How to make the home-loan market work better for buyers

A major piece of unfinished business from the financial crisis is what to do with Fannie Mae and Freddie Mac, which have been in a government conservatorship since 2008. An impasse between Republicans and Democrats on the future of the agencies could be broken if they came to realize that there is a sensible solution that is consistent with the better instincts of both.

While there is agreement that federal government guarantees will continue, it is not clear whether the guarantees will be provided through those agencies or through newly created guarantors. Even more contentious, because it goes to the heart of the political dispute between left and right, is the quid quo pro that government should demand for its guarantees.

The focus of the left is housing affordability. The dominant view is that any housing finance entities whose obligations are backstopped by the U.S. government should be obliged to meet affordability targets for lower-income households.

The problem with this argument is that before the crisis, Fannie Mae and Freddie Mac were subject to such targets, which were periodically reset by the Congress, and it proved to be their undoing. To meet their targets, the agencies were forced into the subprime market, and when that market imploded they became insolvent and forced into conservatorship. I haven't seen any credible schemes for reinstituting affordability targets in ways that would avoid the risk of another insolvency debacle.

The focus of the right is excessive regulation. The dominant view seems to be that the agencies ought to be replaced with other guarantors who would not be subject to affordability targets, and would have minimal regulatory authority.

The problem with this position is that eliminating Fannie and Freddie would entail the loss of an enormous amount of valuable institutional knowledge and systems, for no good reason. The home mortgage market is not over-regulated by Fannie and Freddie - it is badly regulated, which is very different. The agencies would be the best instrument for fixing the dysfunction associated with bad regulation - if given that charge by the Congress.

Using the agencies to fix market dysfunction:

• The Uniform Residential Appraisal Report that appraisers execute when they value a property is used by both Fannie and Freddie. This report shows the lender as the client ordering and controlling the appraisal, despite the fact that the appraisal is paid for by the borrower.

This severely disadvantages the borrower trying to shop for a mortgage. Appraisals are not ordered until borrowers apply, which lengthens the period the borrower must wait for the information needed to shop. It also means that the borrower who withdraws from the process with one lender in order to deal with another must pay for (and wait for) a new appraisal. Few do it.

Making appraisals portable is one of the simplest and most effective ways to empower homebuyers. Bringing that about would require scrapping the regulations that place control of appraisals with lenders. This should appeal to both the left and the right. The logical entities to do this are Fannie and Freddie imbued with a new mission by Congress: to make the home-loan market work better for people.

• While assurance of good title is necessary for an effective housing and mortgage system, the title insurance used for this purpose in our system is grotesquely overpriced. The reason is that existing regulations allow the cost of title insurance that protects the lender to be shifted to the borrower. Since the title agency placing the insurance is almost always selected by the lender or Realtor involved in the transaction, agencies compete for their favor, which raises the price to the borrower.

While companies competing directly to buyers tends to reduce prices for people, competition (and incentives) directed to third parties who refer buyers to those sellers raises prices for people.

If Congress gave Fannie and Freddie the mission of making the home-loan market work for borrowers, the agencies would require lenders to pay for title insurance that protected themselves, passing the cost to the borrower in the price of the mortgage. The result would be a precipitous decline in the cost of title insurance. Much the same reasoning would apply to mortgage insurance.

Those on the left who focus on affordability should not be put off by the fact that the cost reductions engineered by a revamped Fannie and Freddie would be available to all mortgage borrowers, advantaged as well as disadvantaged. Those on the right who focus on redundant regulations that stifle initiative will find that the revamped Fannie/Freddie policies will identify those regulations for easy disposal. If lenders were required to pay for title and mortgage insurance, for example, the large set of regulations directed toward the payment of referral fees would immediately become obsolete. These regulations deal with such weighty matters as whether a birthday present from a title agent or a mortgage insurance salesperson, to a lender, constitutes a prohibited referral fee. Good riddance.

In sum, Fannie and Freddie ought to be retained but with a new mission: to make the home-loan market work better for borrowers. My examples are two of many.

Some of the possibilities I did not discuss here involve innovation and possible experimentation, which are good reasons for maintaining both agencies.

• Contact Jack Guttentag via his website at mtgprofessor.com.

© 2018