and who doesn’t; who could be a carrier and who is not. In that sense, in addition to being a health crisis, this is a crisis of belief – the essence of panic.  At a time like this, the public and the financial markets need to believe in the stability of the financial system just as they need to believe in the stability of the health care system. The GSEs, FHA, and the existing housing finance system are capable of providing stability and reassurance to investors and homeowners.  Let them innovate, lead, and be a part of the solution.