By Joseph Pigg
ABA Viewpoint
One of several contributing factors to the 2007-08 housing crunch and recession was the practice of “equity stripping,” when homeowners used the equity in their homes to purchase other goods and services. When home values fell, many borrowers who had accessed that equity were left deep under water, owing far more than the house was worth.
Rampant equity stripping hurt borrowers, lenders—and ultimately taxpayers, who backed many of these loans through the government-sponsored enterprises Fannie Mae and Freddie Mac. So extreme was the damage to the GSEs that they had to be bailed out by taxpayers in the fall of 2008 and put into conservatorship — where they remain to this day.
In fact, so derelict were Fannie and Freddie in adding risk to the housing bubble that the Dodd-Frank Act eliminated its low-profile regulator, the Office of Federal Housing Enterprise Oversight, and replaced it with a beefed-up Federal Housing Finance Agency.
Sixteen years after Fannie and Freddie were forced into conservatorship, FHFA has made a new decision that calls into question its regulatory judgment and awareness of the reason for its existence. Recently, FHFA conditionally approved a new program from Freddie Mac to purchase second liens on loans where Freddie already owns the first lien. The decision brings back bad memories of mistakes made during the financial crisis.
While placing conditions that limit the deployment of the new program, FHFA’s approved the initiative even though the new product does not meet a need that is not already being met by the private market. Moreover, Freddie has not demonstrated that the program will bring cost savings to borrowers that are not already being provided by the private market.
FHFA’s core mission is to protect the safety and soundness of Fannie, Freddie and the Federal Home Loan Banks, so they can pursue their congressionally mandated mission of enhancing housing access. However, there is no evidence that this program will benefit low-to-moderate-income borrowers consistent with Freddie’s mission. The new offering does nothing to ameliorate the ongoing and serious home affordability crisis, and it may in fact disturb the primary mortgage market, not stabilize it.
Here’s why: When banks make second-lien loans and hold them on their books, they have “skin in the game” that makes them cautious in extending credit. The newfound ability for lenders — in particular the nonbank mortgage lenders that account for a majority of mortgage lending in the post-Dodd-Frank environment — to push off loan risk to Freddie, and by extension taxpayers, means that lenders will be less likely to lend with appropriate caution.
We’ve seen this movie before. Borrowers and taxpayers were the ones who paid the bill for the enterprises’ recklessness during the financial crisis.
Sixteen years later, neither Freddie Mac nor Fannie Mae has rebuilt sufficient capital to a level that is necessary for a safe and sound standalone operation. And yet, their regulator (and conservator!) has decided that it is fine for one of them to repeat one of the signal mistakes that led to their failure.
Congress should take note. If FHFA is willing to take this gamble with Freddie Mac’s finances, what other reforms to rein in the GSEs might they undo next? It is time for Congress to step in, fulfill its oversight obligations and stop this program before it does any damage. The one thing we should have all learned from the financial crisis is not to repeat some of the very mistakes that caused it.
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