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Ten Years Since the Financial Crisis: Some Lessons for Reducing Risks to Households Jane Dokko* and Karen Dynan October 12, 2018 * The views expressed in this presentation do not represent those of the Federal Reserve Bank of Chicago or the Federal Reserve Board. Whither mortgage market reform? • We highlight three goals for mortgage market reform that would mitigate risks to households • Make households more resilient to shocks • Reduce taxpayer exposure to losses • Avoid periods with “unduly limited access” to mortgage credit • Reducing hardships and disruptions for households would also lessen risks for financial institutions and dampen propagation of macroeconomic shocks • In contrast, many proposals for mortgage market reform make specific recommendations on institutional design of new system • E.g. Johnson-Crapo, Bright-DeMarco, MBA, etc. Many Sources of Risk • Idiosyncratic economic risks • Aggregate economic risks • Institutional factors related to mortgage markets • Bad actors and abuses Financial crisis revealed aspects of mortgage market that need to be preserved and vulnerabilities where reforms are necessary. Lesson #1: Procyclicality of Mortgage Credit Drives and Amplifies Business Cycles • Provides rationale for government intervention in mortgage market • During Great Recession, government involvement helped support flow of credit • Implicit/explicit guarantees • Low DP loans available through FHA • Reform should feature policies that: • Support lending in bad times • Weigh against excessive risk-taking in good times Lesson #2: Design of Mortgage Market Affects Monetary Policy Transmission to HHs • During downturns, monetary policy stimulus reaches households via lower rates on ARMs and FRM refi’s (Dudley 2012) • Support higher consumption (Di Maggio et al. 2017) • Help households avoid delinquency and foreclosure (Fuster and Willen 2017) • Major obstructions to monetary policy stimulus during Great Recession • • • • • Credit standards tightened Negative equity impeded refi’s Few borrowers have ARMs Lender capacity constraints Lender concentration • Reforms that ease frictions would make monetary policy stimulus more effective • Such as through auto refi’s of underwater borrowers, countercyclical adjustments to mortgage payments Lesson #3: Negative Equity Is Costly & Leads to Delays in Deploying Assistance • “Double trigger” view of negative equity (Foote et al. 2008) • Politics of negative equity are complicated and slow the deployment of borrower assistance • Policy should aim to make negative equity less consequential during downturns • For example, innovation in mortgage contract design could help Lesson #4: Assistance Delayed for Other Reasons • • • • Design mistakes Regulatory uncertainty "Put back risk" Servicer capacity constraints and incentives • Reforms should allow for assistance to be deployed quickly and at scale Lesson #5: Not Just “Housing” Policy • Countercyclical monetary and fiscal policies support housing market during downturns • Social insurance programs play important role in lessening impact of income disruptions • Unemployment insurance extensions prevented more than 1.3 million foreclosures • ACA's Medicaid expansions have lowered likelihood of financial distress • Are we prepared for the next recession? • ZLB & limited fiscal capacity provide pessimistic view • But policymakers will need to strengthen social safety net in next downturn Lesson #6: Ongoing Conservatorship Keeps Taxpayers at Risk • In 2008, taxpayers "bailed out" GSEs with $187.5 billion • Currently, taxpayers provide $254.1 billion backstop • If another large downturn were to occur, taxpayers would need to provide tens of billions of dollars to cover GSE losses • Taxpayers are likely not compensated for the risks they bear • Reforms that reduce these risks – or allow for compensation – would benefit all taxpayers Do Economic Objectives Help Achieve Goals? • Taming the credit cycle is an economic objective that helps achieve goals but there are tradeoffs and risks • Policy tools provide benefits • But also costs – e.g. macroprudential regulation and consumer protection entail risks for access to credit, e.g. limiting innovation, raising compliance burdens, and uncertainty in "how much" • Streamlining the ex post renegotiation of mortgage contracts or limiting costs of negative equity may come at the expense of more complexity • Reforms that would mitigate taxpayer exposure to mortgage market risks are worthy but politically challenging • Policymakers will need to weigh tradeoffs and understand risks but our view is that goals will not be met unless economic objectives achieved