Housing finance matters. As of the fourth quarter of 2016, there was $22.7 trillion in housing in the United States, financed by $10.3 trillion in mortgage debt and $12.4 trillion in owner equity, making housing the single largest asset for most American families. Accordingly, the housing sector is a critical component of the U.S. economy and an important engine for domestic economic growth: In 2016, the housing sector – comprised of housing services and residential investment – contributed 15.6% to U.S. gross domestic product (GDP), and the homeownership rate in the U.S. was 63.6% in the first quarter of 2017.
Yet, while housing remains an important part of the economy, its significance has shrunk relative to other periods. This is the case when compared to the housing heyday of 2005–2006, when seemingly limitless credit expansion led to significant housing-sector growth, with housing contributing 18.6% to GDP and the homeownership rate rising to nearly 70%. But it is also the case versus the earlier stable and sober period of 1980–2000, when housing contributed around 18.3% to GDP and the homeownership rate ranged between 64.4% (1980) and 66.2% (2000). Today, the housing sector is smaller even though demand continues to be strong: According to the Survey of Consumer Expectations Housing Survey published in June 2017 by the Federal Reserve Bank of New York, 72.2% of those surveyed preferred (22.9%) or strongly preferred (49.3%) owning versus renting.
So, why is the housing sector diminished when demand for housing remains robust?
We believe the decline is directly related to the inability of many quality borrowers (those who have consistently paid their bills and have the financial means to borrow) to access mortgage credit. While many people expected – and desired – a retrenchment in mortgage credit after the frothy days of 2005–2007, many quality borrowers are still unable to secure a mortgage nearly nine years after the financial crisis. There is one overarching reason for this: A major source of mortgage credit – the private mortgage market (i.e., the market outside of the government-sponsored entities known as GSEs) – is effectively moribund, which has not only forced the government to expand its lending where possible, but has also effectively shut out high quality borrowers who do not qualify for GSE mortgage loans.
In our view, the lack of a functioning private mortgage market (which consists of non-agency loans and private label securitizations or PLS) is the result of the increased costs and legal uncertainty stemming from the well-intentioned-but-imperfect Dodd-Frank regulations. These have affected originators, servicers, investors and prospective homeowners alike, culminating in a market that is effectively broken.
The data bear this out: Not only is the supply of mortgage credit still low on an absolute basis, but a staggering 78% of all mortgage originations are issued through the government-controlled entities Fannie Mae, Freddie Mac and Ginnie Mae – up from 47% in 2005 (See Figure 1).
We believe there are two main takeaways for policymakers to consider from these aforementioned insights:
I If policymakers are interested in increasing housing to optimize economic growth, small, responsible modifications to existing law and regulation governing the private mortgage market should be considered; these would bring back mortgage lending in a responsible manner, boost economic growth and provide more people access to mortgage credit.
II Reviving the private mortgage market needs to occur before comprehensive GSE reform. Without a functioning private mortgage market, it will be nearly impossible for the GSEs to shrink their footprint without significant disruption to the housing market and to the underlying homeownership rate.
Below we expand on these points.
Modifications to existing regulation of private mortgage market
In the wake of the financial crisis, the comprehensive policy response understandably targeted the private, non-agency residential mortgage market. Remedies ranged from foreclosure prevention programs to statutory provisions and subsequent regulations that aimed to increase liability and accountability along the entire chain of non-agency mortgage production. While we believe much of this policy was reasonable in light of the financial crisis, there have been significant unintended and undesirable consequences for the private mortgage market – and as a result, for potential homeowners as well.
For originators and servicers, increased regulation has increased the costs of originating and servici