This time last year, housing industry insiders were predicting that the market would collapse under the weight of the pandemic. The opposite happened. Even as the economy suffered its worst year since World War II, the housing market boomed.
But that doesn’t mean all is well. Rising prices have masked but not eliminated longstanding problems and vulnerabilities at the heart of America’s housing market. Most urgently, Fannie Mae and Freddie Mac—the government-sponsored enterprises that own or guarantee roughly half the $12 trillion mortgage market—lack the capital to survive the next inevitable downturn in home prices.
The good news is that unlike the crisis in 2008, should the GSEs fail again, creditors, rather than taxpayers, can absorb the losses. That’s because the Federal Housing Finance Agency, which I direct, completed a new rule last month that creates a process to end taxpayer bailouts of the GSEs once and for all.
By requiring the GSEs to maintain credible resolution plans known as “living wills,” the new rule will enable a failing GSE to be restructured without risk to business continuity or America’s mortgage market. Similar to the requirements put in place by the Federal Reserve Board and the Federal Deposit Insurance Corp. under the Dodd-Frank Act, the resolution plans will facilitate rapid and orderly resolution if necessary.
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For the first time in history, the GSEs are required to demonstrate how, in the event of insolvency, core business lines and charters would be maintained to support the housing-finance system without extraordinary government assistance. By establishing the rules of the road in an insolvency, these living wills give future investors the information they need to price risk appropriately. This is a prerequisite for the GSEs to raise private capital, which is key to the housing market’s long-term stability.
The GSEs are private companies chartered by Congress to promote mortgage credit access, expand affordable housing in underserved communities, and backstop the housing market in a crisis. They have operated under temporary government control since 2008, when they were bailed out and placed into conservatorships run by FHFA. But they remain private corporations. This means their ability to survive a downturn is tied to their capital levels.
When I took office two years ago, the GSEs had only $6 billion in capital backing $5.5 trillion in mortgage-credit risk. This put their leverage ratio at nearly 1,000 to 1, compared with an average of 10 to 1 at America’s biggest banks. FHFA worked with the Treasury Department, the most powerful shareholder of the GSEs, to increase the earnings Fannie and Freddie could retain instead of remitting to Treasury.
The GSEs used their new and modest capital cushions to help millions of borrowers and renters stay in their homes amid Covid-19; the enterprises also contributed a record $1 billion to government affordable-housing funds. Last month the GSEs created a new refinance option that saves low-income borrowers thousands of dollars. But they could be doing even more to support the market today if they had more capital.
Slowly building capital through retained earnings has improved the GSEs’ leverage ratio to roughly 140 to 1. That still isn’t enough capital to take risks or survive a housing downturn. And as 2008 demonstrated, when the GSEs fail, America’s housing problems get even worse. FHFA will continue to address the obstacles to building capital, including the need to restructure the assets that Treasury acquired in exchange for its 2008 funding commitment.
At the same time, FHFA will continue advocating for solutions to structural problems in the housing market that GSEs can’t solve alone. Only local governments can roll back zoning restrictions and land-use regulations that inflate the cost of new housing or stop construction. Only Congress can break up the Fannie and Freddie duopoly, which concentrates risk and blocks new entrants from delivering better prices, innovation, efficiency and stability. Even so, ensuring the GSEs are well-capitalized and ready to withstand the next downturn is essential to avoid exacerbating these problems when housing prices inevitably fall.
The new resolution rule will protect taxpayers from another Fannie and Freddie failure. But it can’t protect the GSEs or the broader housing market from a crisis. Only private capital can do that. The time is long overdue to ensure the long-term stability of America’s housing market. The current boom won’t last forever.
Mr. Calabria is director of the Federal Housing Finance Agency.