immergluck_dan
Stanley Leary

Dan

Immergluck

Sound mortgage markets require a mixed-economy approach

Cover Interview of

In a nutshell

Foreclosed describes the evolution of U.S. mortgage markets from the early twentieth century through to the subprime crisis of the late 2000s. The book details the highly mixed-economy nature of these markets, and how heavily shaped they have been by public policy. I argue that the successful and stable mortgage markets of the past involved an active role for the federal government both as regulator and as an investor. Actions, since the early 1980s, to reduce regulations and to connect global capital markets more directly to homeowners – with little public-sector supervision or involvement – were at the root of the subprime and high-risk loan debacle.

Foreclosed explains both the mechanics of securitized mortgage markets and the political economy that helped connect global capital markets much more closely, and with little mediation or supervision, to homes and neighborhoods – often with disastrous effects. It concludes with an extensive discussion of how policy could help fundamentally restructure mortgage markets to provide for sound, risk-limiting and fair housing finance.

The book describes the evolution and fundamental problems of private-label securitization and the dual regulatory system that resulted in higher-risk lending being less regulated than lower-risk, plain-vanilla mortgage markets. To correct the misperception that there was just one boom in subprime mortgages that began after 2000, I document the history of two recent high-risk lending booms. The first high-risk lending boom, in the late 1990s, occurred primarily in the refinance and home equity markets; the second began after 2001 and involved both home purchase and refinance loans.

“To correct the misperception that there was just one boom in subprime mortgages that began after 2000, I document the history of two recent high-risk lending booms.”

The wide angle

Unlike many books on the mortgage and financial crises in the trade press, Foreclosed focuses much more on the damage that high-risk lending markets imposed on neighborhoods and communities. I pay particular attention to the public policy debates that evolved in the late 1990s and early 2000s over increasing regulation of high-risk lending.

Over a large portion of the twentieth century – from the 1930s through the early 1990s – the federal government’s active involvement in mortgage markets, both as regulator and investor, provided for generally sound, risk-limiting home finance. The penultimate example of this public-private partnership was the 30-year, fixed-rate fully amortizing mortgage that was fairly conservatively underwritten, typically by lenders and investors that had a significant stake in the performance of the loans that they underwrote.

Over the 1980s and 1990s, the U.S. mortgage market moved away from a financial system that, despite some significant flaws, generally delivered safe and sound mortgage finance to one that shifted risk to borrowers, and, as a byproduct, increased risk to the financial system overall. This transition happened first via the government-sponsored entities Fannie Mae and Freddie Mac, and then later through higher-risk investors in private label securities.

Problems in subprime mortgage markets were evident well before 2000. The book documents how policymakers made explicit decisions to let the mortgage industry have free reign in aggressively pushing dangerous products, particularly in minority and modest-income communities. Federal policymakers in both the executive and legislative branches not only failed to expand regulatory supervision over a new high-risk loan sector, they aggressively preempted states that attempted to step into the breach.

Beyond its implications for the literature on housing and mortgage markets and related public policy, Foreclosed fits into a broader literature on the political economy and the role of free-market ideology in the formation of public policy and regulation and, more particularly, of housing and urban policy.

June 24, 2009

A close-up

Historical breadth will hopefully make Foreclosed particularly useful beyond the near term. But the timing of the book is not coincidental. I have a proximate objective of using lessons from the 2007–08 mortgage crisis to promote the principle that sound, affordable, and sustainable mortgage markets require a mixed-economy approach — a public-private partnership if you will — that involves a significant and persistent role for government in the regulation and funding of mortgages. (I refer to the most recent period of serious mortgage market calamity as the “2007–08 mortgage crisis” even though its associated problems and effects will clearly last well beyond 2008.)

In recent years, the costs of deregulation and the privatization of secondary mortgage markets have been very large and, in many cases, painfully obvious. In early 2008, the mortgage crisis had been estimated at creating direct losses to investors in mortgage-backed securities in the $350 to $420 billion range. But because these losses occur at leveraged financial institutions, their full impact has been estimated at $2 trillion or more.

By August 2008, write-downs and losses of mortgage-backed securities by commercial and investment banks alone amounted to over $500 billion, without accounting for leveraged impacts. Some predicted that total write-downs and losses would reach well beyond these levels. By November of 2008, as a result of the broader financial crisis — which was spurred but not solely caused by the mortgage crisis — the global financial sector had lost as much as 85 percent of the sector’s Tier 1 equity capital, which is a traditional measure of the net worth of financial institutions. This amounted to a loss of more than $4.2 trillion at financial institutions. If the post-crisis values of financial assets were measured more liberally, it was argued, such losses were likely to be about half this, but still amounting to over $2 trillion.

But the costs of the crisis go far beyond investors and financial institutions. Homeowners saw their credit records decimated, often after being lured into unfair or excessively risky mortgages without understanding the dangers embedded in the loans. Renters — who clearly had no role in the mortgage process — found themselves given little notice to vacate foreclosed rental properties. Neighborhoods around the country were littered with vacant and abandoned properties that depress the values of nearby homes, that can create havens for crime, and that have the power to undo decades of progress in community development. And the problems were not just confined to the inner city. In some places, entire suburban or exurban subdivisions that had been planned or started at the peak of the high-risk lending boom in the mid-2000s were left half empty or worse. Cities and suburbs have been forced to become custodians of abandoned houses in order to slow the contagion effects of derelict properties.

“the nature, extent, and form of consumer protection and fair lending regulation in mortgage markets should not depend on the path that capital takes into the retail mortgage market.”

Lastly

The silver lining to the 2007–08 crisis may be that it catalyzes a new way of thinking about mortgages, housing, and local real estate, and, perhaps, a new approach to related policies. This approach is based on recognizing a number of precepts.

First, deregulation or the lack of regulation of mortgage markets over the last twenty to thirty years has imposed heavy costs on borrowers, neighborhoods, and broader credit markets and the economy. Given the very substantial costs imposed on local communities by high-risk lending, there is a very strong argument that states should have the authority to regulate such lending, in order to mitigate and limit such risks given the costs that are borne by local and state government and residents.

Second, it has become apparent that the fundamental approach of consumer disclosure is not a sufficient one for developing and sustaining affordable and fair mortgage markets. Borrowers do not necessarily benefit from receiving more choices; in fact, greater choice can confuse borrowers and make sound financial decisions even more difficult.

Third, the nature, extent, and form of consumer protection and fair lending regulation in mortgage markets should not depend on the path that capital takes into the retail mortgage market. A dual system of financial regulation, in which prime lenders are subject to closer supervision and scrutiny than subprime lenders, makes little sense.

Finally, if homeownership is to be encouraged, particularly for low and moderate-income households, policymakers must be sure that such programs promote homeownership that is sustainable and financially beneficial for the households who choose it. But it is also important to increase the tenure options—including rental, ownership, and various limited equity schemes—that are available in a wider variety of communities.

These are the critical principles that will provide the basis for a sound, risk-limiting, and affordable mortgage marketplace and for promoting sustainable homeownership as well as affordable housing options more generally. Although incremental improvements in policy are always valuable, until these fundamental principles are accepted and acted upon, we are unlikely to have seen the end of boom-bust cycles and crises in mortgage and housing markets, with all of their attendant damages and costs.

© 2009 Dan Immergluck
Dan Immergluck Foreclosed: High-Risk Lending, Deregulation, and the Undermining of America’s Mortgage Market Cornell University Press 272 pages, 6 x 9 inches ISBN 978 0 8014 4772 3
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immergluck_dan
Stanley Leary

Dan Immergluck is Associate Professor in the City and Regional Planning Program at Georgia Institute of Technology in Atlanta, where he teaches housing policy, real estate finance, and quantitative methods. Dr. Immergluck’s research focuses on housing markets, mortgage and real estate finance, neighborhood change, and related topics. Besides Foreclosed he has authored two previous books, including Credit to the Community: Community Reinvestment and Fair Lending Policy in the U.S. (M.E. Sharpe, 2004). Dr. Immergluck has been widely published in scholarly journals as well as in more applied venues, and widely cited in the recent policy debates surrounding the mortgage crisis. He has testified before Congress, the Federal Reserve Board, and state and local legislatures. Before becoming a full-time scholar, Dr. Immergluck was a community developer and an applied researcher; his work is grounded in a fundamental pragmatism and characterized by an inductive approach to understanding how markets and policymakers behave.

Cover Interview of
June 24, 2009