Yesterday, the Senate Banking Committee’s Subcommittee on Security and International Trade and Finance held a hearing entitled “Comparison of International Housing Finance Systems”. In his opening remarks, Subcommittee Chairman Evan Bayh (D-IN) explained that the purpose of the hearing was to gain insight into legislative challenges the Congress will face as it considers reform to the U.S. housing finance system. He hoped to gain valuable insight from the housing finance models of other nations to determine the strengths and weaknesses of the various housing finance systems and any aspects of the international systems that can be adapted in the U.S.’s reform. Ranking Member Bob Corker (R-TN) stated that he hoped the hearing would provide an understanding of the successes and failures of other countries’ housing finance markets for consideration in the U.S.’s reform.
Testifying before the Subcommittee were the following witnesses:
- Michael Lea, Director, The Corky McMillin Center for Real Estate, San Diego State University
- Susan M. Wachter, Worley Professor of Financial Management, Professor of Real Estate, Finance and City and Regional Planning, The Wharton School, University of Pennsylvania
- Alex Pollock, Resident Fellow, American Enterprise Institute
Dr. Lea compared the U.S. housing finance market to the housing finance markets in other countries. According to Dr. Lea, the U.S. government has a more extensive role in the mortgage market to support owner-occupied mortgage finance than other countries, with long-term fixed rate mortgages having a more prominent role in the U.S., as compared to adjustable rate mortgages and short-term fixed rate mortgages, which are more popular in other countries. Despite this, he noted that the United States’ homeownership rate is considered average when compared to other countries and “no other country has experienced the magnitude of mortgage defaults and foreclosure that force households out of homeownership.” He also stated that only a minority of countries allow a tax deduction for homeowner mortgage interest and homeowners in the countries without the deduction typically pay down their mortgage debt more quickly and thus reduce mortgage risk. Dr. Lea identified several factors are responsible for the default and foreclosure experience in the U.S. market: (1) sub-prime lending was rare or non-existent outside of the U.S.; (2) there was far less “risk layering” or offering limited documentation loans to subprime borrowers with little or no down payment; (3) less prevalence of negative equity in other countries; and (4) loans in other countries are with recourse and lenders are able to pursue borrowers for deficiencies.
Dr. Lea presented a number of policy recommendations for the U.S. housing finance market. He proposed far less government support because other countries have been able to achieve comparable or higher rates of home ownership and well-developed and stable mortgage markets with much less support. In addition, he recommended features from the Danish’s housing finance system, which retains the fixed-rate mortgage product but adds the option to repay the loan through the bond market if interest rates rise. Further, he believed that the European style of covered bonds provides an alternative to funding through GSE securitization. However, he noted that the Dodd-Frank Act reinforces restrictions on prepayment penalties which would hamper development of the covered bond market.
According to Ms. Wachter, two institutional differences separate those countries which suffered severe recessions with sharp housing price crashes and those countries where housing prices remained stable during the period from 2007 to the present: (1) the role of mortgage insurance and (2) the strictness of regulations countering the market’s tendency toward procyclical behavior. Ms. Wachter noted that, in the U.S., reliance on mortgage insurance, and corresponding private regulation of underwriting practices, declined as the housing bubble grew, which further magnified the procyclical effects. In contrast, Canada mandated mortgage insurance and relied on the insurers as a third-party regulator to ensure that housing prices did not collapse and lending standards did not deteriorate. As a result, Canada avoided the recession and home ownership has remained at high levels.
Mr. Pollock echoed the testimony of the other witnesses by arguing that the one unique aspect of the American housing finance was “the dominant and disproportionate role played by government-sponsored enterprises ... wielding their ‘implied’ government guaranty.” According to Mr. Pollock, high homeownership levels can be achieved without tax deductions for interest paid on home mortgages, without 30-year fixed rate loans, and with prepayment fees on mortgages. In Canada, mortgage lenders have full recourse to the borrower’s other assets and income to provide less incentive for underwater borrowers to “walk away” from their mortgage. In addition, there is no tax deduction for mortgage interest payments, which provides an incentive to pay down debt over time. Finally, in Canada, fixed-rate mortgages are fixed for only up to five years. According to Mr. Pollock, this “relative conservatism” meant that Canadian banks came through “the international financial crisis in much better shape than their U.S. counterparts” and produced virtually the same homeownership rates as the U.S.
When asked by the Subcommittee to design a new housing finance system, all three witnesses agreed that clear and transparent information must be provided to borrowers. In addition, Mr. Pollock recommended that the residential market become a fully private market and that government activity be limited to subsidies and non-market financings, which would have to be approved and appropriated by the Congress. He also recommended covered bonds as a financing alternative and an emphasis on savings to both enter into the housing market and pay down the mortgage. Dr. Lea would emphasize affordability with tax credit programs targeting first time homeowners and low income borrowers. He believed it unwise to have an entirely fixed-rate or adjustable-rate mortgage system and would rather borrowers and lenders self-select the interest rate risk capacities. Finally, Ms. Wachter argued that it is extremely important for necessary institutions to support the long-term fixed rate mortgages and stated that the U.S. has to be determined and careful in the regulation of the mortgage markets.