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Housing policy after the S&L crisis.

Housing Policy After the S&L Crisis

Housing policymakers are influenced by many factors in their efforts to ensure sound and fair rules for government programs. On the federal level, housing policy is shaped by the many individual members elected to Congress, as well as senior members of the administration, particularly those in key posts at HUD. These individuals, like all of us, learn from the experience of history-- both recent and long-past. Undoubtedly, the experience most indelibly imprinted on the minds of housing policymakers in this era will be the S&L crisis and the large sums of precious taxpayers' dollars siphoned off to pay depositors at bankrupt institutions. There are as many views as there are policymakers, as to why so many thrifts failed at such a cost. We asked three individuals who continue to play important roles as housing policymakers how the recent painful memory of the thrift crisis is affecting the shaping of federal housing policy. Their views are their own and merely serve to portray a sampling of the current thinking in Congress and at HUD in the wake of a costly chapter in U.S. history.

All housing policy begins with money, or more specifically, the availability of mortgage financing. Clearly, the 1990s will be a decade of change in financing: higher equity requirements, tighter underwriting and the consolidation of financial institutions. These changes do not necessarily lead to a broad curtailment of the national commitment to affordable housing, however they may offer new opportunities for financing our housing.

An oft-repeated criticism of military strategy is that generals prepare to fight the last war, and thus lose the next one. As Congress, the administration and other policymakers confront and shape changes to finance policy, the specter of the savings and loan disaster of the 1980s should not prevent an orderly consideration of new policies.

Effects from the previous decade

The impressive economic growth of the 1980s expanded opportunities for millions of people in employment, housing and investment. But now the economy is left with the headache of excess decade. The Wall Street Journal reported recently that total debt--governmental, consumer and corporate--increased greatly in the last expansion, to a level higher now (2.4 times the gross national product) than any time since the 1930s. One obvious result of this debt: the many repossessed properties held by the government and private firms.

Meanwhile, the financial services industry is in a period of consolidation and restructuring. The secondary mortgage market continues to expand rapidly, bringing more efficiencies to mortgage finance. Technological changes and an expanding geographic marketplace are challenging banking industry leaders to operate more efficiently. Congress will eventually pass financial institutions restructuring legislation to remove outdated, piecemeal legislation and put U.S. institutions on an equal footing with foreign institutions. These trends point to credit being delivered more efficiently and inexpensively in the future.

But this does not mean the industry will expand the availability of credit without a careful consideration of risk. Both private industry and government policymakers will be looking more carefully at risk assessment with an eye to protecting private and public investments. A proper assessment of risk, however, need not turn into a wholesale withdrawal from the market. Prudent policymakers, just like their private sector counterparts, will identify housing initiatives that expand opportunities while earning decent return. Here are some examples.

Federal Housing Administration

The reform of the Federal Housing Administration's insurance fund is somewhat painful medicine, but a necessary step to halt the slow erosion of the fund; after taking in higher-than-necessary premiums in the 1970s, the fund's costs outstripped its premiums in the 1980s. In addition, home price appreciation of the past two decades is no longer possible. Thus, Congress mandated tighter underwriting standards--hardly a surprise given the current climate. But Congress will have to monitor the situation to ensure that it has not overcompensated for the FHA's recent losses. Sound housing policy mandates that we not shut out any more families from homeownership than is absolutely necessary.

Future changes to FHA should aim to make it a force for "greenlining" neighborhoods, providing credit within neighborhoods that otherwise cannot access mortgage dollars. HUD should examine city codes and FHA requirements to find and remove rules that prohibit new construction of homes on vacant, inner-city lots. The Jack Kemp proposal to establish Housing Opportunity Zones will be revisited, and the FHA could take a leading role.

Fannie Mae and Freddie Mac

As part of the budget deliberations, the Office of Management and Budget and the Department of Treasury proposed that government-sponsored enterprises (GSEs) operate under far stricter standards, such as achieving a AAA rating--absent any government backing--from two credit rating agencies. Critics say the GSEs' ability to borrow at a lower rate than private sector competitors (because investors perceive a federal guarantee) distorts the markets, shifting too much capital to housing at a cost to government measured by the subsidy inherent in the transaction.

The critics would force much higher fees on agencies that could not maintain a AAA rating. It is hard to not attribute part of this trend to the paranoia behind the S&L situation.

In reality, these organizations do not compare to the savings and loan industry of the early 1980s. The organizations have strong capital bases and have no incentive to "gamble" for speculative returns. Furthermore, requiring a AAA rating ignores the fact that they have an explicit public mission to increase housing opportunities for those not well-served by purely private entities. And increasing housing opportunities through these organizations is superior to doing so through programs involving subsidies that are more prone to misuse and inefficiency.

Congress has responded in a predictable fashion: it ordered a study. This study, to be completed by spring 1991, will examine the risks of GSEs present to the government. Possibly, the Congress will find that adjustments are necessary, such as increasing guaranty fees to more accurately reflect risk, or otherwise increase capital standards so the institutions can withstand any economic scenario short of a cataclysmic depression.

But such a change will require a fine hand rather than a hammer. Yanking away the subsidy inherent in these organizations' status would greatly limit the opportunities for all families wanting better housing by increasing mortgage costs across-the-board. It would also hamper, if not arrest, a movement that has been receiving little attention: the opening of capital markets to the class of mortgages traditionally left behind: low-income housing and neighborhood revitalization borrowing. Financial institutions are trying to meet broader community goals and the GSEs have joined together to find creative ways to put more people in homes of their own while carefully managing risk. I look for a continuation of this trend. It will revolutionize low-income housing policy.

In short, while some changes will occur for GSEs, the public-purpose missions of the organizations must be, and will be, retained.

Government-owned inventories of housing

Large stocks of government-held properties, particularly those of the Resolution Trust Corporation, must be looked at as an opportunity to improve the housing conditions of thousands of families. The opportunities for reaching new buyers--literally increasing the supply of buyers, which would hold market prices steady--far outweigh any "dumping" fears. What we need are energetic financial institutions and public and non-profit entities to work with the RTC and the Federal Housing Administration, to get the bugs out of the system and use creative, local wisdom to allow tenant families to buy these vacant homes.

Legislation in the recently passed omnibus housing bill will help. State and local governments will soon be able to use federal funds to buy RTC affordable properties in bulk at a 50 percent discount from individual appraisals. The governments can then design their own programs to move families into the homes, perhaps patterned after the federal urban homesteading program. Further, as of November 28, 1990, cities will be permitted to use CDBG funds for direct homeownership assistance.

The RTC Oversight Board approved changes in October that should speed the sales of all properties, with special attention to affordable properties. These changes include more flexible seller financing and asset securitization.

Debates about credit and risk will never be the same. Political fear of "another S&L crisis" will be with us for several years, and will be the starting point for critics wishing to reduce the nation's commitment to housing. But risk is something that must be managed, not eliminated entirely. Opportunities exist in the private market to lend wisely, pay the bills and make a profit while increasing the nation's housing investment.

The public sector has opportunities as well. It will take some political courage, however, to keep these opportunities in focus. It will take the brightest public- and private-sector personnel to put them into practice.

"Experience should teach us wisdom," declared the President of the United States as he studied the bill before him on his desk in The White House.

"Most of the difficulties our government now encounters," thought the Chief Executive, "... have sprung from an abandonment of the legitimate objects of government by our national legislation, and the adoption of such principles as are embodied in this act. Many of our rich men have not been content with equal protection and equal benefits, but have besought us to make them richer by act of Congress."

President George Bush did not veto the bank bill before him in August of 1989 with those thoughts in mind. President Andrew Jackson made those observations as he penned a veto on legislation proposing to recharter the Second Bank of the United States, which was on his desk on July 10, 1832.

In the 157 years between the Presidential actions on two major pieces of U.S. banking legislation, experience has had plenty to teach. Many of the issues have remained the same, even as the shape of banking in the United States has undergone profound change. And, the bill ultimately signed into law by President Bush, which became commonly known as FIRREA, was clearly shaped by the need to overcome past problems in the banking system while preparing that system for the challenges of the future.

My colleague in the President's subcabinet, Deputy Treasury Secretary John Robson, has pointed out the twin objectives of FIRREA:

"The first is to clean up the massive wreckage of the past and make good on the government's guarantee to depositors in insolvent thrifts. This we do by paying off the depositors and either selling these insolvent institutions to financially sturdier enterprises or dismantling them and separately disposing of their assets. This is a task that looks backwards.

"FIRREA's second objective was to restructure the thrift regulatory system and standards so as to modernize regulation and restore confidence -- in short, to better assure the industry's future and the public's protection. This is the more subtle task that looks forward."

And, as those of us who are advocates of housing finance can attest, FIRREA gives the Department of Housing and Urban Development substantial voice to accompany ongoing authority over FNMA, GNMA and FHA. The result gives Secretary Jack Kemp an enhanced tool in his aggressive advocacy of a new American housing policy, particularly in the area of affordable housing.

Blame for current ills should not be laid at the door of deregulation. David Hoffman, a former bank regulator with 34 years' experience with the Comptroller of the Currency, says critics should stop blaming deregulation, as there is plenty of blame to go around. The cast of characters includes unprepared managers who couldn't move from the market-sheltered land of Regulation Q to the jungle of market-driven rates, and desperate managers who, once their institutions got in trouble, began to do anything that seemed to promise a fast buck. Hoffman also mentions regulators, Congress, the White House, the marketplace and federal deposit insurance itself.

For a variety of reasons, all these individuals and organizations failed to come to grips with the problem before 1989, and the issue was allowed to languish -- until President Bush came into office.

Only 18 days after taking office, President Bush proposed a comprehensive and permanent solution to the savings and loan industry crisis. One year after enactment of the depositor rescue legislation, the cleanup is working and the job is getting done with tough new rules to protect safety and soundness.

To some, the ultimate solution to the political problem of spending massive amounts of money to bail out the thrift industry is to get rid of the industry entirely. Indeed, unless the industry can show a reason for its continued existence, this may happen. I believe, though, that the need for a consumer banking industry to finance housing is very strong.

My friend Harry Albright, Jr., chairman of the Dime Savings Bank of New York, says "... a renewed investment in affordable housing may be the political salvation of the savings industry. The savings industry is arguably more discredited than any time since the 1930s, in the press, the halls of government and the eyes of the public. By making a bold effort to create housing for families of modest means, this industry could not only regain its public credibility, but also position itself to loosen some of the regulatory straightjackets and secure other needed legislative changes necessary to its survival."

Frankly, the thrift crisis has had relatively minimal effects on the availability of mortgage credit. This is because FNMA and FHLMC have more and more come to supplant the thrifts as mechanisms for providing housing finance -- not only because of the problems of the thrifts themselves, but also due to the development of efficient finance mechanisms such as agency mortgage-backed securities (MBSs) and mechanisms to pool MBSs.

Today, the mortgage market is effectively integrated with the nation's overall capital market.

The savings and loan crisis has attuned Congress to potential financial risks from American institutions once thought to be risk-free. The main effect is that Congress and the executive branch now realize that taxpayers must bear some of the risk associated with explicit guarantees, such as FSLIC. By extension, implicit guarantees (GSEs) are coming under renewed scrutiny.

This has come to light within HUD particularly with respect to the explicit guarantees of FHA and GNMA, and the implicit guarantees of FNMA and FHLMC. For these agencies, the issue comes down to the definition of proper balance between safety and soundness and accomplishment of public mission. The public mission includes availability of housing credit, housing affordability and housing assistance for low- and moderate-income families.

The thrift crisis raised new questions about the implicit guarantee, and the government's potential risks associated with any FNMA or FHLMC insolvency. FIRREA commissioned the Treasury and GAO studies. These, together with HUD's annual reports on FNMA and FHLMC, all question the agencies' capital adequacy and underscore the need for further detailed analysis.

FNMA and FHLMC must assume interest rate and credit risks as part of their public mission. The administration is closely monitoring these risks. Specifically, over the next year HUD's approach will emphasize:

* The formalizing of HUD's oversight

responsibilities, including issuing

regulations and setting up

monitoring offices; * Detailed analysis of risks using

"stress test" approach; * Closer monitoring and more

detailed provision of data from the


This will enable HUD to consider systematically the issue of how to reconcile accomplishment of public mission with adequate capitalization to protect taxpayers.

The FHA has been one of the government's great success stories and HUD will to continue to help to provide homeownership through the FHA program.

However, FHA is in serious financial trouble as confirmed after careful analysis by Price Waterhouse. The FHA fund was not operating on an actuarially-sound basis -- the fund's net worth had been steadily eroding in the last decade, from 5 percent of outstanding insurance in force at the beginning of the 1980s to only 1 percent in 1989. Because FHA was loosing money on each year's new business, FHA would eventually have had a negative net worth.

As the S&L experience demonstrates, an undercapitalized federal insurance program cannot be allowed to continue operating on an unsound basis. Therefore, Secretary Kemp proposed and Congress adopted the following remedies for putting FHA in the right direction:

* Risk-based premium structure; * Ending the practice of financing

most closing costs, * Substantial administrative reform to

minimize future claim losses.

No one at HUD is happy that FHA is in serious financial difficulty and we recognize that some homeowners will have to pay more under the new program. But, we had to stop the financial hemorrhaging to guaranty the survival of FHA's Mutual Mortgage Insurance (MMI) fund. With the passage of the National Affordable Housing Act, FHA will now be able to function on a foundation of actuarial soundness and financial strength, ensuring the availability of FHA mortgage insurance for future generations of Americans seeking an opportunity for homeownership.

I was a strong supporter of the FIRREA law and the recently adopted FHA reforms included in the Cranston-Gonzalez National Affordable Housing Act. While the reforms were long overdue, and perhaps not perfect, I am convinced that they will contribute to the restoration of a firm foundation of fiscal integrity and sound financial management for housing and the mortgage lending industry.

In other words, I do not share the "gloom and doom" expressed by some that the savings and loan crisis has resulted in a "radical change" in federal housing policy. Indeed, I believe the basic federal commitment to housing has been reaffirmed with the passage of the Cranston-Gonzalez National Affordable Housing Act. In addition, I believe federal housing commitment has been reinvigorated and strengthened through the extension of the low-income housing tax credit and the continuation of the mortgage revenue bond program.

Some industry experts have pointed to certain provisions of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and have complained that the post-FIRREA "fallout" distorted the FHA debate and even contributed to the current "credit crunch" engulfing the nation. I do not believe this was a direct consequence, but rather the result of a confluence of market forces that undermined the integrity of financial institutions.

The assessment of those changes are surely in the proverbial "eye-of-the-beholder." Many of us in Congress saw the changes made in FIRREA and the final FHA compromise as necessary steps reaffirming the federal housing committment by demanding that those programs insured by the federal government and underwritten by the American taxpayer not breed future taxpayer bailouts because of fraudulent and greedy mismanagement.

I would agree that the gut-wrenching seven-month period the House and Senate Banking Committees spent developing and enacting a thrift reform bill in 1989 did impact on housing policy and practice; but I believe these reforms were overdue and absolutely necessary. There was an assumption by some that federal housing policies entitled everyone to a home no matter what the consequences or the costs. Those policies supported by the industry and enacted by Congress were clearly unsustainable (i.e., little or no capital, minimal down payments, no equity on the part of the borrower, inadequate underwriting principles and little oversight.)

For this Member of Congress, the reforms initiated with respect to new capital requirements for S&Ls, changes in accounting principles and the treatment of items such as purchased servicing within the definition of capital, increased loan-loss reserves and more audits were a more definitive and direct positive change. The creation of the Resolution Trust Corporation (RTC) and the affordable housing program within the RTC were also positive moves to provide additional housing resources for those Americans who long to realize the American dream of homeownership.

Clearly, where there is action, there is also a reaction, and nowhere was the impact of the changes in FIRREA more directly felt than on the reform of the FHA program.

Was it fair for those of us "battle-scarred" veterans of the savings and loan crisis to equate the FHA problem with the S&L crisis? I believe it was I who rejected the arguments of those who said there were definitive differences. Clearly, the two problems were not the same order of magnitude, but the parallels were all too familiar and the symptoms all too apparent.

To me, the crisis in the S&L industry was not the specific number of thrifts that were poorly managed, or run by "high-fliers" and fradulent operators, or who made bad loans, or who were simply insolvent. The real crisis was found in the fact that too many thrifts lacked capital and were not being run on an actuarially sound basis, and that the federal insurance fund, the FSLIC, which was the government's commitment to depositors that their money would never be lost, was bankrupt. The fact that poor management, derelect federal and state regulation and thievery were the causes of the crisis could not detract from the reality that the empty coffers of the FSLIC and the lack of capital in the thrifts was going to cost the taxpayers of this nation in excess of $300 billion.

The Price Waterhouse study analysis of the Mutual Mortgage Insurance Fund (MMI) made two things perfectly clear. First was that the fund had been losing money for 10 years and its capital had been reduced from 5 percent in 1980 to 1 percent at the end of 1989. And second, the fund had been managed in an actuarially unsound manner and was now losing upwards of $350 million annually. At that rate, Price Waterhouse concluded that the fund would be insolvent within a few years. Yet another government insurance fund, the MMI, was facing bankruptcy and threatening to hit the American taxpayer with yet another multibillion dollar bill.

Was it unfair for us to say we had another potential disaster on our hands? In light of this substantial evidence, yes it was. And was it fair to say that, unlike our "go slow, things will work" approach to the S&L crisis, the government needed to act as quickly and as decisively as possible? I believe so.

Congress had the responsibility to restore the fiscal integrity of the FHA by requiring stronger capital levels, increased premiums and to require that future users of the program assume a greater stake in its well-being by providing more of an equity stake in the home they were to purchase through increased down payments. The Price Waterhouse conclusion that the MMI fund could not likely survive even moderately poor economic conditions, let alone a recession, was warning enough that strong action was needed.

Just as Congress demanded more accountability from the regulators and the auditors to ensure that thrifts in the future stick to prudent and sound investment and lending practices, so too, the Congress mandated that those involved in the FHA program, the Realtors and the lenders, be more vigilent in their sales practices and underwriting.

Congress, in approving the very restrictive FIRREA laws, knew that the changes in the way S&Ls conducted their business would result in a contraction of the thrift industry and the loss of mortgage lenders. So too, did Congress understand that changes in the FHA program would result in the loss of potential homebuyers. But we were willing to accept the short-term consequences to the FHA program as long as the end result was a stronger program. It is true that the FHA program has provided thousands of our citizens the opportunity to realize the American dream of homeownership. However, as we continue to see, poorly underwritten, improperly monitored and excessively risky mortgages (in the words of Price Waterhouse), have resulted in thousands of those same individuals experiencing the nightmare of default and foreclosure. The MMI should not be a welfare program for aspiring homebuyers or for the industry.

Did this attitude on the part of Congress represent a dramatic change in federal housing policy? No, but it did represent a degree of maturity and responsibility and demonstrated that we had not so soon forgotten the S&L debacle and that perhaps "never again" was a meaningful pledge. This is why, as stated earlier, the changes we made were necessary and for the better, and why I reject the comments of some that these changes will peal the "death knell" for the FHA or that the changes will drive more homebuyers to conventional financing.

It is true that the objective of the FHA is to expand homeownership opportunities. But, again, it is not a welfare program. The FHA, by law, must also operate on a sound financial basis. In times of economic constriction, declining real estate values and lender "credit crunches," these two goals will necessarily conflict. But, in the post-S&L crisis environment, there can be no doubt that the long-term acturial soundness and fiscal integrity of the FHA program must take precedence even at the expense of potential homebuyers.

These changes will not come without a price. The current apprehensions over the result of these necessary and correct changes is a direct result of the increasing awareness that certain lending and underwriting practices are no longer acceptable. This will be an uncomfortable period for some, but the end result will be a stronger home mortgage program for all. My only hope is that Congress, in both the S&L and FHA cases, has acted fast enough and that the reforms went far enough to avoid future liabilities to the federal government.

These new standards reinforce the safety net, protect the public and the taxpayer and are totally consistent with the charter and public policy objectives of the FHA. They will actually enhance opportunities for those who qualify and add stability to the marketplace. The result will be a healthier, fiscally sound thrift industry and a solvent FHA program responsive to market conditions. With this foundation, the housing industry should grow stronger in the 1990s.

PHOTO : Congressman Steve Bartlett

PHOTO : Deputy Secretary Alfred A. DelliBovi

PHOTO : Congresswoman Marge Roukema

Congressman Steve Bartlett is a Republican member of Congress from Texas who serves on the House Banking, Finance and Urban Affairs Committee. Alfred DelliBovi is HUD Deputy Secretary and serves directly under HUD Secretary Jack Kemp. Congresswoman Marge Roukema is a Republican member of Congress from New Jersey who serves on the House Banking, Finance and Urban Affairs Committee.
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Author:Bartlett, Steve; DelliBovi, Alfred A.; Roukema, Marge
Publication:Mortgage Banking
Date:Jan 1, 1991
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