Gimme Shelter: The Future of the U.S. Housing Market
Published November 22, 2013
Updated On May 12, 2015
Deputy Director of the Economic Program
Chief Economist, Moody’s Analytics
Location: 385 Russell Senate Office Building, Washington, D.C.
Time: 12:00 p.m. EST
Date: Friday, November 22, 2013
Federal News Service
LAUREN OPPENHEIMER: I wanted to welcome everyone to today’s Capital Markets 101. I’m Lauren Oppenheimer and I head up Third Way’s Capital Markets Initiative. We decided to launch the Capital Markets – Capital Markets Initiative two and a half years ago. And want to promote balanced, nonpartisan and, above all, informative and accessible written products. Our only bias is that we believe healthy, well-functioning capital markets benefit the economy and average Americans. The rest is up for debate.
I’m thrilled to welcome back today’s speaker, Mark Zandi. In 2011 Mark was our inaugural speaker for the Capital Markets 101 series. And before I introduce Mark, I just wanted to let you know, it looks like you all have food, but there’s – there is food in the back. We’re going to have a question and answer period at the end, and there’s a microphone over there, but if you do have questions during the session, feel free to ask. And lastly, thank you so much for coming. This is a really tremendous turnout. And we know you’re very busy right before Thanksgiving, so thanks a lot.
As I mentioned, our special guest today is Mark Zandi. And he’ll be speaking on the future of the U.S. housing market. He’s one of the nation’s most influential, respected and sought-after economists. He also co-founded economy.com and has written two books. As chief economist of Moody’s Analytics, Mark often testifies before Congress, and actually did so just this morning. He came over here from the Senate Banking Committee. So thank you for joining us. Mark has a knack for boiling down complicated economic concepts into digestible tidbits. He earned his Ph.D. from the University of Pennsylvania and his bachelor’s at the Wharton School. So please help me in welcoming Mark Zandi. (Applause.)
MARK ZANDI: Thank you, Lauren. Thank you, Jim. Thank you, Third Way, for the opportunity. Thank you for the two hours to speak. That’s really kind. (Laughter.) No, nothing worse than an economist for – I can speak for three days or three minutes. How about – how about 15, 20 minutes? And then I’ll turn it back to you.
Actually, because I don’t know sort of the level of attention you’ve given this issue. So before I dive in, what can I help you with? What would you like me to – what questions do you have? What’s bothering you about this issue? Just give me a sense of where I should go with, because this is a big topic. There’s a lot of moving parts. Anything in particular up front you want me to talk about?
Yeah, all the way in the back.
Q: Which housing firm should we invest in?
MR. ZANDI: Really? (Laughter.) Really? You want personal investment advice? (Laughter.) I’ve got a great stock for you. MCO – no, I’m only kidding. (Laughter.) That’s Moody’s, by the way. And I should say – I should – I am an employee of the Moody’s corporation. The views I express here are my own. I’ve been part of Moody’s for eight years. I actually sold my company to Moody’s eight years ago almost to the day – almost to the day. I’m also on the board of MGIC, that’s the nation’s largest mortgage insurer. So you need to know that. And I’m also on the board of TRF, that’s a large CDFI – one of the nation’s largest CDFIs, that does a lot of work in the northeast. It’s headquartered in Philadelphia, but does work from New York down to D.C.
Q: And this probably doesn’t help narrow it down at all, but can you talk about your vision for the future of GSEs?
MR. ZANDI: OK. Very good. An open – nice open-ended question. Very good. Yeah.
Q: Qualified mortgages and qualified residential mortgages.
MR. ZANDI: I’m sorry?
Q: Qualified mortgages?
MR. ZANDI: Yeah.
MR. ZANDI: QM mortgages and what impact that’ll have on the housing market? OK, very good. Yeah.
Q: Can you talk about what should trigger the – (inaudible)?
MR. ZANDI: I’m sorry, can you say that a little louder?
Q: What should trigger the – (inaudible) – guarantee?
MR. ZANDI: OK. Great. Good. Where should the government come in and provide this guarantee – yeah, the attachment.
MR. ZANDI: Ah, OK, very good. You’ve been reading the New York Fed work and now you have – (inaudible).
Q: Someone just handed me that question I just asked.
MR. ZANDI: Oh, is that right? (Laughter.) Because that was a very detailed question – it was a good question. OK. Yeah.
Q: Is it possible to preserve the 30-year mortgage without the government – (inaudible)?
MR. ZANDI: Is it possible to preserve the 30-year fixed rate, pre-payable mortgage without a government guarantee? Yeah. The answer is no. (Laughter.) Yeah. But I’ll get – that’s a great question. I’ll come back to that. Yeah. What else? Anything else? OK. Well, we’re a small enough group so if I say anything that prompts a question, please don’t hesitate. We’ll have – we’ll have time – plenty of time at the end.
I do have a slide show. I’m not sure I’m going to use it. But, Third Way, it’s yours. Feel free to distribute it, if you’re able to. If I see –
MS. OPPENHEIMER: It’s on our website.
MR. ZANDI: it’s on your website? OK. So if I see it on eBay I might be a little disappointed, but you know, feel free. (Laughter.) Well, let me begin by saying that the ultimate objective of housing finance reform is to move from the current system, which is effectively a nationalized system – 85 percent of all mortgage loans that are originated to purchase a home are originated effectively by the government, Fannie Mae, Freddie Mac, FHAVA – to a – to another system that has more private capital involved, that isn’t dominated by the government, and do this in a way that is not disruptive, that mortgage loans continue to get originated as they are now and to ensure that there’s affordable mortgage loans for creditworthy borrowers.
This is very important, obviously, to get right because the mortgage market’s key to the housing market and the housing market’s key to the economy. In fact, currently that’s even more – it’s even more true, that the economic recovery is not going to kick into a higher gear – we’re not going to get back to full employment anytime in the near future unless housing plays a leading role. And that’s not going to happen unless the mortgage finance system is operating well.
So – and moreover, the U.S. mortgage market is very large. There’s $10 trillion roughly in residential mortgage debt outstanding, single-family residential mortgage debt outstanding. And that’s a big part of the global financial system. So if that – the U.S. mortgage market is disrupted in any way, it would be the catalyst for global financial event. So this has to be done well.
Now, there are, broadly speaking, three approaches to this. One approach is essentially do nothing, maintain a nationalized system, you know, with some tweaks. You could ask Fannie Mae and Freddie Mac to remain part of the government, continue to provide mortgages as is, maybe require that they’re capitalized to a certain level to withstand certain losses but, you know, effectively take what Fannie and Freddie are doing and just keep it on the government’s balance sheet.
In fact, that’s a real possibility. You know, I wouldn’t say that’s the most likely scenario, but that’s a real possibility, in part because the system is – seems to be working. I mean, mortgage loans are getting originated at a relatively low rate. And Fannie Mae and Freddie Mac are now starting to make a lot of money. They’re very profitable, pretty close to paying back all the money that taxpayers put into them during the crisis.
And by early next year, all that money will be repaid that will be all going into the government – it’s already going into the government coffers. And that cash can be used to fund other things. So you know, politically if Fannie and Freddie aren’t – if reform isn’t accomplished soon and nothing changes, it’s going to be very, very difficult to change the system. We’re going to effectively end up where we are today.
What’s the downside of that? Well, the downside is it’s completely unnecessary. I mean, there’s plenty of private capital that’s interested in participating and, you know, taxpayers are going to be taking a boatload of risk here and it’s not necessary. We – the private markets are very capable of participating and in forming a viable house finance system. Another downside is Fannie Mae and Freddie Mac have about $5 trillion in debt.
So at some point if we nationalize the system, as I’ve just articulated it, that 5 trillion (dollars) comes on the government’s balance sheet, right? So effectively, the nation’s debt-to-GDP ratio goes from what it is today – publicly traded debt-to-GDP is 70, 75 percent – it’ll be 130, 140 percent – that would put is in the same scale as Italy, you know, something like that. So that – you know, I’m not sure how much we should worry about that but clearly that’s an issue.
Perhaps even more importantly than all – the other reasons is that these institutions, as part of the federal government, are becoming ossified. They’re in limbo status. And you know, they’re not really making decisions. And it’s having – it’s having consequences. You know, for example, currently it’s pretty tough to get a mortgage loan if you’re a first-time homebuyer. Just to give you a sense of that, the typical credit score for a loan to purchase a home that is sold to Fannie Mae as – is 760 – a 760 credit score. Just for context, how many of you guys know your credit score? How many is over 760? No, don’t answer that. (Laughter.) But only one-third of Americans have credit scores above 760. So that’s where the market is right now.
In a more typical environment, the score is about 700. That’s right in the middle of distribution of scores. So the market’s very tight. This really hasn’t been an issue for the housing recovery to date because most of the improvement in the recovery has been driven by investors coming into markets and scarfing up property cheaply, fixing the property and renting. And they’ve been using cash to make those purchases. They aren’t using mortgages. But if the housing recovery is going to continue on and add to the economic recovery, which everyone’s counting on, we need to see first-time homebuyers step up. And they can’t step up in the current credit environment. The credit underwriting is too tight.
And that’s party because Fannie Mae – there’s various reasons for that, but one of the reasons is Fannie Mae and Freddie Mac are very slow to change some of the ways they deal with lenders with regard to their reps and warranties. I won’t go into unless you ask, but it’s making the lenders very nervous. They want more clarity with respect to this process. And because they don’t have that clarity, they’re being very, very cautious in their lending.
Now, I do expect Fannie Mae and Freddie Mac to ultimately adjust, change and to ease lenders’ concerns. And we’ll start to see credit flow more normally. But one of the reasons why that hasn’t happened to date is because they’re part of the federal government and it’s just a very, very slow process and there’s no competition and they’re not – they’re not moving – or they’re not moving.
This brings up QM. You know, QM is a matter of some concern. I think longer run – the idea behind QM is that it defines what is an affordable mortgage loan. So this is a CFPB rule. And they lay out very clearly what qualifies for being a QM loan, what qualifies as being a loan that is affordable. If a lender originates a QM loan, then it’s protected legally. It’s going to be very difficult for a borrower to sue and say, look, you gave me a loan under bad terms and you have to compensate for that bad lending. So it is very important to the legal status of the loan itself.
The QM definition is pretty tight. And so some of the lenders say it’s very tight. And we’ll get a sense of that in January when the QM rule, at this point, is supposed to be implemented. Many of the lenders that I listen to, at least anecdotally, are very concerned that this is going to tighten up credit even more. Now, longer run, we need some kind of definition of affordability – of what an affordable loan is and some sense of that for legal purposes and also for designing the future housing finance system.
You could clearly see in most of the legislative efforts that have been put forward a QM loan us the type of loan that would get the government guarantee. So you need something – and I’m not arguing that we don’t need something – but in this period when everyone’s adjusting to the new rule, it could also exacerbate, you know, some of the tight underwriting that exists today. And this is something – this is a script that’s going to be written beginning now and into early next year. We’ll see how well this goes. But mortgage credit is tight. And that’s one key reason why you probably don’t want to maintain the current system.
So – but nonetheless, you know, a nationalized system has, you know, some appeal. And politically, again, it might be that that’s where we end up. I certainly wouldn’t advocate it, but that’s a clear possibility.
Another possibility is just to go to the exact extreme end and say, well, let’s have a privatized system, so very little government role in the mortgage market. You would still – under all proposals, would have the FHA – the FHA is – would play a role, and that of course is part of the government, but outside of that, there’s no other meaningful role for government to play. So that idea, the privatized market, is the basis for the PATH Act. That’s the act that came – the legislation that came out of the House Financial Services Committee this summer.
And you know, that has some appeal as well kind of intellectually. I mean, you’re getting the government out almost completely. You’re letting private capital come in. You know, private capital would support all – would digest all of the losses, and if it was designed properly and all the incentives were right, then you would get good – in theory, you’d get good mortgage lending.
Now, the problem with a privatized system is that in that system, you would not have a 30-year fixed-rate pre-payable mortgage of any consequence. You know, right now almost three-quarters of all mortgage loans outstanding are 30-year fixed-rate loans. This is a product that most Americans want.
Now, there’s a legitimate debate about the economic merits of a 30-year fixed-rate pre-payable loan. I can see arguments on both sides of whether, you know, this is a good thing for the economy and the homeowners in the long – in a – from a theoretical perspective, but from a practical perspective, Americans want their 30-year fixed-rate loan.
To get a sense of where we’re going to go on the 30-year fixed-rate loan in a privatized system, you just have to look overseas. We’re the only country in the world that really has the 30-year fixed-rate loan or 15-year fixed-rate loan as a mainstay of their mortgage market. Most other countries have mortgages that are adjustable-rate; the rates adjust with shifts in market rates relatively quickly.
There’s only a couple of exceptions to that statement. One is France. France has 30-year fixed-rate loans, but that’s only because you can’t prepay on the loan. There’s – you – there – in our mortgage – in our world – system, you can refinance; you can prepay. In France, you can’t do that. Denmark is another example, but they have a very different kind of structure, and there’s only 7 million Danes, so I’m not sure, you know, how well that translates. And their language is very weird, so – (laughter) – you know, I’m not sure if it translates.
I’ll come to your question in a second.
So my guess is that in a privatized system, the cost of getting a 30-year fixed-rate loan would be so high, the mortgage rate would rise to such a degree that a very small percentage of Americans would be able to get it, afford it, probably 10, 15, 20 percent. So we go from 75 percent of debt outstanding to, say, 15, 20 percent debt outstanding, which, you know, again, from an economic perspective, may not be bad. We – you know, we can argue that and debate that, but I don’t think politically it’s even a practical debate because Americans want their 30-year fixed-rate loan. I think we have to design a system that will provide that to most creditworthy middle-income Americans.
Yeah, you had a question.
Q: You actually answered it.
MR. ZANDI: I did, OK. I’m glad I did. I’m glad I did, yeah.
So that’s another approach. Nationalization is one approach. That’s kind of what we’ve got now, so to speak. Privatization is on the opposite end of the spectrum. The third approach – and this is the approach I prefer – is a hybrid approach. And the hybrid approach is private capital takes most of the risk. It’s called first-loss risk, so as soon as there are mortgage defaults and there are losses, private investors would shoulder the burden of those losses, but if you get into a financial event, crisis, you know, the Great Recession as a good example, and the losses are so significant that they overwhelm the private capital, you have a government backstop, that the government will come in and provide a backstop in the case of a catastrophe – catastrophic backstop. That’s a hybrid system.
That is the basis of the legislation that’s coming out of the Senate Banking Committee, the Corker-Warner legislation, S. 1217, and that’s the principle behind that legislation. And I think that’s the most logical way to go because it does preserve the 30-year fixed-rate pre-payable mortgage as a mainstay of the U.S. mortgage market, and it ensures that there will be affordable mortgage loans to most middle – creditworthy middle-income Americans.
One other quick point. In a privatized system, one other problem that you have is that private capital will get scared. You know, at times – there are always things going on in the financial markets that make investors nervous and at times just downright panicky, and in those periods of time, if they pull away from providing capital to the mortgage market, you could see big swings in mortgage rates. You’ll see a lot more volatility in mortgage rates and the availability of mortgage credit in a privatized system than you would see in hybrid system with a government – with a government backstop. So it’s not only the fact that you have a 30-year fixed-rate loan in the hybrid system; it’s also you have less volatility in mortgage rates in a hybrid system.
One other quick point. Each of these systems have different costs, and they show up in the form of mortgage rates for borrowers. So let me just give you a sense of the costs. And there’s, you know, obviously a lot of moving parts here, a lot of assumptions that have to be made. In fact, I wrote – just wrote a paper that I think I provided to you that describes my calculations and how I come to them. And with this paper, there is an Excel-based calculator that you can use to change the assumptions to see what happens to mortgage rates under those different assumptions, because again, there are a lot of assumptions you have to make; there’s a lot of moving parts, but just to give you a sense of how these different proposals kind of line up in terms of the impact on mortgage rates.
So in the current system, the – Fannie Mae and Freddie Mac are charging about a little over a half a percentage point for the services that they’re providing. They’re guaranteeing the loans against default. They’re collecting this to pay for any losses they suffer on the mortgages that they originate. It covers their operating expenses. And of course, a lot of it’s now ending up in these higher profits that they’re generating.
And if you do a little bit of the calculation, the GSEs, Fannie Mae and Freddie Mac, are capitalizing to a 2 ½ percent loss rate. So essentially, what they’re saying is, you know, we’re charging enough money to ensure that if losses on all mortgage loans that we insure is less than 2 ½ percent, we’re good; we got that covered. If it’s over 2 ½ percent, then taxpayers are going to start have to – anteing up again. So it’s about 2 ½ percent.
In the Corker-Warner legislation – that’s they hybrid system that I talked about – the legislation requires – the system capitalizes to a 10 percent loss rate. So we’d have to go from 2 ½ percent – that’s where we are today – to a 10 percent. That’s where the legislation envisages that we have to go.
And by the way, 10 percent’s a lot of capital. I mean, just to give you context, in the Great Recession, Fannie Mae, Freddie Mac and the private mortgage insurers that also participate, along with the GSEs – their loss rate in the Great Recession is probably going to come in around 3, 4 percent. You know, if you really stretch it, maybe it gets to 4 or 5 percent. So Corker-Warner is saying we want 10 (percent). That’s more than double what we suffered in the Great Recession. So that’s a lot of capital, and you’re creating a fortress mortgage system if you go to 10 percent.
Another benchmark – most banks are going to have to capitalize to a 5 percent loss rate. So if you look at their capital requirements that are coming into place now and the requirements relative to their mortgage lending, it’s going to come up to be about a 5 percent – they’re going to have to capitalize to about a 5 percent loss rate. So Corker-Warner is, again, asking this part of the mortgage finance system that gets a government guarantee to capitalize to a loss rate that’s double what the banks would be asked to capitalize to under current banking regulations. So this is a lot of capital.
So the question is, you know – and the benefit of that, obviously, is you’re going to have a mortgage finance system that is, you know, granite; it’s rock solid; it will never be tested; you know, there’s very little chance that the government will ever be called upon to help backstop the system. I can’t even envisage – you know, a meteor would have to take out California, you know, for something like that to happen, a really, really bad scenario. Bad things happen, but that’s pretty bad.
The other thing to point out is the 3, 4, 5 percent loss rate on Fannie/Freddie loans in the Great Recession was largely because they were making loans that would not be considered QM today. If they were QM loans, they would not have suffered these loss rates. And we’re only talking about the government guarantee on loans that are QM. So this 10 percent is even more than that.
But you know, 10 percent – actually, when you do the calculations, you could design a system within the context of Corker-Warner that results in an increase in mortgage rates of only about 40, 45 basis points, above what you would need if you capitalize to 5 percent. So going from 5 percent – let’s say that would be what I say would – from an economic perspective, would be appropriate – that’s bank – similar to what the banks are going to be capitalizing to – but say we went from that to 10 (percent), that extra capital will only cost about 40 or 50 basis points, so almost a half a percentage point.
Just for a little bit more context, by – all the way to the PATH Act, in the privatized system, they made some other assumptions; the increase in mortgage rates would be a full percentage point. So to get from where we are to Corker-Warner adds 40 or 50 basis points. To get from where we are to PATH gets you to – gets you a hundred basis points, a full percentage point. And that is the minimum increase. So again, all my assumptions – I’m assuming everything is designed the way I – you know, King Zandi says is going to be designed. You know, I put in my expectations about different things, and that’s the minimum increase in mortgage rates that will occur from going from where we are to Corker-Warner, the hybrid system, or to PATH, the privatized system. But again, you have the calculator; you can do your own calculations. You can read what I did and make up your own mind as to what to go.
Now, this gets back to the attachment point. Just to make this concrete, you know, in my view, I think that a 5 percent loss rate is appropriate. That is, it will cover the Great Recession, and let’s just say that’s your hundred-year flood, so we’ve got that covered and then some, and I think the odds of ever blowing through that and getting to the government guarantee would be extraordinarily low.
I would say one other thing about the attachment point, though: It has to have some flexibility because you can get into financial crises and events where you would want to change the attachment point and allow the government to provide more credit when things are really tough and private capital is not interested in participating in providing capital to the credit markets. So you need to have a system that allows any regulator that’s overseeing the system – in the case of Corker-Warner, S. 1217, it’s called the FMIC, which is FDIC-like – you’d have to give them some authority to adjust that attachment point, you know, how much risk the government would take, in periods of – that are dark, when private capital is not there and no one’s lending, so that we can ensure that mortgage credit is flowing in all times, including in times like the Great Recession.
In fact, I’ll end this way. You know, our system actually worked – it didn’t work in the sense that we are – taxpayers are now proud owners of Fannie Mae and Freddie Mac. It didn’t work in that sense. But it worked in the sense that the credit to the mortgage market continued to flow even in the depths of the worst financial nightmare since the Great Depression. And if you look at the entire financial system through that period, through the Great Recession, the only part of the financial system that continued to provide credit in a normal way was the U.S. residential mortgage housing market. So in that sense – and that’s not only testimonial to policymakers’ actions, but that’s testimonial to the way the FHA is designed and how that functioned. But at the end of the day, the system worked under extraordinary stress and I think deserves a lot of credit for that.
We covered a lot of ground. I think I hit your questions. I thought I did that pretty gracefully, actually. (Laughter.) And I took my time, probably a little bit more than my fair share. But I’ll stop there and see where you want to take the conversation.
JIM KESSLER: Do people have questions? Yes.
Q: Could you talk about credit availability more specifically under these different proposals?
MR. ZANDI: Yeah, the availability of credit under the various proposals – well, the riskiest structure with regard to the availability of credit would be a privatized system. You know, when I talk about the cost of mortgage credit and said under the PATH Act it would cost you an additional percentage point above current interest rates, I’m actually talking about the borrower in the middle of the distribution, actually a pretty good borrower; a borrower that put 20 percent down on their home, a borrower that had a 750 score so they’re, you know, in at least the top part of the distribution of scores and has a debt-to-income ratio that’s 30 percent. So this is a pretty high-quality borrower. You know, most first-time borrowers would not fit that description.
If you ask, well, what’s the increase in cost to the borrower that would be on the edge of the QM box – so let’s just assume we’re in the QM world – at the edge of the QM box and in a stressed economic environment, meaning a recession or a period when financial markets are unsettled, then the impact on mortgage rates and credit availability in a privatized system would be very significant, probably double that – you know, say, 200 basis points or 2 percentage points. At that – what that increase in rates – that’s just another way of rationing credit, right? You’re not going to have – you just knocked out a boatload of people that can’t afford that increase in interest rates and credit is no longer available to them, effectively.
In Corker-Warner, in that system, same kind of exercise. Go from the assumption that we’re looking at the borrower in the middle of the distribution: 20 percent down, 30 percent DTI, 750 FICO. As I said, that would – their borrowing rates would rise about 50 basis points – 40 to 50 basis points under Corker-Warner. If you go to the edge of the QM box, that’s the least creditworthy borrower who could get a government guarantee under the legislation in a stressed economic environment. When I say “stressed,” to be specific, I’m taking the typical recession since World War II – not the Great Recession but the typical recession. Mortgage rates would rise for that borrower another, roughly, 50 basis points. So that kind of gives you a sense of context.
Now, in a nationalized system, you know, it depends on how that system is operated and designed. It’s conceivable that you would – that rates wouldn’t rise at all. But of course the taxpayer would be taking a lot more risk in that – in that kind of a system and there would be more losses to the taxpayer because you’re going to be originating loans that are going to be less creditworthy. You’re not going to get compensated for that if you don’t raise the rate.
And therefore, the losses will be higher, and because it’s part of the government taxpayers would pay for it one way or the other. But credit would be more stable and the impact on interest rates of going to the edge of the QM box in a stressed environment would be – could be zero, depending on how you – how that system was operated.
Does that give you a sense of it? Yeah. And I should say, in the calculator I don’t give you the – I’ve blocked you into the borrower in the middle of the distribution. It’s too complicated. There’s too many moving parts in an Excel Workbook to give you that flexibility. But I’m pretty clear about that that’s the – that’s the – that’s the box you’re in when you – when you change the assumptions.
Q: Can you talk about tweaking the attachment point in hard times? (Off mic) – to go below 5 percent – (off mic)?
MR. BECKWITH: Right. So the attachment point in a stressed environment, what’s the mechanism for changing it? You know, what are the rules?
In Corker-Warner, in S. 1217, the structure is very – the process is very similar to the process for granting emergency powers to other regulators to step in to the financial system when things are going bad. You need the – as I recall, you need the Federal Reserve Board chairman, the secretary of Treasury and the person who’s running the FMIC – that’s the regulator in S. 1217 that oversees the system – to agree that things are going really badly and we need to change the attachment point.
In S. 1217, there are other restrictions on how long the attachment point can be changed. And I think that’s an area where it would be important for lawmakers at the current time to think about this a little bit more carefully because if you limit how long the attachment point can be lowered in an emergency environment, you do run the risk of exacerbating the situation in the financial market, right?
So suppose – I can’t remember exactly where the legislation ended up. I haven’t looked at this part of the legislation for a while, but let’s suppose you can take the attachment point to zero, meaning the government is taking all the risk for three months. I’m making that up but let’s just say that’s the case. Then in month 1 that’s great. In month 2 people start getting really nervous. As you approach the deadline of the third month people are going to lose their minds, all right?
So you need to be very careful how that’s structured so that you don’t get into that kind of a situation. But that’s kind of the framework. It’s a very similar one to the framework that was used in Dodd-Frank for emergencies. And actually we got – people in the room probably know this better than I, exactly how this is –
Q: Six months?
MR. BECKWITH: Oh, it was six months – six months – six months, not three months, yeah. So they would freak out after five months and 23 days and two hours, yeah. Yeah.
Q: I’ve got an open-ended question as well, but how –
MR. BECKWITH: You’re good at that. Didn’t you –
MR. BECKWITH: Oh, it was the guy behind you? OK, all right. OK. (Laughter.) Yeah, good.
Q: (Off mic.) Anyway –
MR. BECKWITH: Yeah.
Q: – how would any of these bills affect smaller financial institutions – credit unions, community banks?
MR. BECKWITH: Yeah, it’s a good – very good question and a great – it’s a very significant concern. It’s very important that in any housing finance system, that there’s access to the system and, if there’s a government guarantee, to the government guarantee to lenders of all sizes.
Now, in the PATH Act that’s almost not an important – it’s not particularly relevant because it’s a completely privatized system. But I will say this: You could easily see, in the privatized system, big lenders dominating – clearly dominating the system, right, because the way it would go, it would be the big banks that would essentially take over, and it would make life very difficult, I think, for smaller lenders.
So it sounds intuitively appealing to say, oh, it’s a privatized system and then therefore small lenders should be able to flourish in this system, but the reality of it is I think they’d get – they’d get crushed in that – in that system. It would be a very concentrated mortgage market. And I don’t think that’s appropriate or in the best interests of homeowners, you know, particularly in rural areas, in areas of the country – you know, urban cores. Availability of credit will be significantly reduced and the cost of mortgage credit will be a lot higher. So we want to keep that access.
And I think that’s one of the problems with privatization in the PATH Act. In the hybrid system, particularly, again specifically the Corker-Warner system – I’m using S. 1217 because this is – you know, it’s not a perfect piece of legislation but it’s a really good starting place, and so it gives you a structure and a way to think about this.
The way that legislation addresses this issue is that they actually – the – (inaudible) – actually sets up a guarantor in the system. You know, when I say “guarantor” it’s kind of – it’s a competitor to what would be the future Fannie Mae and Freddie Mac. You want lots of future Fannie Mae’s and Freddie Mac in this system, and one of those would be a mutual that would be for the benefit of small lenders and originators so that they would get access to the government guarantee through that guarantor, which would be set up by legislation and capitalized. The capital would be provided or be supported by the legislation itself.
So that’s the idea or way, within the Corker-Warner legislation, you give access. And I think in general – I haven’t been following this as carefully as I should, but I think most of the groups that are advocates for smaller lenders, like the ICBA, feel that this is a reasonable approach to, you know, ensuring that there’s access to the – to the system. But that’s the – that’s the thinking. And I think it’s – I think it’s entirely appropriate. We need to provide access for small lenders.
I know this because when I started my company when I was – way back when – it’s a good story. So it was me, my brother, my best friend. You know, we were working out of my best friend’s condo. And he was getting very upset because – this will be hard to believe, but back then we were hole punching. You know the hole puncher? I’m sure Jim remembers. No one else – what’s he talking about, a hole puncher?
Well, we worked in paper. It wasn’t – you know, this was circa 1990, right? So there was no Internet, you know. There was no cellphone, you know, none of that stuff. So I was – to produce a report you’d Xerox paper and then you’d punch holes in it, right? And you’d put a binder – I know this sounds really weird – (laughter) – but this is – this is how we operated.
And of course there was three guys in the condo. And my best friend got really mad at us one night because he found all these hole punches in his bed. (Laughter.) And so that was the catalyst for going – saying, we’ve got go get out of this condo. He said, don’t come back on Monday, essentially. So we had to go down to our friendly bank to get a loan to get an office. It wasn’t a great office. I’m not even sure you’d call it an office. It was just out of his condo. And then we wanted to hire somebody at the same time.
So I trudged down to my local bank. Should I name names? They’re actually my banker now so – I love them, PNC. I’m from – I’m from Philadelphia. So I trudged down to my bank, PNC, and, you know, tell them, you know, our story, our narrative. And they listened very nicely and said, uh, no. (Laughter.) You know, you can’t have a loan.
So what does one do in that situation? Don’t give up. So it just so happens that one of my friends worked for a community bank, Malvern Federal Savings Bank – you know, I live in Malvern, Pennsylvania – three branches, and this guy vouched for me. He said: He will pay us back – he is saying this to the president of the Malvern Federal – and if he doesn’t, he will give us his firstborn child. (Laughter.) And so they gave me a loan.
So ever since that experience, the small lender is key to making this whole thing – making our economy dynamic. They are on the front line. They provide the seed capital for all the entrepreneurial activity that occurs in this country. And so I think it’s very, very important that we watch out for the small lender and make sure they have access to all the things that big lenders have. You know, it’s one of the strengths of our system compared to other systems across the world.
Q: Could you give us an instance of what you think of the – (inaudible)?
MR. BECKWITH: Yeah. I’d say a couple things. One is, I actually took a great deal of encouragement in it, in the sense that here’s private capital – this is – in the flesh, private capital. If you read the proposals, actually not putting up – if you kind of read the headline it says we’re going to raise $52 billion in capital. The reality is it’s 17 billion (dollars) in real money. The rest of it is not real capital, in my view, but let’s just say 17 billion (dollars). But 17 billion (dollars) is a lot of money. And in fact, if you do a little bit of arithmetic you’ll find that you can set up the housing finance system under Corker-Warner with about – you know, you need more than 17 billion (dollars), but that gets you pretty close in year 1.
So the fact that a private actor – you know, he’s a real honest-to-goodness investor – says, I can do this and I want to do this, I found incredibly encouraging. It means that there is – there is private capital out there that is very interested in participating in the future housing finance system – going to my point – early – first point, why we don’t want a nationalized system. You know, why put taxpayers at risk when we have private capital that’s willing to put, you know, their money on the line? That’s the way it should work and I think it’s a more effective system.
So the first reaction I had was, wow, this is – this is great. The second reaction is let a thousand flowers bloom, right? You know, this is a complicated matter – a lot of different approaches and ideas. And the one thing I find is we are incredibly – we, the collective “we” – incredibly creative. You know, all kinds of issues and problems but people come up with amazingly interesting approaches and ideas that I go, wow, I never really even thought of it from that perspective. And still, every day that happens to me. You know, I talk to a person from a different part of the mortgage finance system and I’m surprised at, you know, what they bring to the table almost every day.
So the second reaction is, great, let’s get more ideas out there; let’s vet them; let’s go down every path. You know, almost all of them are going to be dead ends but nonetheless it’s a very therapeutic process that we’re engaged in here.
And this gets to the third point. I think this idea is a dead end, you know, the reason being that I think we end up with a system if we go down the – his path – the Fairholme road – do not, you know, mix it with the other path – that we’ll probably end up with a system that is not dissimilar to the system we started with. (Chuckles.) You know, a mortgage market that’s dominated by a couple large guarantors – maybe even just one large guarantor, and that’s in no one’s interest, right? I mean, that’s not in the interest of taxpayers, that’s not in the interest of homeowners. It may be in the interest of investors; I can see that, you know, because, you know, you have a duopoly or monopoly, you can make a boatload of money. But I don’t see that in the best interests of anyone else.
So the third reaction I have – but again, I don’t want to – I’m not saying we shouldn’t go down the path and really think this through; I’m all for it. But my third reaction was that this isn’t really advancing the ball to any – it’s going back to the future, in a sense, and I don’t want to go back to that future. Does that make sense? Yeah.
Anything else? Anything else bothering you about the housing market? (Laughter.) Yeah, given what’s gone on here in the last couple of days, I’m sure there’s a lot bothering you, but, yeah.
Q: With the Fed keeping rates pretty low for awhile now, do you think that’s going to be a problem down the road?
MR. ZANDI: Yes. So the question is, the Fed has been working hard to keep mortgage rates low; what happens when they normalize interest rates? If – did I phrase that correctly?
MR. ZANDI: OK. So a – (inaudible) – really, this is a really important trick of economists. They take your question and turn it into the question they really want to answer. (Laughter.) So this is my favorite trick. Usually I don’t give the questioner the opportunity to correct me if the question I articulated was wrong, but – well, the trick – the key here is for the Federal Reserve Board to end quantitative easing and normalize short-term interest rates consistent with the improvement in the job market.
So if they can allow long-term interest rates to rise, short-term interest rates to rise consistent with the decline in the unemployment rate, then the housing market is going to be fine, because the better job market will trump the negative consequences of the higher mortgage rates. And by the way, this is in the context of the assumption that mortgage credit availability improves. You know, going back to my point about first-time homebuyers and all the things I said about that – this is much easier said than done, right? And this is where the crux of the matter is.
If the Chairwoman Yellen can execute in the way I just described, then we’re golden. We’re good; life is going to be fine and the economy is going to improve. And by the way, in my view, the economy is going to be a lot better than people think if she’s able to reasonably execute on this, because the housing market is going to be incredibly strong – much stronger than the consensus which would argue, you should be buying housing-related stocks – and that’s not investment advice, by the way. I’ll just give you one statistic, because I just like the statistic. It’s not completely relevant to your question, but I’m going to tell – give it to you anyway.
So just to give you a sense of why you should be optimistic here if things go reasonably well – the current level of housing construction is at 950,000 units. So if you add up the single family homes that are being built, the multifamily homes and the manufactured housing – mobile homes, it’s 950k per annum – that’s an annualized basis. Just for context, in the teeth of the recession in ’09, it was 500k, and that was the lowest level of construction since the middle of World War II. That gives you a sense of how low that is. But we’re at 950k, and that’s helped to support some of the economic recovery.
In a normal economy – not even a good one, just a normal one, we should be producing 1.7 million homes. That’s 1.15 million households that will form every year – this is looking at population growth, age, ethnic distribution of the – and by the way, it’s going to be higher than that at some point in the next couple – three years, because there is a boatload of twenty-somethings that have doubled up with their parents, and that is not a – what an economist would say, an equilibrium social situation. And that is – (laughter) – that is definitely not going to work for very long. (Laughter.) And so we’re going to see a lot of households form at some point.
But let’s just go with 1.15 million. There’s 300k in obsolescence; what I mean by that is, Hurricane Sandy blows through my neighborhood up through New York; that wipes out 250,000 homes, but we have tornados and – we have just normal obsolescence. I mean, I have a home in Florida and I must spend – I don’t know, I must spend $100 a month just keeping insects out of my home – I mean, literally. And these are weird insects, you know. (Laughter.) Can you imagine what is happening to those vacant homes in those Florida communities? It’s like – it’s got to be Jumanji in those homes. (Laughter.) I mean, it’s like, you know – really – these things are becoming obsolete pretty quickly.
And then there’s 200k in vacation homes. So, you know, the baby boomers are in their 50s – high-income households – they’re doing very well, thank you. They’re benefiting from the queuing effect on stock gains, on house price gains. If they have any debt at all, it’s a 15-year mortgage they’ve locked in – they’ve re-fied down. They may have an auto loan just because it’s free money. You know, they’re getting, like, 2 or 3 percent.
So they’re buying second vacation homes. So you add it all up, it’s 1.7 million. We’re going to go from 950k to 1.7 million over the course of the next several years and then some, because we’ve actually blown through all the excess vacancy, and markets across the country are going from overbuilt to underbuilt. That’s a boatload of jobs. Every single family start is – creates four jobs over a period of a year. Construction, manufacturing, transportation, retail – you know, Home Depot, Lowe’s, Home Improvement, financial services, cable hookup, landscaping – this is – this is a big part of how we’re going to get to full employment, and housing is going to – housing is going to lead the way for that. I don’t know why I took that, sidebar, but, you know, just to be – just to be optimistic about it.
But this only works if the Federal Reserve lands the plane on the tarmac. (Chuckles.) If they can’t land the plane, then this isn’t going to work. And that’s why people don’t fully believe yet that, you know, the economy is going to engage in the way I just described. So monetary policy is really important – really important.
Q: How is multifamily impact – (inaudible) – systems?
MR. ZANDI: Good question. So how is multi-family affected? This is kind of a part of the script to be written. You know, under the current system, Fannie and Freddie, they provide a backstop to the multifamily mortgage market. In fact, Fannie Mae and Freddie Mac are currently providing about 40 percent of all the mortgage loans for multifamily property right now, and the FHFA is asking them to reduce their so-called footprint, meaning scale that back – you’re providing too much credit, and in all fairness, in a typical economy housing market, Fannie and Freddie’s share is generally lower – it’s closer to a third of the market. So it’s a bit elevated.
So in the current system – in a nationalized system, you’d probably still have some kind of backstop to the multifamily mortgage market, but it’d be smaller than it is today. In the privatized system, of course, there’s no backstop, right? So the multifamily market is on its own, which, again, I would say is probably a very serious problem, because what will happen in a crisis is, multifamily mortgage credit will go to zero. You know, you could see that in the great recession – only Fannie Mae and Freddie Mac were providing multifamily mortgage loans during the great recession. All other providers of multifamily mortgage credit stopped – banks, insurance companies, you know, pension funds – they stopped. The CMBS market – that’s the securitized market – that went to zero, right? So there was no – so in a privatized system, in a crisis, you’ll get zero, which is going to be a real problem, and the one reason, again, you might not want to go down that path, so to speak.
In the Corker-Warner legislation, there is no – it’s a blank – it’s a blank in the legislation. Essentially, they ran out of time, I think – the writers of the legislation – and they kind of said, this is – the FMIC, the regulator will figure this out. That’s all it said. So this needs to be laid out for – in the legislation. Now, in my view, I think the multifamily market should have some government backstop for the reasons I just articulated.
In fact, I wrote a paper for Freddie Mac FHFA that you can find on their website kind of documenting my thinking around why and what the costs would be if you do not have a government – some form of government backstop in the multifamily market. So if you Google, you know, Zandi multifamily FHFA, you’ll probably find it – probably, unless FHFA has buried it somewhere, you know, you’ll find it.
Q: Can you give your just general take on the recent development of rental-backed securities – (inaudible) – California – (inaudible) –
MR. ZANDI: You know, I have not followed that market. You mean – this is securitizing rent streams? Is that what you’re talking about?
Q: I’m sorry, what?
MR. ZANDI: You’re talking about the process of securitizing rent streams – rental income?
MR. ZANDI: Yeah, no I haven’t followed that market at all. Sorry, yeah.
MR. ZANDI: Yeah, no, no. I mean it’s got to be a very small – how many – what kind of issuance has there been? Is it – it’s got to be –
MR. ZANDI: No, not very much. So I – yeah, I really don’t know. Yeah, I haven’t really followed that at all.
Q: OK, no worries.
MR. ZANDI: Yeah. Great. You’re tired? I’m tired. Thank you. (Applause.)
Have a great Thanksgiving, everybody.
MR. : You too.
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