The American Mortgage System

The American Mortgage System: Crisis and Reform

Susan M. Wachter
Marvin M. Smith
Copyright Date: 2011
Pages: 400
  • Cite this Item
  • Book Info
    The American Mortgage System
    Book Description:

    Successful home ownership requires the availability of appropriate mortgage products. In the years leading up to the collapse of the housing market, home buyers frequently accepted mortgages that were not only wrong for them but catastrophic for the economy as a whole. When the housing market bubble burst, so did a cornerstone of the American dream for many families. Restoring the promise of this dream requires an unflinching inspection of lending institutions and the right tools to repair the structures that support solid home purchases. The American Mortgage System: Crisis and Reform focuses on the causes of the housing market collapse and proposes solutions to prevent another rash of foreclosures. Edited by two leaders in the field of real estate and finance, Susan M. Wachter and Marvin M. Smith, The American Mortgage System examines key elements of the mortgage meltdown. The volume's contributors address the influence of the Community Reinvestment Act, which is often blamed for the crisis. They uncover how the government-sponsored enterprises Fannie Mae and Freddie Mac invested outside the housing market with disastrous results. They present surprising information about low-income borrowers and the strengths of local banks. This collection of thoughtful studies includes extensive analysis of loan practices and the creation of unstable mortgage securities, presenting data largely unavailable until now. More than a critique, The American Mortgage System offers solutions to the problems facing the future of American home ownership, including identifying asset price bubbles, calculating risk, and preventing discrimination in lending. Measured yet timely and by turns provocative, The American Mortgage System provides a careful assessment of a troubled but indispensable part of the economic and social structure of the United States. This book is a sound investment for economists, urban planners, and all who shape public policy.

    eISBN: 978-0-8122-0430-8
    Subjects: Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Introduction
    (pp. 1-4)
    Marvin M. Smith and Susan M. Wachter

    Erica and James are the best of friends. They went to the same schools, grew up in the same neighborhood, and got jobs at the same company. Their spouses work together, their children play together, and their families celebrate Fourth of July together. On paper, a mortgage lender would have trouble differentiating them. They have the same household income, the same credit score, and are the same age.

    But that is where their similarities end. Imagine we are in 2005: Erica pays 6.9 percent in mortgage interest each year. She can pay off the principal as early and as often...

    • Chapter 1 The Secondary Market for Housing Finance in the United States: A Brief Overview
      (pp. 7-25)
      Ingrid Gould Ellen, John Napier Tye and Mark A. Willis

      Understanding both the current problems in the secondary market and the proposed solutions requires an understanding of the role of the secondary market in U.S. housing finance.¹ In this chapter, we focus in particular on the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, which for decades were the largest players in the U.S. system.² We first review the history of the secondary market and summarize the basic operations of the GSEs before they were placed into conservatorship by the U.S. Treasury in September 2008. We then outline the key arguments that are made about the strengths and weaknesses of...

    • Chapter 2 Reasonable People Did Disagree: Optimism and Pessimism About the U.S. Housing Market Before the Crash
      (pp. 26-59)
      Kristopher S. Gerardi, Christopher L. Foote and Paul S. Willen

      Optimism about future house price growth shoulders much of the blame for the mortgage crisis that swamped the U.S. and world economies starting in 2007. Had borrowers and investors in 2006 known that the nearly decade-long expansion of the U.S. housing sector had ended and that house prices would decline 30 percent over the next three years, few would have made the decisions they did.

      To many people, the fact that investors and borrowers were optimistic about house prices in 2006 seems inexplicable or even inexcusable. The experience up to that point showed all the hallmarks of an asset-pricing bubble....

    • Chapter 3 Exploring the Determinants of High-Cost Mortgages to Homeowners in Low- and Moderate-Income Neighborhoods
      (pp. 60-86)
      Michael S. Barr, Jane K. Dokko and Benjamin J. Keys

      In spite of the recent impetus to reform home mortgage markets, particularly as they affect low- and moderate-income (LMI) households, little systematic evidence is available about how potential abuses in mortgage lending manifest in the mortgages held by those households. While racial discrimination in mortgage markets has a long history in the United States, the role of mortgage brokers in lending has only recently increased and become controversial.¹ In this chapter, we uncover two mechanisms through which differential mortgage pricing occurs among LMI homeowners: black borrowers and borrowers who use mortgage brokers pay more for mortgage loans than other borrowers,...

    • Chapter 4 Implications of the Housing Market Bubble for Sustainable Homeownership
      (pp. 87-111)
      Paul S. Calem, Leonard Nakamura and Susan M. Wachter

      The recent housing market bubble and subsequent meltdown dealt a triple blow to sustainable homeownership in the United States. First, the rapid rise in housing prices that characterized the period from 2004 to 2006 reduced housing affordability as traditionally measured. Second, an expansion of high-risk mortgage lending helped to fuel, or at a minimum helped to sustain, the rise in house prices, facilitated the drawing out by households of accumulated home equity, and left homeowners at greater risk of default. The subsequent meltdown generated the ongoing wave of foreclosures that has further eroded homeownership. Third, although affordability has recovered, the...

    • Chapter 5 A Framework for Consumer Protection in Home Mortgage Lending
      (pp. 112-134)
      Kathleen Engel and Thomas J. Fitzpatrick

      In this chapter, we catalog and describe the various dimensions to regulating home mortgages. We do not discuss specific lending practices, loan terms, or legal prohibitions; rather, we discuss the major issues that policy-makers should consider when framing a system to protect consumers who take out loans secured by their homes. The chapter’s discussion has been broadened and deepened with the passage by Congress of a sweeping financial reform bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), which includes provisions governing mortgage loans.

      The task of regulating mortgages is not finished. In the Dodd-Frank...

    • Chapter 6 A Profile of the Mortgage Crisis in a Low- and Moderate-Income Community
      (pp. 137-158)
      Lynn Fisher, Lauren Lambie-Hanson and Paul S. Willen

      It is an accepted fact in the current policy debate that the U.S. housing crisis has damaged communities. A search for newspaper articles with the words “foreclosure” and “community” coupled with such words as “ravaged,” “destroyed,” and “damaged” turns up thousands of entries. In this chapter, we attempt to measure the effects of the crisis in a systematic way.

      We focus on Chelsea, Massachusetts, a city adjacent to and just north of Boston. We chose Chelsea partly because we have an exceptionally good dataset but also because Chelsea was particularly hard hit in the housing crisis. As we will show,...

    • Chapter 7 Constructive Credit: Revisiting the Performance of Community Reinvestment Act Lending During the Subprime Crisis
      (pp. 159-186)
      Carolina Reid and Elizabeth Laderman

      In 1977, when advocates and legislators were first debating the merits of Senate Bill 406, the Community Reinvestment Act (CRA) of 1977, the key question confronting Congress was whether or not “redlining”—the practice of denying access to credit based on where one lived—was contributing to the decline of inner-city neighborhoods. Advocates argued that banks had a social responsibility to reinvest locally held deposits back into the communities where they had branches; in short, the savings of residents in the inner city should not be directed to promote homeownership in the suburbs. Evidence of geographic discrepancies in areas where...

    • Chapter 8 Navigating the Housing Downturn and Financial Crisis: Home Appreciation and Equity Accumulation Among Community Reinvestment Homeowners
      (pp. 187-208)
      Sarah F. Riley and Roberto G. Quercia

      Homeownership has historically been considered an effective wealth-creation mechanism for low-income households. These households typically hold a very large proportion of their wealth in their homes. In addition, they also historically have greatly benefited from home price appreciation, not only because of overall positive market trends but also because of the high leverage provided by high loan-to-value mortgages. These factors have made homeownership the primary driving factor in wealth creation for many low-income homeowners (Belsky and Calder 2004; Stegman, Quercia, and Davis 2007).

      However, as recent economic trends have illustrated on a national scale, such lopsided wealth portfolio allocation has...

    • Chapter 9 The Community Reinvestment Act: Evaluating Past Performance and Reviewing Options for Reform
      (pp. 209-240)
      Mark A. Willis

      The passage of the Community Reinvestment Act (CRA) in 1977 set in motion a bold experiment that has yet to achieve its full potential. In the language of the legislation, the CRA sought to “encourage” banks to lend (“reinvest”) in their “entire community, including low- and moderate-income neighborhoods.”¹ While banks had existing statutory responsibilities to serve the convenience and needs of their communities, little or no lending had been taking place in many low- and moderate-income (LMI) neighborhoods. By “encouraging” (but not requiring) increased availability of capital, Congress sought to make banks more proactive in the stabilization and revitalization of...

    • Chapter 10 Information Failure and the U.S. Mortgage Crisis
      (pp. 243-270)
      Adam J. Levitin and Susan M. Wachter

      The global financial crisis of 2008 developed out of the failure of mortgage finance markets to adequately price risk. This chapter focuses on the role of securitization in housing finance. It does so both because of the role of securitization in the recent debacle and because of the importance of securitization for ensuring the widespread availability of the long-term fixed-rate mortgage, which has been the bedrock of American homeownership since the Depression and the prevalence of which is critical for rebuilding a sustainable housing finance system.

      We argue that markets failed to price risk correctly because of an informational failure,...

    • Chapter 11 The Expanding Financial Safety Net: The Dodd-Frank Act as an Exercise in Denial and Cover-Up
      (pp. 271-285)
      Edward J. Kane

      In 1766, Voltaire famously opined that “Men use thought only to justify their wrongdoings, and speech only to conceal their thoughts.” The behavior of many government officials confirms this dictum. Officials routinely misinform the public about the reasons for—or the probable effectiveness of—their economic policies. This behavior violates a duty of accountability that every public servant owes to citizens of his or her country.

      Because the integrity of representative democracy turns on this duty, government or media deceptiveness poses a professional and ethical challenge to conscientious news reporters and academic economists to uncover the spin and explain the...

    • Chapter 12 A Private Lender Cooperative Model for Residential Mortgage Finance
      (pp. 286-304)
      Toni Dechario, Patricia C. Mosser, Joseph Tracy, James Vickery and Joshua Wright

      For the past several decades, Freddie Mac and Fannie Mae have played a central role in U.S. residential mortgage finance. The design of what replaces Freddie Mac and Fannie Mae, the housing government-sponsored enterprises (GSEs),¹ which are currently in conservatorship, is of enormous consequence to the performance of the U.S. housing market in the future. In our opinion, the goals of the efforts to reorganize Freddie and Fannie should be to promote the availability and stability of mortgage finance for the core of the housing market while minimizing systemic risk and costs to taxpayers. Any new structure should be designed...

    • Chapter 13 Improving U.S. Housing Finance Through Reform of Fannie Mae and Freddie Mac: A Framework for Evaluating Alternatives
      (pp. 305-338)
      Ingrid Gould Ellen and Mark A. Willis

      As was noted in Chapter 1, the government-sponsored enterprises (GSEs) known as Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation)¹ were, until recently, the largest players in a U.S. housing finance system that provided mortgage financing for millions of Americans. Since early 2008, the firms’ insolvency has called their future into question. This chapter lays out criteria for evaluating proposals for reform of the two firms. After we introduce the basic goals of a healthy secondary market for both the single-family and multi-family markets, we offer a framework that will help to...

    • Chapter 14 Some Thoughts on What to Do with Fannie Mae and Freddie Mac
      (pp. 339-357)
      Robert Van Order

      We have some time to decide on what to with the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). They, along with the Government National Mortgage Association (Ginnie Mae), are almost all of the market, and no one is going to mess with that any time soon. But something will have to be done. Looking ahead, we need to think about not only what to do with Fannie and Freddie, but also what to do with the whole housing finance system, particularly where the risks will go. Problems of credit risk in mortgage...

    • Chapter 15 The Road Not Taken: Our Failure in Redoing the Financial Architecture
      (pp. 358-368)
      Vincent Reinhart

      The legislation on financial reform signed by President Barack Obama this year runs over 2,000 pages in length. Its enactment into law changes the scope of permissible activities for financial firms, shifts other activities onto organized exchanges settled in clearinghouses, and limits the scale of bank balance sheets relative to their capital. New responsibilities are given to old agencies, old functions are given to a new agency, and a council of regulators will sit atop it all to identify risks and coordinate responses.

      For all the legislation’s length, the substantive changes will follow as regulatory agencies write rules to put...

  7. List of Contributors
    (pp. 369-376)
  8. Index
    (pp. 377-390)
  9. Acknowledgments
    (pp. 391-392)