Many agree that there needs to more clarity in the government’s participation in the housing finance system—that consensus is evident among the expert panelists at our event on the future of the housing finance system we held this summer (see the white paper with the event’s conclusions). Nonetheless, Congressman Garrett’s plan takes that too far by failing to propose alternatives to the GSEs’ role in promoting market stability, financing multifamily housing, and furthering fair housing. It also prevents regulators from taking important measures to get the housing market back on track, like imposing risk retention rules or mandating principal reductions for underwater loans.
One of the Private Mortgage Market Investment Act’s problematic provisions is the abolition of risk-retention and Qualified Residential Mortgage (QRM) provisions of Dodd-Frank. While consumer groups (including Woodstock) have raised concerns about the overly restrictive definition of the QRM proposed by regulators, the concept of risk retention is ultimately sound. Risk retention incentivizes banks to originate better loans by requiring them to have a stake in the future performance of the loan. Prohibiting rules on risk retention would take away an important tool that encourages prudent underwriting.
Additionally, Congressman Garrett’s proposal would prohibit regulators from mandating principal reductions. Negative equity is a significantly destabilizing force in the housing market, particularly in a time where one in five loans nationwide is underwater (that figure is one in four for the Chicago region). Research has shown that deeply underwater homeowners are much more likely to default than homeowners with some equity, and principal reductions are needed on a broad scale to address those incentives. In situations where restoring some lost equity makes long-term sense, regulators and financial institutions should have the ability to choose principal reductions as an option.
The Private Mortgage Market Investment Act does not explain how the private mortgage market would adequately fulfill some of the GSEs’ important roles. Historically, the GSEs have provided a critical source of liquidity for multifamily buildings, especially small- and mid-sized buildings that are difficult to finance but are important sources of affordable housing. In addition to providing liquidity, the GSEs were also chartered to affirmatively further fair housing goals, and that mandate would be lost in a purely private mortgage market.
Finally, Congressman Garrett’s proposal does not address issues of stability in the housing market. The GSEs play an important countercyclical role in times of low demand, and a private market like the one in this proposal would lend itself to boom-and-bust cycles that could provide too much liquidity when home prices are increasing and delay a recovery when home prices are decreasing, destroying substantial amounts of equity and wealth.
While the Private Mortgage Market Investment Act includes some common-sense provisions that improve the transparency of securities transactions and remove conflicts of interest, its harmful prohibitions and glaring oversights mean that it is nowhere near an adequate alternative to the current housing finance system. For more information, Janneke Ratcliffe of the University of North Carolina has a useful analysis of the bill in her testimony to Congressman Garrett’s committee.