Homeownership ethos and subprimes

June was proclaimed National Homeownership Month by President Bush to recognize the importance of owning a home and to urge citizens to consider homeownership.

There is a long, bipartisan tradition of supporting homeownership in this country. Since 1934, the Federal Housing Administration has been a primary mortgage source for many first-time and minority homebuyers. The congressional creation of the Federal Home Loan Bank System in 1932, Fannie Mae in 1938 and Freddie Mac in 1970 sped the establishment of a liquid and stable secondary mortgage market that continues today.

Through these and many other congressional and regulatory actions, including President Bush’s Homeownership Challenge, nearly 70 percent of Americans own their own homes today. It is an impressive statistic that is a foundation of the American dream.

But several current factors might erode this foundation. Subprime mortgages enabled many homeowners to buy their first home, but as demand tripled over the last few years, some lenders developed shoddy practices. When combined with rising interest rates and declining house prices in some markets, problems quickly surfaced. Delinquencies and potential foreclosures put some Americans at risk of losing their homes. Fannie Mae and Freddie Mac, the companies regulated by the Office of Federal Housing Enterprise Oversight (OFHEO), own securities backed by $170 billion of subprime mortgages. Both are expanding efforts with lenders and consumer groups to avoid foreclosures and make safer subprime mortgages but need a stronger regulator to oversee these efforts.

This is a difficult time for the housing industry. OFHEO’s most recent House Price Index report shows house prices continue to rise but at the slowest pace in 10 years. Many subprime mortgage companies have failed. Fannie Mae and Freddie Mac, government-sponsored entities (GSEs) created to keep the flow of money to the mortgage market, are still recovering from years of mismanagement and underinvestment in infrastructure. Their remediation is a work in progress. They continue to remain significant supervisory concerns.

Given these factors, I view National Homeownership Month as a “call to action” to address the need for GSE reform. The case for strengthening the regulator of these extremely large financial institutions has been made repeatedly, by Republicans and Democrats. The enterprises’ numerous problems in recent years show that since the debt market and rating agencies do not provide effective market discipline, the job of the regulator is even tougher.

Putting their size in perspective, Fannie Mae and Freddie Mac own or guarantee almost 40 percent of all home mortgages. As of March 31, 2007, the combination of the mortgage backed securities (MBS) that they guarantee ($3.1 trillion) and their debt outstanding ($1.6 trillion) totaled $4.7 trillion; not that much smaller than the publicly held debt of the U.S. of $5.0 trillion.

Once these enterprises fix their problems, it may be back to business as usual without enhanced regulatory oversight. As both Fannie Mae and Freddie Mac say, the clear solution is to create a stronger, banklike regulator with all the necessary tools. A stronger regulator must be free from the appropriations process. OFHEO has had to operate under a continuing resolution for at least part of almost every year since its inception, stalling regulatory operations in key areas and at critical times. Enhanced capital authority with appropriate flexibility to reflect changing risks is critical, as are strong receivership powers. The regulator should have the power to evaluate the risks of new products as well as the ability to approve them.

Specific statutory guidance is necessary to ensure the regulator can promulgate a regulation to focus the enterprises’ portfolios on their charter missions of supporting affordable housing and contributing to the stability and liquidity of the secondary mortgage markets while considering other relevant factors including risks. It is important to combine OFHEO with the Federal Housing Finance Board, the regulator of the other housing GSEs — the 12 Federal Home Loan Banks — several of which have also had significant problems. A combined regulator will have more stature and independence and will make the risk-based examination process stronger and more efficient.

Reform legislation is needed to create a stronger regulator for these two companies so critical to the U.S. housing finance system. Enhanced powers will allow the new, stronger regulator to focus on the housing GSEs and prevent the problems of the past from recurring. Such legislation has already passed the House. That bill is a good, balanced start, but needs some work. Now, it is the Senate’s turn to act. At stake is the future health of a key component of our economy and ultimately opportunities for increased homeownership. National Homeownership Month is the perfect time to take the next step.

James B. Lockhart is director of the Office of Federal Housing Enterprise Oversight of the U.S. Department of Housing and Urban Development.