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The Role of the GSEs and Housing Policy in the Financial Crisis Dwight M. Jaffee Haas School of Business University of California, Berkeley Testimony for the Financial Crisis Inquiry Commission, February 27, 2010, Washington D.C. © Dwight Jaffee, 2010 Page 1 Major U.S. Housing Policy Programs (2009 Costs in Parentheses) GSEs ($111 billion bailout to date and counting, $1.3 trillion purchases of GSE debt and MBS) FHA (self-supporting; no taxpayer funds to date) CRA (no direct expenditures, no quantification) Tax incentives for home mortgages ($143 billion) HUD ($38.5 billion approximate annual budget) Other federal and state housing programs © Dwight Jaffee, 2010 Page 2 Housing Policy and the Financial Crisis The issue of housing policy as a source of the financial crisis is much less concrete than that of specific institutions/acts, e.g. GSEs, FHA, or CRA. – Of course housing policy was a crisis catalyst. – I do not find any recent changes (say post 2000) in housing policies to actively expand the incentives to make low-quality, high-risk, mortgages. In line with the Commission, the paper does not: – Attempt an overall evaluation of housing policies; – Provide any evaluation of policy reform proposals. © Dwight Jaffee, 2010 Page 3 The GSEs Played a Major Role in Expanding the Financial Crisis GSE high-risk mortgage purchases and guarantees helped fuel the housing bubble and financial crisis. Evidence: – GSEs purchased major share of all high-risk loans. – High-risk loans are major share of all GSE holdings. Comments: – GSE actions unacceptable as government entity. They are supposed to stabilize, not to destabilize. – GSE failure is inevitable result of combining private incentives with public mission/guarantee. © Dwight Jaffee, 2010 Page 4 Housing Goals (HGs) were Secondary Influence of GSE High-Risk Lending HGs were certainly complementary to GSE profits as a source of their high-risk mortgage activity. – But profits were the primary GSE motivation. Evidence: – The GSEs failed to meet some HGs ‘05-’08. – Regulator HG goals excluded high-risk loans. – Academic literature suggests GSE “cherry-pick” HG loans to be of the highest possible quality. Comment: – Further empirical research could be useful. © Dwight Jaffee, 2010 Page 5 FHA, GSE, and High-Risk Share of Total Mortgage Originations © Dwight Jaffee, 2010 Page 6 Sources, FHFA, GSEs, Inside Mortgage Finance, Ed Pinto GSE Activity and High-Risk Lending © Dwight Jaffee, 2010 Page 7 The FHA Played a Minor Role in the Financial Crisis Traditional FHA activity dramatically decreased as subprime lenders and GSEs dominated markets. Evidence: – FHA lending fell to less than 5% of overall market. – FHA showed no interest in pursuing these clients. Comments: – FHA default rates are now rising, but this is true for all U.S. mortgage lenders. FHA – FHA foreclosure rates remain far below subprime, just a bit above prime loans. © Dwight Jaffee, 2010 Page 8 Community Reinvestment Act (CRA) Evidence Indicates No Impact While CRA may have “guilt by association”, the evidence suggests no unique impact on financial crisis. Evidence (Federal Reserve studies): – CRA requires “safe and sound” lending. – Non-bank , non-CRA lenders, mortgage and financial companies, were active high-risk lenders. – Only 6% of 2006 subprime loans were CRA lenders. – “Over and under income” zip-code evidence. Comments: – Further empirical tests could be useful. © Dwight Jaffee, 2010 Page 9 Five Other Essential Financial Crisis Causes U.S. trade deficit and global savings glut created a large and continuing demand for U.S. mortgage products. U.S. monetary policy remained benign even in the face of a housing bubble clearly visible based falling housing affordability. Innovations in underwriting and securitization allowed lending to concentrate on previously underserved areas. Commercial/investment banks held large, leveraged, and maturity mismatched high-risk loan positions. OTC credit default swaps on high-risk, loans far exceeded the actual volume on the actual loans. © Dwight Jaffee, 2010 Page 10 GSE Investment Portfolios and MBS Lines © Dwight Jaffee, 2010 Page 11 Additions to GSE High-Risk Portfolios (As share of total GSE annual purchases) © Dwight Jaffee, 2010 Page 12 GSE High-Risk and Total Mortgages © Dwight Jaffee, 2010 Page 13 Fannie Mae Single-Family Default Rates by Year of Booking © Dwight Jaffee, 2010 Page 14 Freddie Mac Single-Family Default Rates by Year of Booking © Dwight Jaffee, 2010 Page 15 Foreclosure Rates, Year-End Inventory (Mortgage Bankers of America) © Dwight Jaffee, 2010 Page 16 Housing Affordability Index, California (California Association of Realtors) © Dwight Jaffee, 2010 Page 17
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