New HUD Secretary – The Good and Bad So Far

Editor’s Note: A version of this post ran this morning in the San Antonio Express News.

I can’t remember any speech Mayor Julian Castro ever made to which I paid much attention.

julian_castro_sub_prime_mortgages
Shouldn’t be pushing Subprime Mortgages

Decade of Downtown?
Meh. I had just moved to San Antonio’s downtown and I didn’t have any context.
Democratic National Convention?
I missed it because I was recovering that day from a blowout wedding in the Yucatan.

But last Tuesday’s speech introducing his priorities at HUD?

Did somebody say mortgage and housing policy?

Now you’re in my wheelhouse, Secretary Castro. As a former mortgage bond salesman, I’ve got some strong opinions about federal mortgage and housing policy.

Two things stood out for me from his speech, one bad, and one good.

First, the bad:
HUD Secretary Castro named increasing access to mortgages for borrowers with low credit scores a top priority of HUD.
I cringed.

home_ownership_rates
Home Ownership Rate Comparison, 2011

Do you know another name for increasing access to mortgages for borrowers with low credit scores?
That’s called sub-prime mortgage lending.

Restricting mortgage loans from people with bad credit scores is not housing discrimination or lending discrimination.
Rather, restricting mortgage loans from people with bad credit is prudent practice for both borrowers and lenders.

People with low credit scores are people who have not previously paid their bills on time. That’s just the definition of bad credit.

People can fix their bad credit over time, and government can play a positive role in encouraging financial education, for example, or by regulating credit reporting and consumer protections.

But most importantly, people with bad credit are people who should probably wait a bit longer before taking on the largest loan generally available to them – a home mortgage.

Encouraging more people with low credit scores to take out mortgages is a bit like breaking out the champagne at the AA meeting to celebrate a month of sobriety. Bad things can and will follow.

 

Look, I get it, when you’re a hammer, everything looks like a nail. And when you’re HUD Secretary, more home ownership is always better.

I guess my larger problem with Castro’s stated HUD priority is that home ownership isn’t always better.

It’s fine with me if banks or private lenders want to take extraordinary risks and lend to people who won’t pay them back in the future, but I really don’t think the federal government should be encouraging more of that activity.

Back in the pre 2008-Crisis days, mortgage giant Fannie Mae used to run constant radio advertisements proudly proclaiming “We’re In The American Dream Business!” and at the time, who could argue with them?

Home ownership traditionally fell somewhere between Motherhood,
Baseball, and Apple Pie on the spectrum of unimpeachable good things.
Well, since 2008 we’ve gotten wiser:
Apple pie causes obesity.
Baseball is full of PED cheaters.
And Mothers are the direct catalyst for about 50 percent of all of the adults who seek psychotherapy. (Since you’re curious, scientific studies show that Fathers are responsible for the next 25 percent of all therapy-seekers, and scary, scary clowns make up the final 25 percent. In my case, it was the clowns.)

monopoly_housing
Housing as an investment tool

And home ownership? Well, it’s both an incredibly powerful tool for building middle class wealth, as well as the cause of the worst financial crisis since the Great Depression.

While I would advocate home ownership for many people, pushing home ownership to excess – like Apple Pie, Baseball, and Motherhood – also leads to terrible outcomes.

We don’t need more subprime lending, and we don’t need government agencies encouraging more subprime lending.

Speaking of Fannie Mae and the American Dream Business, I really liked a different part of Castro’s speech.

Castro advocated passage of a bi-partisan Senate bill (sponsored back in March 2014 by Tim Johnson D-South Dakota, and Mike Crapo R-Idaho) currently languishing indefinitely in the Senate purgatory between Banking committee passage and the Senate floor.

The GSEs worth killing
The GSEs worth killing

The bill would set broad guidelines for mortgage lending and securitization in the future. Most importantly – from my perspective – the bill would kill former mortgage monstrosities Fannie Mae and Freddie Mac, which themselves currently languish indefinitely in conservatorship purgatory.

Why were they monstrosities?

To me, the definition of a monstrosity is a company that enriches private investors and its executives, all the while enjoying a government guaranty, and therefore represents a massive public subsidy of private enrichment.

And yes, I understand that all of Wall Street briefly earned monstrosity status by that definition in 2008.

But the difference between Wall Street and the mortgage monstrosities Fannie Mae and Freddie Mac is that the latter companies always had this monstrosity status, from their very inception.

Technically, they were described as “Government-sponsored entities” and government officials occasionally tried to point out that their debt was not explicitly guaranteed by the Federal government.

In practice, Fannie and Freddie bond investors always assumed that when push came to shove Fannie and Freddie would be bailed out by the Federal government. Of course, push did come to shove in 2008, and bond investors were proved right.

Would you like an example of the kind of private enrichment and public liability I am talking about? Fannie Mae’s CEO Franklin Raines earned $90 million in compensation between 1999 and 2004. Their next CEO, Daniel Mudd, earned $80 million between 2004 and 2008. And then the federal government (that’s you and me, fellow-taxpayer) assumed all of the liabilities of Fannie Mae and Freddie Mac in 2008, up to $800 Billion.

I don’t know. That just seems like a lot of money to be paid to run a government sponsored (and guaranteed) entity. There’s no flies on that pair of Dickensian-named CEOs, Raines and Mudd, despite SEC investigations of both of them for securities and accounting fraud, and a paltry settlement with Raines.

The Senate bill supported by Castro would not eliminate federal government subsidies for the housing and mortgage markets, but it would greatly reduce the future taxpayer subsidies for the enrichment of quasi-private monstrosity entities like Fannie Mae and Freddie Mac, and their investors and executives.

The bill would replace them with a much more narrowly-functioning government entity – modeled on the banking deposit insurance agency FDIC – to provide mortgage insurance and a taxpayer-protection fund against mortgage losses.

That would lead to much less private enrichment with a public subsidy.

That would represent great progress.

 

Please see related posts

Mortgages Part I – I am a Golden God

Mortgages Part VIII – The Cause of the 2008 Crisis

Book Review – Edward Conard’s Unintended Consequences

On Housing Part II – The Risks

On Housing Part III – The Opportunity

 

 

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