The Tale of Fannie and Freddie, A Tragedy (Conclusion): On the Foreclosure Crisis and the Logic of Resistance VI

Evaluating the Logic of the Alternative: The Downside of "Winding Down" Fannie and Freddie

There are two separate points that I want to make in my evaluation of Obama's suggestion that it might be time to "wind down" the government-sponsored secondary mortgage market agents.  I'll tackle the first in this section.  It is, in my view, indisputable that the removal of the GSEs from secondary mortgage markets in the U.S. would significantly increase the volatility of housing markets and make the institution of home ownership more tenuous and risky for all but an increasingly small minority of the U.S. population, capable of purchasing residential property without recourse to mortgage loans.  My foundations for making this conclusion emanate from the recent record of mortgage securitization and from the history of GSE/agency issuance of MBSs and CDOs relative to private sector/non-agency issuance of MBSs and CDOs. 

In order to understand why I am arguing that the dissolution of Fannie and Freddie would damage the accessibility of home ownership for moderate to lower income households, I have to introduce a series of statistical data, from diverse sources, that seem to support my case.  Bear with me on this, even if all the numbers seem inane!  My point is that the goal of expanding home ownership cannot withstand the elimination of a secondary market substantially structured by the federal government.  The whole idea of setting up a secondary market is to accumulate capital for the issuance of mortgages in primary mortgage markets, even if private holders of capital do not envision the potential to realize adequate rates of return from lending to prospective home buyers.  Since the 1970s, securitization of home mortgages by the GSEs has been the standard mechanism by which the GSEs (and Ginnie Mae, the wholly government owned secondary market agent for FHA-insured and VA-supported home mortgages) have raised capital for their financing of primary mortgage markets, supporting larger quantities of mortgage lending than might otherwise have occurred over this period.  The key period that interests me, however, is the period encompassing the high tide of the housing price bubble (around 2005) through the meltdown to the present.

Table 1 attempts to make an important point about the relationship between primary and secondary mortgage markets.  Specifically, over the course of the housing market expansion, securitization in the secondary market became increasingly important as a strategy, especially for agents in primary markets seeking to accumulate capital for their lending processes.  By 2007, over 50 percent of mortgage debt outstanding in the U.S. had been securitized into MBSs and/or CDOs.  Prior to this period, bundling of mortgages was almost entirely restricted to the GSEs and Ginnie Mae, and securitizations rarely exceeded 40 percent of outstanding mortgage debt.  On the other hand, rates of owner occupancy for U.S. housing stock rarely exceeded 65 percent prior to this period and exceeded 69 percent at the height of the housing price bubble.  The difference here, reflected in an unprecedented increase in owner occupancy of U.S. housing stock, appears, to a substantial extent, to be explained by securitization.  Likewise, the rapid decline of private/non-agency securitization after 2009 accompanies a severe, if not unprecedented, decline in housing sales, shown in table 3, and a decline in owner occupancy of housing stock from 69.0 percent in mid-2006 to 65.0 percent in mid-2013 (see Census Bureau, "Homeownership Rates for the U.S. and Regions: 1965 to Present," Table 14, at: http://www.census.gov/housing/hvs/data/histtab14.xls).            

Table 1: Mortgage Debt Outstanding and Mortgage Securitization,
2002-2012
                       Mortgage                   Securitized             Percentage
Year        Debt Outstanding(MD)     Debt(SD)              Securitized
                      (Thousands $)          (Thousands $)           (SD/MD)  
2002                  8,361,212                 3,994,462                 47.77%
2003                  9,376,248                 4,353,353                 46.43
2004                10,652,318                 4,835,957                 45.40
2005                12,096,298                 5,791,969                 47.88
2006                13,508,779                 6,625,504                 49.06
2007                14,602,757                 7,431,954                 50.89
2008                14,693,954                 7,576,601                 51.56
2009                14,391,889                 7,621,690                 52.96
2010                13,738,559                 3,055,482                 22.24
2011                13,411,868                 3,001,598                 22.38
2012                13,156,187                 2,927,522                 22.25
Source: Board of Governors of the Federal Reserve System, "Mortgage Debt Outstanding," at: http://www.federalreserve.gov/econresdata/releases/mortoutstand/frb_mdo_historical.csv. 

The point here is not that securitization, as a financial practice, is intrinsically good or beneficial. Rather, securitization increases the liquidity of mortgage debt, encouraging primary market mortgage originators to write more mortgages at lower rates of interest relative to what would have to be charged if originators were forced hold on to all the mortgages they've written in their own financial portfolios.  If, as a society, we are really committed to the goal of increasing the number of owner occupiers of residential property, then securitization is definitely a reasonable strategy to pursue in organizing the accumulation of housing market capital for issuing debt. 

This process works really well when all of the secondary and primary mortgage market players are playing by the rules, writing mortgages for households that stand a fighting chance in paying them off, and buying and bundling mortgages with relatively low risk of default.  It describes what Fannie Mae, Freddie Mac, and their primary market partners did before 2004, and it still describes what Ginnie Mae does with FHA-insured and Veterans Administration loans.  Over the period that I am reviewing here, however, private/non-agency secondary market actors (e.g. Bear Sterns, Merrill Lynch, Bank of America) started to overwhelm the secondary markets, buying risky MBSs, repackaging them into risky CDOs, and insuring them with default swaps.  Table 2 shows how issuance of MBSs and CDOs increasingly became the business of private, non-agency actors and how the GSEs and Ginnie Mae were increasingly crowded out of secondary markets (in relative terms - they were, after all, practically monopolizing the secondary markets prior to the passage of Gramm-Leach-Bliley).  As private, non-agency issuers of securities increased their share of the secondary markets, the securities became substantially riskier, because primary market lenders were awash with capital to write riskier mortgages for households who were unlikely to be able to repay their debts. 
    
Table 2: GSE (Agency) and Private (Non-Agency) Securitized Residential Mortgage
Debt Issued, 2002-2012
Year                   MBSs, CDOs Issued (Billions $)               Percentage of  Total Issues   
                         Agency                     Non-Agency               Agency               Non-Agency  
2002                 2,044.3                          243.5                        89.36                     10.64
2003                 2,757.2                          343.1                        88.93                     11.07
2004                 1,393.0                          430.1                        76.41                     23.59
2005                 1,347.7                          726.0                        65.00                     35.00
2006                 1,239.1                          687.5                        64.32                     35.68
2007                 1,465.6                          509.5                        74.20                     25.80
2008                 1,366.8                            32.4                        97.68                       2.32
2009                 2,022.9                              9.2                        99.55                         .45
2010                 1,919.9                            12.1                        99.37                         .63
2011                 1,615.3                              2.8                        99.83                         .17
2012                 2,015.8                              4.2                        99.79                         .21
Source: Securities Industry and Financial Markets Association (SIFMA), "U.S. Mortgage-Related Issuance and Outstanding," at: http://www.sifma.org/uploadedfiles/research/statistics/statisticsfiles/sf-us-mortgage-related-sifma.xls?n=23348#Issuance!A1. 

And so, in mid-2007, the outcome that was likely to happen happened, as shown in table 2.  As subprime defaults started piling up, the private, non-agency issuers of mortgage backed securities withdrew from the secondary markets, and, as a result, the primary mortgage markets froze up making it difficult for anyone, even with very high credit ratings, to obtain credit to purchase residential property (see table 3 below for the mild drop in housing units sold in 2007 and accelerated drop in 2008).  For all intents and purposes, private MBSs and CDOs cease to exist after 2007.  Without all of that private capital in secondary markets, the forward march of the "Ownership society" came to a grinding halt. 
    
Table 3: Total Housing Sales and Median and Average Sale Prices in U.S., 2002-2012
Year      Housing Units Sold        Median Sales Price           Average Sales Price
                   (Thousands)                                                                                          
2002                     973                          $187,600                           $228,700
2003                  1,086                            195,000                             246,300
2004                  1,203                            221,000                             274,500
2005                  1,283                            240,900                             297,000
2006                  1,051                            246,500                             305,900
2007                     776                            247,900                             313,600
2008                     485                            232,100                             292,600
2009                     375                            216,700                             270,900
2010                     323                            221,800                             272,900
2011                     306                            227,200                             267,900
2012                     368                            245,200                             292,200
Source: U.S. Census Bureau, "Houses Sold by Region: Annual Data," at: http://www.census.gov/construction/nrs/pdf/soldann.pdf;
and "Median and Average Sales Prices of New Homes Sold in United States: Annual Data," at: http://www.census.gov/construction/nrs/pdf/uspriceann.pdf.

The interesting thing here, and the larger point of my argument as to why "winding down" Fannie and Freddie might not be a good idea, concerns how the financing of home purchases changes after 2007, as shown below in table 4.  As expected, a smaller percentage of households purchase residential property with conventional mortgages (conforming prime rate mortgages, Alt-A, subprime, or otherwise).  In 2010, two out every five housing purchases in the U.S. were financed without recourse to a conventional mortgage.  Significantly, two other financing sources gain prominence - first, purchases with Federal Housing Administration (FHA) insured or Veterans Affairs (VA) supported loans, and, second, purchases with cash.  In fact, FHA and VA loans, which had seen a decline over the period of the housing price bubble, witness a substantial increase in their shares as sources of residential financing.  Going back to table 2, this increase also explains, in part, why the total number of MBSs and CDOs issued by agency issuers rises by as much as it does after 2007.  Even as Fannie and Freddie come under U.S. government conservatorship (i.e. they get taken over and forced to divest of their toxic asset portfolios), Ginnie Mae, which purchases FHA and VA loans, becomes a major issuer of MBSs and CDOs, again, fully and faithfully backed by the U.S. Treasury in explicit terms against borrower default. 

Table 4:  Percent of Housing Sales by Financing Type, 2002-2012
Year        Housing Units Sold      Conventional Mortgage     FHA+VA Loan    Cash
                     (Thousands)                      (Percent)                     (Percent)          (Percent)
2002                   973                                80.99                           14.39                4.32
2003                1,086                                83.89                           11.97                3.78
2004                1,203                                87.03                             8.73                3.82
2005                1,283                                89.71                             6.16                4.05
2006                1,051                                90.29                             5.99                3.62
2007                   776                                89.56                             6.70                3.87
2008                   485                                73.81                           21.44                4.74
2009                   375                                62.40                           33.07                4.53
2010                   323                                58.51                           35.91                5.88
2011                   306                                62.09                           31.37                6.54
2012                   368                                63.59                           29.89                6.52
Source:  U.S. Census Bureau, "Houses Sold by Type of Financing," at: http://www.census.gov/construction/nrs/pdf/soldfinca.pdf.

All of this statistical evidence says something important to me about the idea of having a society in which there is at least some expectation that home ownership, across the general population, will increase over time.  Specifically, it suggests that a secondary market is absolutely indispensable in accumulating the necessary capital to expand the scale of housing purchases, that we need institutions committed to making housing purchases for moderate to lower income groups affordable with tangible, rigorous standards for mitigating default risk (i.e. conformity standards), and that, as a matter of housing policy, the federal government must have a role in housing market processes. 

Under present conditions, moreover, the federal government will maintain a place in secondary markets, even if Fannie and Freddie are "wound down."  To my knowledge, there has been no talk from the Obama administration about "winding down" Ginnie Mae or eliminating FHA and VA housing programs, although I am sure that there are at least some House Republicans for whom this is the ultimate goal!  The evidence in table 4 attests emphatically to the fact that taking such a step would be an unmitigated disaster for the U.S. housing market and for the prospect that anyone without substantial household reserves of cash would be able to finance a housing purchase in the immediate future.  A total elimination of the federal role in housing markets would crush the feeble housing market recovery since 2010.  However, at question in the fate of Fannie and Freddie is the health of conventional mortgage markets. 

Obama's suggestion that "private lending should be the backbone of the housing market" (see Calmes,"Obama Outlines Plans for Fannie Mae and Freddie Mac,"  New York Times, at: http://www.nytimes.com/2013/08/07/us/politics/obama-fannie-mae-freddie-mac.html?_r=0) is manifestly unrealistic, unless we are content to have less expansive housing markets and fewer home owners.  Private capital, especially in the U.S., is simply too focused on short-term rates of return to accept substantial investments in long-term assets, like thirty-year mortgage debt.  The success of Fannie Mae and Freddie Mac, from the 1970s through 1999, at accumulating private capital, with small margins of profitability, probably did have much to do with the implicit government guarantee on its issues of mortgage backed securities.  On the other hand, it also had to do with the innately conservative nature of investments in thirty-year conforming mortgages.  Such assets do not yield exciting blockbuster returns to investors, but they provided decent low-risk flows of income.  The same can be said for assets currently being marketed by Ginnie Mae.  These assets certainly have their place in financial portfolios, but it seems unlikely that, in the high-flying world of the contemporary global financial sector, U.S. secondary mortgage markets, structured around conservative, fixed income assets, will solicit enough interest among larger institutional investors to adequately, and consistently, finance new generations of prospective moderate to lower income home owners.

A more likely scenario for secondary mortgage markets, if private investors are to become the default source of capital, would be a repetition of short run boom and bust cycles, where risk-loving institutional investors periodically hurl large quantities of money capital into secondary markets and into housing construction projects chasing and/or generating abnormally high rates of return.  In the process, they'll drive down interest rates and induce a temporary bubble in housing prices, as new generations of households that have no business looking to purchase real estate find their way into housing markets, lured by unscrupulous lenders, and compete for temporarily diminished inventories of housing stock for purchase.  When the wisest of the investors come to their senses, realizing that they'd been through this territory before, they'll pull out and many more will follow.  Mortgage markets will lock up once more, and the unlucky erstwhile home owners who fell for the promise of a place of their own will end up out on the street with their earthly possessions as a new foreclosure crisis ensues.

If Fannie and Freddie are "wound down" or otherwise reorganized without either an implicit or explicit guarantee of U.S. Treasury insurance against risk of default, then, following the logic of supply and demand, maybe U.S. housing markets are due for a long-term secular deflation of housing prices to bring the valuation of housing stock back in line with the long-run diminished availability of capital in mortgage markets.  Such a deflation would reverberate across many, many other markets, including labor markets, and inflict lingering pain on the larger U.S. economy.  This is, however, a long-term prediction, and, as with any long-term prediction, it abstracts from a wide range of countervailing tendencies (e.g. short term housing booms) and the possibilities for changes in government policies that could transform the reality that it seeks to comprehend.  At least in the short run, it seems incomprehensible to me that private capital will satisfy the contemporary demands for primary mortgage market financing to revive housing markets, reduce current inventories of vacant housing stock in particular regional markets (e.g. Las Vegas, Phoenix) especially hard hit by the deflation of the housing price bubble, and energize residential building construction.  Likewise, it is probable that the federal government, through Ginnie Mae/FHA/VA, will continue to play an enhanced role, at least until the last remnants of a federal role in housing markets can be killed off by Congressional conservatives at war with the New Deal.  Without significant, robust efforts by the federal government to restore the GSEs to financial viability and to a pivotal role in secondary mortgage markets, it seems likely to me that housing markets and housing construction will continue to be depressed for the indeterminate future.  Given Obama's comments, such a robust effort is not going to be in the cards.

Housing Market Realism and the Potential for a Radical Turn

My remaining comments here concern the other, more realistic side of Obama's recommendations for federal housing policy.  In particular, the tone of Obama's comments suggest a change in policies to realize a "rebalancing" of federal housing expenditures to enhance the development of affordable rental housing.  He, likewise, expressly argues that "banks and the government too often made everyone feel like they had to own a home, even if they weren't ready and didn't have the payment," and suggests that this was a mistake.  Again, I emphatically want to argue that such a position recognizes the fact that lower income households were, to a great extent, eagerly pushed by the primary mortgage market operators to purchase property when there was no expectation that they would be able to continue making their payments and retain their purchase as interest rates reset on prevalent adjustable rate mortgages.  On the other hand, it neither explicitly blames or absolves either side in primary subprime and Alt-A mortgage markets for their roles in creating the mortgage market meltdown.  And, critically, it recognizes that the federal government needs to proceed with a greater deference to the role of rental housing as one component within the larger landscape of affordable housing options, especially for lower income groups. 

Clearly, if the "winding down" of Fannie Mae and Freddie Mac and replacement of these secondary mortgage market agents with a greater reliance on private capital remain the central elements of the Obama administration's recommendations on federal housing policy, then the government would need to develop expedients that could supplement private capital accumulation for conventional mortgage issuance, such as an expansion of FHA mortgage insurance programs. Active fiscal support of affordable rental housing is another necessary piece as we extend beyond what FHA can do to insure households at reasonable thresholds of risk for default.  Thus, we are bound to encounter the outer limits of the "Ownership society."  If, however, ownership of one's own home has become synonymous with our conception of the "American dream," then we need to critically examine the proposition that some segment of the U.S. population, perhaps two-fifths and maybe more over time, will never be able to enjoy the prospect of home ownership. 

Two concerns immediately jump into my mind, the first ideological and the second practical, although each of these concerns tends to shape the other and, in at least some sense, they are intertwined.  First, there is no clear conception of what the "American dream," as an ideological construct, actually means or entails.  Following Althusser's Marxian conception of ideology, the American dream represents the imaginary relationship of every individual American to our lived experiences of economic, political, and cultural conditions of existence.  That is to say, the American dream isn't an objective something lying "out there," outside of our selves, unifying us as a society through our consensus image of success - it is an image that all Americans individually make up as we go along to represent our particular (fantasized) relationships to our real life processes as citizens, wage workers, capitalist entrepreneurs, retirees, parents, homemakers, churchgoers, etc.  Those images shape us as individuals making everyday life choices and, cumulatively, shape the evolution of American society as we all strive to obtain what our (individual) American dream promises.  Thus, to question the terms of the American dream must necessarily induce a personal psychological crisis of sorts in the lives of many millions of Americans, as the transformation of a real economic process (i.e. home ownership) forces individuals to reconfigure their images of what it means to succeed in America.  In this manner, I don't think that, in the "winding down" of Fannie and Freddie, the American dream is in any danger of disappearing, but, for millions of Americans locked out of home ownership, it must change, and these transformed individual images of the American dream will necessarily reflect the full range of economic, political, and cultural processes that we as individuals experience in our everyday lives. 

There is fertile ground here for cultural arguments to actively reshape images of the American dream as they are constructed by more and more American households who find themselves locked out of home ownership.  By this I mean, theories and analyses, that attempt to hammer home the point that, absent some significant federal intervention into housing markets (that is, itself, highly improbable), the dream of owning one's own home is going to be unrealistic for a steadily increasing number of American households, might actively contribute to the cultural reconfiguration of the meaning of success.  It is not a question of getting lower to moderate income households to merely accept that they will never get to live on a half an acre of their own space in the suburbs, but it must, on the contrary, support the necessity of opting out of individual home ownership as a goal and a criterion of success per se.  What we need is to produce a counterargument on the definition of the American dream, with the hope that this counterargument will embody the sort of transformations in American society that we are trying to produce.

As a Marxist, I know precisely what sort of counterargument I would advance.  As a larger society, we need to acquiesce in the cultivation of community, embodying the intentional unification of extended groups of households into private, democratized organizations that will operate to support the interests of individual members and of the collectivity as a whole.  In relation to housing, the sorts of organizations that most readily come to mind are housing cooperatives or co-housing arrangements, where multiple households cooperate in pooling financial resources to purchase and maintain a larger, multi-unit property.  Such organizations are voluntary, and they certainly do not abolish the sanctity of individual choice.  On the other hand, they perform a critical life process (i.e. housing) through collective organization and democratic deliberation between involved households.  Ideally, they reinforce an ethos of collective, organizational self-reliance, even to the extent that such cooperatives may require some measure of outside financial assistance, perhaps by small lenders, other cooperative entities (e.g. credit unions), or governmental entities. 

Moreover, collective housing implicates a range of other practical concerns.  First among them, it is entirely conceivable (and ready examples exist) that housing cooperatives will arise in suburban or rural areas, but the notion of having multi-unit housing purchases by an organized group of households seems to prioritize urban areas where such units readily exist.  As an urban redevelopment strategy, collective housing achieves a critical goal: it endogenizes incentives in the maintenance of multi-unit rental housing stock.  In other words, if renters in multi-unit urban housing group together as a cooperative and purchase the larger space in which they are renters, then they will have an incentive to maintain the quality of the space that did not exist when they were pure renters from a single, possibly external/absentee, landlord.  Further, if such households lack the potential to exit and, individually, purchase single-unit suburban property, then they will, likewise, embody incentives to enhance the quality of their collective space over time insofar as such enhancements individually benefit the quality of life for members (even to the extent that enhancements marginally elevate the collective property tax burden on the property). 

Finally, collective strategies in housing both necessitate and enhance the potential for collective, communal organizations in other economic processes (e.g. finance, consumer services, health care, manufacturing).  In this manner, if the breakdown of a reliable pathway to suburban living as isolated, individual households for millions of Americans creates the potential for collective housing as an improvisation, arising from a reconfiguration of the terms of the "American dream," then such an improvisation must generate some collective mechanism for the assembly of residential financing (a cooperative financial pool), and the collective reorganization of finance and housing may give rise to other collective organizations to resolve still other social problems.  Within my own research, I would posit that such an extensive networking of collective/cooperative organizations seems to characterize the development of the cooperative movement in Quebec, arising initially among financial cooperatives (caisses populaires) organized at the level of individual Catholic parish communities and extending into a wide range of economic processes, first in rural areas and later in cities.  The pathways might be distinctly different in the U.S. and different from region to region and city to city, but the critical point is that a turn toward collective organization might exist as a radical potential to be actively and intentionally developed here as a response to the truncation of more individually focused opportunities embodied in the "Ownership society."  This potentiality would certainly be neither an automatic nor axiomatic outcome of a retraction of the Ownership society, but it exists as a definite improvisational and entrepreneurial strategy for progressive advocates of a different course in American economic development and, critically, for the redevelopment of urban space and urban economies. 

Having dealt with my ideological concern, there remains another very practical matter.  Namely, in the current context of an affluent consumption oriented economy, accumulated housing equity remains a very important component as collateral in the financing of consumer expenditures and household investments, especially big ticket items like college education.  If, as a society, the institution of owner occupancy is bound to encounter at least a temporary diminution if not a long term secular decline, then how can we maintain a macroeconomy so centrally committed to consumption as a driving force of development?  Similarly, if other the costs of higher education continue to increase at predictable rates in the future and other avenues of educational financing (e.g. federal educational grants) encounter constrictions, how will moderate to lower income American households continue to finance higher education as a (theoretical) means of social mobility for younger generations without recourse to home equity?  I need to directly ponder the larger question of higher educational financing and its connection to social mobility in some future post, but, for now, the general subject of a loss of home equity as collateral for household borrowing presents itself as a very clear problem if we accept the idea that the Ownership society is going into retreat. 

For reasons that I have already stated, I believe that the home equity question is intertwined in ideological questions concerning the definition of success (the "American dream").  In some sense, owning a home out in the suburbs is less satisfying without certain other big (or at least moderately big) ticket consumption goods, like swimming pools, plasma screen t.v.s, a finished "man cave" in the cellar complete with a mini-bar and, maybe, a pool table, etc.  All of these things contribute to the larger definition of what it means to live the "American dream" for many moderate income Americans, and it is harder to realize them outside of the unique spatial contexts of suburban living, absent ownership of single-unit housing, and without the ability to draw on home equity to finance consumption.  Again, if an increasing population can expect to remain continuously in rental property in more or less urban settings, then the foundations for a consumption-driven economy will be undermined and the terms defining individual success must, necessarily, come into question. 

As a practical matter, households locked out of home ownership and locked into rental housing will have to reconfigure household consumption and investment expenditures to account for the critical absence of an ability to draw on home equity.  Maybe this will imply that an increasing segment of the U.S. population will experience a degree of austerity in consumption comparable to that experienced by American households in the 1930s.  If this happens, then motivations may exist for improvisational community organization to supplement everyday consumption processes.  Again, my imagery in this regard is shaped by my own theoretic preferences for collective, democratized entities like cooperative organizational forms, but the larger idea is that we, as a society, are going to have to become more creative and entrepreneurial in our conceptions of how we purchase or otherwise obtain, consume, recycle, and re-use articles of consumption, especially durables.  In this regard, I am very much impressed with the idea of "community glue," denoting the development of volunteer groups of handy-people seeking to repair and re-use consumption articles/appliances rather than discarding broken household items and buying new ones (see the Community Glue Workshop, at: http://communityglueworkshop.wordpress.com/2012/06/13/welcome-to-community-glue-workshop/).  Experiments like this have the potential to enhance the quality of life for households with lower incomes and wealth while simultaneously promoting ecological sustainability by re-using and recycling materials that would have otherwise made their way into landfills.  It reminds me, in part, of a passage in Jane Jacobs' The Economy of Cities (Vintage Books, 1973) where she argues that one day, perhaps, urban entrepreneurs may discover boundless wealth in mining their own cities' garbage for desired commodities and for sources of alternative energy - maybe now we are arriving at such a moment. 

Further, the loss of home equity as a source of collateral must exert some impact on small business development through private commercial lending.  If individual entrepreneurs or groups/partnerships (including prospective cooperatives) are unable to marshal home equity as a basis for obtaining financing from private lenders, then alternative, non-bank financial sources will attain a much greater importance as means for moderate and lower income entrepreneurs.  One clear alternative already exists in loans and grants by government agencies (e.g. federal Small Business Administration (SBA)rule 7(a) loans and the SBA microloan program), but, in an environment in which the fiscal stability of governments at all levels has become highly uncertain and in which, at the federal level, partisan struggle over the role of government in economic development threatens to undermine any active intervention to promote the health of local economies, government does not constitute a reliable funding source for small business financing.  Once again, the point here has to be that, in a future characterized by greater limitations on access to traditional lending, local communities will have to organize themselves to enable pooling of financial resources for prospective entrepreneurial projects, evaluating risks and devising means to support experimentation.  This might involve the development of credit unions or other formal institutional mechanisms for capital accumulation, but it must go further.  In particular, it will require entrepreneurs to expressly articulate supply-chain connections (i.e. networks of prospective upstream suppliers and downstream clients) in their business plans in order to provide a tangible basis for evaluating the viability of projects where scarce community resources would be at stake.  The sorts of entrepreneurial projects emerging from such processes might be expected to be quite modest in scale but highly detailed in organizational planning to ensure that limited, conservative objectives to realize profitability might be readily achieveable. 

Another alternative remains, on the question of home equity, in the organization of collective housing, particularly cooperatives.  Divergent scenarios in the organization of home equity in cooperative property (e.g. market value v. contractually limited equity cooperatives) introduce possibilities through which cooperative members would be able to individually marshal equity from their shares in cooperative housing to finance household consumption or investment expenditures.  Here again, however, the organization of cooperatives relies on a much broader level of community organization, including financial pooling to enable cooperative members to obtain adequate financing for the purchase of multi-unit property.  In these terms, the larger body of alternative possibilities advanced in this section require a substantial degree of intentional cultural transformation by committed advocates of such an alternative, laying the groundwork for commitments within particular moderate to lower income communities to support a network of new collective institutions, in lieu of individualist methodologies that might otherwise be pursued if involved households had greater access to financing to move off to isolated suburban plots.

To me, there is something meaningful and positive to be extracted from the impending disintegration of the "Ownership society," conveyed by the retraction of a federal role in the structuring of secondary mortgage markets in the interest of expansive home ownership.  Reframing the "American dream" around a more communal vision is not only more viable in a context where capital for mortgage markets is more scarce, but it also enjoys the potential for a deepening of economic democracy through collective organization and for the creation of endogenous incentives for the redevelopment of urban communities on a more ecologically and economically sustainable basis.  As I have suggested here, there is nothing automatic about any of this - if any of this is going to happen it will take immense quantities of work, ingenuity, and entrepreneurial creativity.  However, in my view, it represents the best possible hope for the reconfiguration of expectations regarding American society beyond the death of the New Deal project.        

The Tale of Fannie and Freddie, A Tragedy (Opening): On the Foreclosure Crisis and the Logic of Resistance V

This post is a reply to a specific news story appearing a week and a half ago in the New York Times, "Obama Outlines Plans for Fannie Mae and Freddie Mac," by Jackie Calmes (at: http://www.nytimes.com/2013/08/07/us/politics/obama-fannie-mae-freddie-mac.html?_r=0). In some respect, my comments here need to be read partly in conjunction with and partly in divergence from the other posts that I have included in this series. The larger conclusion that I have attempted to convey in this series of posts on the foreclosure crisis has been that, while we need to reconsider the institution of home ownership as a component of the "American dream," in the name of stabilizing communities and restoring housing values after the deflation of the housing price bubble, we need organizations that will fight foreclosure, actively (and, if necessary, physically) contest eviction of foreclosed mortgagors, promote renegotiation of principle by lenders to reflect diminution of housing values, and demand the support of governments in developing statutory restrictions on the actions of lenders to execute foreclosure. In line with this ultimate conclusion, it has not been my contention that irresponsible borrowers, who had no business being in markets for the purchase of residential real estate, deserve to be absolved of culpability for their actions and, as such, be granted free property at the expense of lenders. Rather, for reasons that I will elaborate, I think we need to deal with the facts on the ground concerning the health of local real estate markets and the effects of diminishing home values on the fiscal health of local governments and, in so doing, develop public policies that will address the culpability of all parties in relation to the mortgage market meltdown.

The particular direction being taken presently by the Obama administration appears to proceed on a tangent from my perspective on the foreclosure crisis and its effects on housing markets. Emphatically, the views expressed by President Obama in the above article lay the groundwork for a larger reconsideration of expanded home ownership as a goal in federal housing policy. To the extent that it does so, there may be merit to what the administration is seeking to do in "winding down" the government sponsored secondary mortgage market enterprises, Fannie Mae and Freddie Mac, institutions that are ultimately unnecessary if we are assuming that the majority of U.S. households should continuously reside in rental housing that conforms to their ability to make rental payments. If the promotion of affordable rental housing becomes a goal of federal housing policy, it further raises questions about how we will have to alter our conception of the U.S. economy as consumption driven, insofar as the vast majority of Americans would be incapable of marshaling home equity as a source of collateral in borrowing to finance big ticket consumption. I want to consider these questions as a larger part of what I consider to be a politically controversial but logical and, perhaps, sensible conclusion to be derived from President Obama's enunciation of the new direction in U.S. housing policy.

If, on the other hand, as it seems here, the ostensible goal of the administration is to continue, like the Bush administration before it, to promote an "Ownership society," in which the expansion of home ownership to lower income groups is the declared goal of the federal government, then the policies contemplated by the Obama administration appear singularly unsuited to the goals that it seeks to pursue. Rather, the administration is proceeding from false premises in concluding that, on the one hand, irresponsible portfolio management practices by managers at Fannie Mae and Freddie Mac, emanating from moral hazard constituted by the implicit guarantee of the federal government to insure financial losses by the institutions, were primarily to blame for the mortgage market meltdown, and that, on the other hand, secondary mortgage markets consigned wholly to private sector investors will generate a robust environment within which the majority of Americans will be able to secure affordable financing for purchases of residential real estate. Instead of developing housing policies sensibly relate to ensuring liquidity in primary mortgage markets and, thus, lowering borrowing costs on 30 year fixed rate mortgages in relation to other credit instruments, the administration is borrowing a page from traditional right wing critics of the New Deal to blame the government sponsored secondary mortgage market agents for a crisis that was not entirely of their making.

In this post, I plan to address each of these fallacious conclusions in order to argue why the "winding down" of Fannie Mae and Freddie Mac, absent a substantial expansion of explicitly guaranteed FHA mortgages (that neither seems to be part of Obama's agenda nor seems likely to emerge from this Congress), must, invariably, reduce liquidity in primary mortgage markets and, thus, produce a severely constricted institution of home ownership in the U.S. In this regard, I want to evaluate the record of Fannie Mae and Freddie Mac relative to housing markets since the 1970s, reiterate why the critical source of the mortgage market meltdown derives from private securitization of mortgage assets, and argue why elimination of the government sponsored secondary market enterprises will both substantially increase volatility in secondary mortgage markets and differentially truncate the eligibility large segments of the U.S. population for mortgage financing based on the availability of highly mobile investment capital, seeking the highest possible rate of return across the global macroeconomy.

The Secondary Mortgage Market and the Structural Role of the GSEs

From its inception in 1938, the Federal National Mortgage Association/Fannie Mae possessed a Congressional mandate to generate a secondary market for home mortgages by purchasing mortgages from primary market issuers (e.g. savings-and-loan associations, savings banks, etc.). Emerging from the broader project of the New Deal, the idea of generating a secondary market for mortgages enacts a critical postulate of Keynesian economic theory - that financial lending, as a linchpin in generating economic growth, will only occur if the financial instruments issued satisfy the demands of lenders for liquidity (i.e. liquidity preferences). The business of Fannie Mae was initially to inject federal money into primary mortgage markets by purchasing mortgages directly from issuers to clear their balance sheets of assets with extended turnover times on investments (i.e. to purchase mortgages that would completely realize their values in 15, 20, or 30 years, compensating banks with an estimated present value of the assets). The presence of a secondary market for mortgages transforms a 15 or 30 year mortgage, especially fixed rate mortgages, into relatively liquid assets, capable of being transformed at will by a mortgage lender into new capital to issue new mortgages.

Importantly, by increasing the liquidity of a mortgage asset, the secondary market gives lenders an incentive to issue more mortgages at lower rates of interest to borrowers because the existence of an entity purchasing mortgages, in effect, insures the lending process against the risks of default. In exchange for the enhanced liquidity, primary mortgage issuers were compelled to meet a set of "conformity" standards in the issuance of mortgages, concerning the overall size of a loan and threshold loan-to-value ratios/down-payment requirements or purchase of mortgage insurance by borrowers. The presence of these standards served both a strategy of risk management by Fannie Mae and a regulatory mechanism for lenders to firmly define limitations on the liquidity of the mortgages they issued. Beyond this, the mechanism of establishing and altering conformity standards by the Government Sponsored Enterprises (GSEs) (i.e. Fannie Mae and the Federal Home-Loan Mortgage Corporation/Freddie Mac) constitutes a policy tool with regard to the housing sector. If standards on loan conformity are loosened, the change in policy must necessarily generate a expansion in home-loan activity to the extent that mortgages beyond the margin of conformity become conforming and, hence, become relatively liquid assets for lenders.

At its inception, Fannie Mae's primary funding source is the federal government. In the 1950s, however, it gains the ability to market common equities in financial exchanges to raise capital. In 1968, the enterprise is split, with Fannie Mae spun off as a fully private corporation marketing prefered and common equities to private financial market shareholders and the Government National Mortgage Association/Ginnie Mae remaining under full ownership of the federal government to repurchase Federal Housing Administration (FHA) insured mortgages and rebundle them into mortgage backed securities (MBSs), backed by the full-faith and credit of the federal government. Both enterprises were empowered to fund their mortgage repurchases by issuing MBSs for sale by private investors. In 1970, Congress establishes Freddie Mac to actively compete with Fannie Mae for secondary market purchases and, thus, increase the sale prices of mortgage assets received by primary market lenders. Both GSEs are constrained by Congress to limit their purchases to mortgages conforming to defined conformity standards, and, until the 1990s, the GSEs jointly devise these standards. Given the relatively conservative character of GSE conformity standards, an implicit guarantee exists for purchasers of GSE securities that the federal government will back GSE-issued MBSs against default by underlying borrowers.

With these considerations in mind, the GSEs jointly monopolize the secondary market for conforming mortgages until the passage of the Gramm-Leach-Bliley Act in 1999. A secondary market certainly exists for non-conforming mortgages and, within this market, subprime loans make up a small part, but this segment remains at the underserved margins of mortgage issuance. Over this period, the secondary market for conforming loans remains a bland and boring place, where low risk assets, supported by tangible borrower down payments and by rigorous credit investigations, are issued largely by well regulated primary mortgage market enterprises (e.g. savings banks, commercial banks), purchased by Fannie or Freddie, and rebundled for sale to investors interested in low risk, long term steady-return assets as MBSs. The only significant alternative model in funding for home financing, involving strict reliance on depositors to savings institutions (i.e. savings banks or thrifts/savings-and-loan (S&L) associations), was largely undermined during the 1970s as simultaneous inflation and elevated interest rates created insurmountable negative rifts between deposit liabilities and mortgage revenues for savings institutions (a major cause of the S&L crisis of the mid-1980s - due to the fixed rates on mortgages and variable rates on savings accounts, the S&Ls frequently found themselves owing more in interest to depositors than they were being paid back by borrowers). Thus, secondary mortgage markets continued to enjoy greater and greater prominence in assembling the capital necessary to fund home financing. After a short term decline in the mid-1980s around the time of the S&L crisis, home ownership rates (as a portion of total U.S. housing stock) remained relatively steady through the 1990s, around 64 percent increasing to 65 percent through the mid-1990s.

All the while, Fannie and Freddie acted like any other publicly traded major U.S. financial corporation - it hired executive officers at modest salaries and compensated them with exorbitant bonuses for financial performance, creating adverse incentives for cost accounting and reported revenues, raising the eyebrows of the Securities and Exchange Commission and Congressional critics, many of whom never fancied either the government's role in establishing the secondary market in the first place or the prospect that Fannie and Freddie enjoyed an implicit guarantee by the U.S. Treasury to fund outstanding mortgage backed liabilities to investors in case of insolvency. On the other hand, the latter prospect was, in some measure, warranted in view of the burdens of federal regulatory oversight and restrictions placed by Congress on the composition of Fannie and Freddie's asset portfolios. They were restricted to investing in secondary mortgage markets. Their loan purchase activities were restricted to conforming mortgages. In 1992, Congress established the Office of Federal Housing Enterprise Oversight (OFHEO) within the Department of Housing and Urban Development (HUD) to set standards for conforming loans for Fannie and Freddie, thus (theoretically) tying the hands of each enterprise on setting criteria for mortgage purchases. The same legislation allowed HUD to regulate goals for Fannie and Freddie to invest in underserved Census tracts, purchasing mortgages in low-income, often urban communities with high minority populations, originally setting a requirement that 33 percent of the portfolios for each of the enterprises should be composed of mortgages from such communities. Insofar as Fannie and Freddie were legally prohibited from diversifying their asset portfolios with assets from outside of the housing sector, the solvency of each enterprise relied critically on the larger health of housing markets and in the quality of the conforming mortgages that they were mandated to purchase.

The Problem of Secondary Market Deregulation

As I have argued consistently in this set of posts, the real problem with mortgage markets in the U.S. comes with the elimination of restrictions on who can invest in mortgage markets and how mortgage lenders can finance their activities. By removing the Glass-Steagall firewall between the commercial banking and investment banking sectors, the Gramm-Leach-Bliley Act allowed for a significant inflow of capital into secondary mortgage markets, seeking high-risk, high-profit opportunities. From being a bland and boring market, dominated by bundled conforming loans securitized as MBSs by Fannie and Freddie, with relatively low, fixed-rate returns, secondary markets were, within five years of the law's passage, awash with high-return, high-risk MBSs and collateralized debt obligations (CDOs) (in many cases, mysteriously rated AAA (extremely low risk) by bond rating agencies, when they were loaded with B or CCC (high or extremely high risk) rated mortgage loans!), produced through confusing bundling and "tranche"-ing practices (i.e. separating "tranches"/slices of mortgage assets by diverse levels of risk). As new private sources of mortgage capital began to crowd Fannie and Freddie out a secondary market that they had virtually monopolized for three decades, issuance of non-conforming mortgages in primary markets, especially subprime and Alt-A mortgages, boomed, further driving the inflation of housing prices up to 2006.

Again, taking this context as the point of reference, it is disingenuous to argue that Fannie Mae and Freddie Mac were, somehow, paragons of irresponsible profiteering in the face of an impending crash of high-risk investments. Moreover, leveling such charges omits any consideration of the role of the federal government, through HUD and OFHEO, in managing the engagement of Fannie Mae and Freddie Mac relative to the purchase of high-risk assets. At a minimum, OFHEO regulators were negligent at ensuring that Fannie and Freddie maintained adequate market capitalization through equity to support the purchase of their asset portfolio (i.e. that they did not over-leverage their purchase of assets through the marketing of debts instruments, predominantly MBSs, that they would be left on the hook to pay if the mortgage market collapsed). Worse, HUD pushed Fannie and Freddie to increase their exposure to assets issued in underserved tracts, to 56 percent in 2005, in the process necessitating a watering down of conformity standards (these "underserved" tracts were typically in poorer, urban, minority neighborhoods, where borrowers might be expected to rely on subprime or Alt-A financing terms, often with hybrid adjustable rate mortgages, the signature creation characterizing the subprime meltdown).

For an alternative reading, stressing the significant political clout of Fannie and Freddie, and their consequent capacity to manipulate Washington policy makers and overwhelm powerless regulators, see Appelbaum et al. ("How Washington Failed to Rein in Fannie, Freddie," Washington Post, Sept. 14, 2008, at: http://articles.washingtonpost.com/2008-09-14/business/36771321_1_new-regulator-fannie-mae-freddie-mac). I discount this perspective simply because it does not take into account changes in the regulatory environment of secondary mortgage markets and the participation of private, non-agent (i.e. non-GSE) issuers of MBSs in the aftermath of Gramm-Leach-Bliley. Still, there must be some grain of truth here, insofar as the GSEs did, in fact, lower their standards for conforming mortgage purchases in or around 2004, and there is no tangible evidence that I can find that OFHEO had any meaningful influence in constraining their actions in the public interest, much less a stamp of approval. My own position in this post seeks, in part, to defend the roles of Fannie Mae and Freddie Mac in the larger goal of expanding home ownership, but it should not be construed as suggesting that the GSEs were not, in some way, culpable in the mortgage market meltdown or that their political influence in Washington, on both major parties, in the years leading up to the meltdown did not have corrosive aspects!

The roles of Fannie Mae and Freddie Mac in the mortgage market meltdown, like those of all other relevant players, must be understood in their proper contexts. They were active participants in the expansion of subprime mortgage markets as much as they were victims of this expansion. They purposefully responded to the pressures of changing secondary mortgage markets the only way that they possibly could - by watering down their purchasing guidelines to accumulate the high-risk assets that their equity shareholders wanted and that HUD wanted them to invest in, as a political prerogative in line with the goals of the Community Reinvestment Act (CRA). It is easy for critics of Fannie and Freddie, or, for that matter, for critics of the larger New Deal-inspired project of expanding home ownership opportunities, to situate the insolvency of these institutions in 2007/2008 within a temporal framework in which they acted as irresponsible oligopolists, operating under moral hazard arising from the implicit guarantee of their MBSs by the U.S. Treasury. Such an interpretation omits the specificity of the short span of time (less than one decade from the passage of Gramm-Leach-Bliley in 1999), when their circumscribed market niches were compromised by the infiltration of Wall Street actors seeking high-profit opportunities at the expense of inflicting extreme market volatility and unmanageable risk. Moreover, both of these relatively short term interpretations ignore the larger place of the GSEs in housing markets in the period since the initial inception of federal housing policy during the New Deal.