Comment Detail

Comment

Subject: Public Comment on Freddie Mac Proposed Purchase of Single-Family Closed-End Second Mortgages

To the FHFA,

We accept that everyone makes mistakes, but there is nothing more frustrating than making the same mistake twice. It is confirmation that despite knowing better, there is a deeper dysfunction within us that is stronger than our ability to learn, adapt, and grow. The Great Financial Crisis of 2008 was the result of policies that encouraged excessive speculation, leverage, and malinvestment in the housing market. By allowing Freddie Mac to acquire closed-end second mortgages, the Federal Housing Finance Agency would be demonstrating that we have failed to learn the lessons from one of the worst financial disasters in American history.

We should coolly examine the direct consequence of this policy. Allowing Freddie Mac to acquire closed-end second mortgages will increase the frequency that second mortgages are taken out on homes. This will have the following predictable impacts:

1) Lenders will engage in riskier lending

When Freddie Mac purchases second mortgages, originators will rightly conclude that the government-sponsored enterprise is protecting them from downside risk of second mortgages. As Russ Roberts wrote in Gambling with Other People’s Money, “…the greater the chance that Uncle Sam will cover the debts of the poker player if he goes bust, the less likely you are to try and restrain your friend’s behavior at the table.”

2) Borrowers will increasingly find themselves underwater

With any second mortgage, equity built in a home will be converted into debt for the borrower in one large lump sum. Decreasing homeowners’ equity and increasing debt increases the likelihood that homeowners will be underwater on their homes with any downturn in the market.

3) Fighting inflation will become more difficult

A recent column in the Financial Times estimated that as much as $3 trillion could be released into the economy as a result of this policy. This amount of stimulus would it make it more difficult for the Federal Reserve as it tries to reduce inflation to its 2% target.

Advocates will argue that this policy will allow more homeowners to access the value of their home equity. Thankfully, there are several wonderful methods for this that already exist.
The first method is the HELOC loan. The major difference between HELOC and a second mortgage is that the former is a revolver and the latter is a term loan. Advocates for this policy in question will counter that banks have pulled away from approving HELOCs post-GFC: the volume of HELOC lending has declined even as homeowners’ equity has increased. These advocates are unwittingly telling on themselves. The banks are trying to limit the risk exposure in their portfolios and have determined that lending against a property multiple times generally exceeds their risk appetite. Why is it acceptable for a government-sponsored enterprise with a history of being bailed out by the US government to take the risk of second mortgages on behalf of originators who believe this is too risky?

The second method is to simply sell the home. With the post-pandemic era of low inventories nationally, there is no pressing need to spare homeowners from the decision of choosing between their existing mortgage rate or the equity in their homes.
Over the past 70 years, the median price of a home has typically been 4-5 times higher than the median income. There have been two notable exceptions: 1) The GFC, in which the median price of a home reached as high as 6.78 times the median income; 2) The present day, in which the median price of a home is 7.64 times the median income. This is the result of policies that turned housing into a financially engineered speculative asset instead of what it really is: a good to be consumed.

What’s truly disappointing about this proposal is what we are once again choosing to prioritize: people who already own homes over people who do not yet own a home but would like to someday. This is a transfer of benefits from the young to the old and the poor to the rich. It is a designed outcome to limit homes coming onto the market. Policies that subsidize demand and limit supply will only result in more housing inflation. The Federal Reserve has learned this lesson and has been steadily shedding its balance sheet of Mortgage-Backed Securities with a policy of Quantitative Tightening. We hope the FHFA also learns the same lesson by rejecting this proposal from Freddie Mac.

X: @GayBearRes